S&P Downgrades Ratings of 9 European Nations, Affirms Seven

The Bloomberg reports,

France and Austria lost their top credit ratings in a string of downgrades that left Germany with the euro area’s only stable AAA grade as Standard & Poor’s warned that crisis-fighting efforts are still falling short.

France and Austria were cut one level to AA+ from AAA and face the risk of further reductions, the rating company said in Frankfurt late yesterday. While Finland, the Netherlands and Luxembourg kept their AAA ratings, they were put on negative watch. Spain and Italy were also among the nine nations downgraded.

It’s important to stress that the S&P has only been reacting to what the market has already done.

Major credit ratings in the US are limited by regulation, particularly the Nationally recognized statistical rating organization, thus operates as a quasi-cartel, specifically, the big three: S&P, Fitch and Moody’s. Since these firms apply ratings not only to private companies but to sovereign securities, they are largely sensitive to political influences.

S&P’s recent downgrade of US debt was apparently timed during the congressional debate on the debt ceiling, perhaps or most likely aimed at influencing the political outcome, which of course earned the ire of the Obama administration.

Nevertheless so far the markets has proven S&P’s US downgrade as largely ill-timed as 30 year US treasury bonds gained an astounding 35%!

This seem to validate predictions of deflationists but for the wrong reason. Global bond markets have been manipulated by regulation (Financial Repression-forcing financial institutions to hold or own sovereign papers, based on Basel Accords) and by monetary policies. The outperformance of the US bonds has been magnified by the Euro crisis, and importantly, the US Federal Reserve act to monetize debts. Deflation proponents should thank the US Federal Reserve for actualizing most of their predictions.

The red circle shows of Fed’s purchases of long term treasuries (chart from Cleveland Fed)

Going back to the issues of debt, a similar furor today over S&P’s European downgrades seems to hug the headlines as Europe’s politicians/bureaucrats contest S&P’s decision.

From the G7Finance.com

The EU’s top economic official criticised Standard & Poor’s downgrades as “inconsistent” on Friday and said the currency area was taking action to resolve its debt crisis.

“After verifying that this time it is not accidental, I regret the inconsistent decision,” EU Economic and Monetary Affairs Commissioner Olli Rehn said in a statement, taking a jab at the ratings agency in recalling its November accident in which it informed some clients of an erroneous French downgrade.

Anyway, these represents no more than histrionics to the crisis havocked Eurozone.

Bottom line: you can’t count on what credit rating agencies say. And you can’t rely on them to materially influence the markets. Rather, these firms act largely on market’s influences, except for some instances.

And there has been no better proof than the ‘stamp pad’ activities undertaken by these credit rating agencies on mortgage securities which help facilitated the US housing bubble.

Of course the operational “conflict-on-interest” relationship which has been enabled by above cartel inducing regulation, has produced a business paradigm where debt organizers and issuers compensated the credit rating agencies. So US credit rating agencies served the interests of their consumers. The rest is history.

Politicization of the Financial Markets

Below is an example of what I have been calling as the politicization dynamics of the financial markets.

Writes fund manager Axel Merk [who calls this celebrity central banking], (bold emphasis mine)

Swiss National Bank (SNB) President Philipp Hildebrand finds himself in the hot seat. SNB rules prohibit his family from trading based on non-public monetary and foreign exchange intentions of the SNB (c.f. §4). His wife netted a 60,000 Swiss franc profit buying, then selling U.S. dollars, all within a month; her husband’s intervention in the currency market was mostly responsible for the gain. Arguably, she traded to make a profit, publicly explaining, “what motivated me to buy dollars was the fact that it was at a record low and was almost ridiculously cheap”. In instructing her account manager, however, she emailed that her motivation was to manage the share of US dollars in their asset mix as part of a long-term investment allocation (c.f. Hildebrand statement).

The court of public opinion might be more damaging than the legal process in a country with a tightly knit elite that favors consensus over controversy. Relevant for policy makers and investors alike is that this episode highlights the vulnerability of what we call celebrity central banking. That is, central banking that heavily relies on the persona rather than underlying policy. In Switzerland, the 2009 attempt to peg the Swiss franc to the Euro was mostly driven by Hildebrand; similarly, last year’s introduction of a ceiling for the Swiss franc versus the euro is again mostly attributed to Hildebrand. The 2009 peg was given up after it proved too expensive. The 2010 intervention has, so far, held. But it is entirely dependent on the market believing that the SNB will do “whatever it takes” to keep the Swiss franc from rising….

What the Fed and the SNB have in common is that they are both run by celebrities. Bernanke has appeared on “60 Minutes”; Hildebrand is also learning what it means to be in the media limelight. Policy makers only have themselves to blame with the market’s obsession with their personas. If they pursued sound monetary policy rather than try to micro-manage their respective economies, market forces could play out. Instead, we may have capital chase the next perceived move of policy makers, leading to capital misallocation, greater volatility, and ultimately more intervention; a self-reinforcing cycle. The public has a high price to pay for modern celebrity central banking.

Conflict of interests (agency problems, regulatory capture and arbitrage), insider trading based on actions of politicians or bureaucrats, intensive lobbying and anticipating political actions by policymakers becomes the major thrust of market participants, instead of working to satisfy the consumers.

End result: vast distortions of the marketplace, malfeasant actions by political actors and their networks and boom bust cycles.

Joseph Stiglitz: The US Federal Reserve is ‘Corrupt’

From the Huffington Post,

One of the world's leading economists said Wednesday that the very structure of the Federal Reserve system is so fraught with conflicts that it's "corrupt."

Nobel laureate Joseph Stiglitz, a former chief economist at the World Bank, said that if a country had applied for World Bank aid during his tenure, with a financial regulatory system similar to the Federal Reserve's -- in which regional Feds are partly governed by the very banks they're supposed to police -- it would have raised alarms.

"If we had seen a governance structure that corresponds to our Federal Reserve system, we would have been yelling and screaming and saying that country does not deserve any assistance, this is a corrupt governing structure," Stiglitz said during a conference on financial reform in New York. "It's time for us to reflect on our own structure today, and to say there are parts that can be improved."

Stiglitz made the remarks at a conference held by the Roosevelt Institute. He and other speakers, including Harvard Law Professor and federal bailout watchdog Elizabeth Warren and legendary investor George Soros, had bold ideas about reforming the nation's financial system.

After the conference, Stiglitz said that his remarks on the Fed were "maybe a little hyperbole," but then again made the case that if another country had presented a plan to reform its financial system, and included a regulatory regime that copied the makeup of the Federal Reserve system, "it would have been a big signal that something is wrong."

To Stiglitz, the core issue is that regional Fed banks, such as the New York Fed, have clear conflicts of interest -- a result of the banks being partly governed by a board of directors that includes officers of the very banks they're supposed to be overseeing.

Corruption is a product of arbitrary edicts, fiats or laws which benefits vested interest groups.

Central banking has been institutionalized to safeguard the interests of the welfare-warfare state through the funding mechanism of the banking system. So obviously ‘conflicts of interests’ that leads to corruption has been the institution's conventional trait.