By Susan Schroeder, a lecturer in the Department of Political Economy, University of Sydney, Australia, and author of Public Credit Rating Agencies: Increasing Capital Investment and Lending Stability in Volatile Markets (Palgrave Macmillan, 2015). Originally published in the July/August 2016 issue of Dollars & Sense magazine; cross posted from Triple Crisis.
The beauty of mainstream economics, which assumes the inherent stability of markets, is that, if markets work well, the public interest aligns with the interests of private agents. In this view, then, the key policy objective is to improve the efficiency of markets. But if markets are inherently unstable, the interests do not align. In this context, increased government presence to promote a more stable economy and financial system is what promotes the public interest.
A Minskian basis for credit risk-assessment and a public credit-rating agency would be a good start, but they will not be enough to thwart the ups and downs in ratings over the course of the business cycle. To do this requires reducing the cyclical patterns of the economy as a whole. This will likely require an industrial policy focused on civilian industries that promotes the sale of output by firms (often referred to as “supply support” or “demand management”). One way to facilitate the absorption of some firms’ output by other firms is to create an insurance scheme to protect the accounts receivable of firms from the risk of non-repayment, focusing particularly on small and medium-sized firms as their failure rate is higher than for corporations. That way, if one firm owes another one money, but does not pay on time, the latter firm does not find itself short on cash to meet its own obligations. (That is, one firm’s default on its debts does not set off a chain reaction.) The “trade credit insurance” enjoyed by export banks is a precedent for this kind of scheme. Stabilizing their cash inflows strengthens their ability to absorb goods and services from other firms and to employ workers. With this mechanism in place, banks will be more willing to supply short-term financing during bouts of instability. Living wages that reduce consumers’ reliance on credit would also reduce debt-service burdens and support consumption. Robust consumption and strong cash-flow for firms, in turn, stimulates investment.
When models of the market economy and credit assessment better reflect the inherent instability of a market economy, policy options widen dramatically. For instance, living wages may not be inflationary, as conservative pundits suggest, and industrial policies may be better than free markets for promoting economic development and social goals.
Unfortunately, neither of the Democratic candidates for president appears to offer convincing policy recommendations for the ratings industry. Former Secretary of State Hillary Clinton prefers the status quo, under which standards of due diligence and development of credit risk models remain squarely at the discretion of rating agencies and financial institutions. Of even more of concern is the signal Clinton seems to send, intentional or not, that her administration may be willingly captured by financial interests.
Sen. Bernie Sanders, on the other hand, at least addressed the problems with the issuer-pays model, which promotes borrowers “shopping” for favorable ratings. Sanders suggests creating non-profit agencies that generate ratings for issuers and instruments. (This is not a new idea. The Bertelmann Foundation, for instance, has been promoting the creation of an international non-profit rating agency.) There are two unresolved issues with this approach. First, who pays for the ratings to be created? Second, who is ultimately accountable for the ratings issued? Likewise, a government agency that allows itself to be accountable, directly (by creating ratings itself) or indirectly (by being responsible for assigning that task), could find itself litigated to death when an economy turns sour.
Like Clinton, however, Sanders misses the key point. The source of the problems with ratings is not the rating agencies’ behavior or the issuer-pays model per se. Rating firms have only so much leeway in inflating ratings. While Sanders’ suggestion might be able to achieve better uniformity of opinion, it cannot thwart the natural swings in creditworthiness over the course of the business cycle. The ultimate source of the problem is the inherent instability of a market economy itself.
Stabilizing creditworthiness requires new thinking on how, as Minsky put it, to “stabilize an unstable economy.” That means an industrial policy, not just for a single nation, but for a system of many nations embedded in a global economy. In combination with a living wage, such an industrial policy would go a long way towards putting the U.S. and world economies back on track—boosting supply support for firms within targeted industries and bolstering income growth for consumers. Programs that facilitate the absorption of firms’ output protect the incomes of workers which, in turn, reinforces the demand for output. A new international system could also go so far as to enhance coordinated efforts to fight climate change by encouraging development of industries associated with renewable energy and reforestation.
When it comes down to it, credit rating agencies are important. If they disappear, either through legislation or litigation, what would take their place? A public rating agency could facilitate the development of better products in the credit rating industry. Leaving the development to private agencies, or “to the markets,” is not likely to work, as history has shown. Private credit rating agencies are more apt to maintain unrealistic assumptions to facilitate speed of assessments rather than develop more accurate assessments. More accurate methods require time and funding, and this is where government can be of assistance. It is in the public interest to do so.