Ratings Firm Misread Signs of Greek Woes
In a stern pronouncement, Moody’s Investors Service this week warned of rising prospects for multiple defaults by countries in the euro zone and credit rating downgrades of nations across Europe if leaders should fail to resolve the spreading debt crisis.
When it comes to Greece, critics say Moody’s should have been tougher a lot earlier.
Until two years ago, the ratings agency took a relatively lax approach to growing signs of troubles in Greece, epicenter of the current crisis, even as the country plowed ahead with a borrowing binge that jeopardized its fiscal condition.
Moody’s held off dropping its strong A rating of Greece’s bonds despite growing political turmoil and economic woes through 2009. Investor fears over Greece’s short-term financing needs were “misplaced,” Moody’s said in a report in early December 2009. Twenty days later, after a review, the agency downgraded the nation’s debt, the last of the major ratings agencies to do so.
After that, the ratings of the debt-ridden country went into a virtual free fall, and within six months Moody’s assessed its debt as much riskier for investors, giving it junk status.
“If you look at the fact that this is going to be a country that is going to default on its debt, and two years before it was still single A, that is a very, very precipitous fall,” conceded Pierre Cailleteau, Moody’s head of sovereign debt ratings until he left in spring 2010. He rated Moody’s performance as mediocre, but added that it could have been worse.
That rapid deterioration underscores how, critics say, the credit ratings agencies that judged Greece’s debt as investment grade for most of the last decade missed or badly misread signs of trouble. Moody’s held its rating steady even after Greece in 2004 admitted lying about its deficits to join the countries using the euro in 2001. Now, the ratings agencies are under fire from European regulators about whether their recent downgrades of Italy and Spain worsened an already tenuous situation.
Moody’s offers a rare look inside the sometimes fierce debates over Greece’s deep problems, at how the prevailing belief that Europe would not let Greece default on its obligations drowned out opponents, and how in hindsight the agency could get it so wrong.
Moody’s lapses before last year helped embolden Greece to heap on billions in sovereign debt and encouraged investors to invest more heavily in its debt. Now some of those buyers face 50 percent losses on the bonds — loans that carried the agencies’ stamp of approval but that Greece can no longer afford to pay off. Had the rating agencies been more skeptical of euro zone countries’ borrowing beyond their means, critics say, that might have slowed the debt carousel for Greece and others.
The higher credit ratings made it “easier to raise debt” than to raise taxes or make other unpopular and painful economic adjustments, said Barbara Ridpath, head of Standard & Poor’s ratings activities in Europe between 2004 and 2008.
“The credit rating agencies failed in their job,” said Wolf Klinz, a European Parliament member from Germany and author of a critical 2010 report on ratings agencies. “They held on artificially too long to their original rating. They should have started earlier.”
The agencies have defended their performance, noting that investors were much more optimistic than the agencies were, with bond markets assigning interest rates to Greek debt at levels that were just slightly above what Germany was paying.
“The market was scarcely differentiating between any of the 16 sovereign members of the euro zone,” said David Beers, the head of Standard & Poor’s global ratings business, during a British parliamentary hearing last summer. “We differentiated these opinions from the outset. The market ignored those opinions for many years.”
In an e-mailed statement, a spokesman for Moody’s agreed, saying the market’s perception of the safety of Greek bonds was equivalent to an AAA rating, “while Moody’s rating was considerably lower.”
The current crisis was years in the making. It was born of Greek leaders who misled the European Union with false economic statistics to gain entry to the euro; of European policy makers who turned a blind eye to Greece’s deceptions; of banking regulators who deemed sovereign debt virtually risk-free; and of banks and other investors who, hungering for profits, joined in the groupthink that the euro zone would never let a member default.
The rating agencies’ missteps on Greece’s sovereign debt are the latest chapter for an industry long dogged by allegations of wrong calls and conflicts of interest. The energy company Enron was rated as “investment grade” by the three major agencies just days before it filed for bankruptcy in 2001. The agencies were accused of putting top ratings on questionable mortgage-related securities to continue collecting rich fees before the 2007-9 financial crisis.
