Did Credit Rating Agencies Cause the European Sovereign Debt Crisis?

Abstract

It must not be easy being a rating agency. Where corporate debt is concerned, the major credit rating agencies (“CRAs”) are said to be too slow and lagging the market. When the topic is structured finance, the agencies are said to inflate ratings to attract business. And when the subject is European sovereign debt, those same agencies are said to be suddenly too conservative, issuing aggressive downgrades that destabilize the market and precipitate a crisis which otherwise would not have happened. (If only those CRAs remained slow laggards issuing inflated sovereign ratings, all would be well.)

But, in the sovereign debt case at least, is it instead that CRAs are simply the messenger, telling us what we should have known — that certain sovereign debt service may become unsustainable. Are the CRAs the villains in this story, or are they more like the little boy who announces, “the emperor has no clothes?”

Keywords: CRA, Ratings, Sovereign Debt

JEL Classification: G23, G38, K21