What most shaped Moody’s view on Greece was that few in the agency could conceive that euro countries would let one of their own become a deadbeat.
”We never thought of such a catastrophic stress scenario in the euro zone,” said Sara Bertin, who was Moody’s lead analyst on Greece before leaving in spring 2008. “That’s the issue ratings agencies had with subprime. That’s the issue ratings agencies had in Asia, and that’s the issue the ratings agencies have in Europe.”
The Moody’s Team
The sovereign debt team at Moody’s — about a dozen people with diverse backgrounds and eclectic interests — traveled the world, digging into country statistics and meeting with leaders and policy makers. The aim was to figure out where each country stood on its global measuring stick of creditworthiness.
Ms. Bertin, an economist who joined Moody’s in 2001 from the International Monetary Fund and grew up in Lyon, France, said she enjoyed the free-flowing banter and debate, even when the group disagreed, as it often did.
Shortly after Greece became part of the euro zone in 2001, a “fierce debate” erupted in a committee meeting as some people argued that the country should be upgraded to be nearly on par with Italy. “We wanted to upgrade the country on the belief that Greece was now part of the euro zone and that nobody was ever going to default and that everything was safe,” Ms. Bertin recalled. “But how many notches was the nature of the debate.”
The emphasis, she and others said, shifted somewhat from an economic and financial analysis of the country to a bet that policy makers would keep the euro zone — which is now, with the addition of Estonia, made up of 17 countries — together.
Greece Is Upgraded
Rated a weak investment grade in the mid-1990s, Greece was upgraded to A2 when it joined the euro and to A1 for most of the 2000s. Armed with strong ratings, Greece ratcheted up its borrowing in global credit markets at historically low yields. In 2002, Greece paid 5 percent on its 10-year government bonds, far below the 15 percent it paid seven years earlier.
But in fall 2004, Greek officials stunned European policy makers when they admitted that the country’s budget deficit had exceeded the European Union’s ceiling of 3 percent of gross domestic product in every year since 1997. The European Commission sued Greece for disguising its deficits and said it should never have joined the euro.
The revelation surprised few inside Moody’s. “I remember whenever you would discuss Greek fiscal numbers, it was always with a smile on your face because you knew these were not always the most accurate statistics available,” said Vincent J. Truglia, a Moody’s veteran who headed the sovereign group before he left in 2007.
Partly as a result of the statistics fiasco, Standard & Poor’s cut its rating of Greece, but only modestly, to A from A+. Moody’s kept its rating unchanged, arguing that its view was still supported by high economic growth and Greece’s membership in the euro zone.
In January 2007, Moody’s changed its outlook on Greece’s rating to “positive” after Greek officials said its budget deficit had finally fallen below 3 percent.
“The growth was there. The shipping industry was getting steam again,” said Ms. Bertin, who was in favor of the upgrade. “One story that I really liked was that Greece was developing its own banking know-how and exporting it to the Balkans, places like Albania.”
During the go-go years of 2005-7, bankers sometimes called the analysts, complaining that they were missing Greece’s growth story, Mr. Cailleteau said, declining to name them. Banks would earn fees from underwriting bonds and the ratings agencies earned fees from the countries issuing the debt.
According to Spyros Papanicolaou, who served as general director of Greece’s Public Debt Management Agency from February 2005 to February 2010, Moody’s was paid $330,000 to $540,000 each year by Greece to rate its debt. The other agencies received the same amounts.
We had no choice,” Mr. Papanicolaou said in a telephone interview. “Without the ratings, we couldn’t sell bonds, we couldn’t go to the markets.”
In an e-mailed statement, a spokesman for Moody’s said it did not comment on fees, but added that the “commercial and analytical aspects of our business operate separately.”
But inside Moody’s in 2007, fees from the lucrative business of rating United States subprime mortgage-related securities were beginning to evaporate. In response, the company began cutting costs. As part of that, Ms. Bertin said sovereign analysts, who typically covered 10 countries, were advised to spend less time in those countries.
In an e-mailed statement, Moody’s said the agency had added resources to its sovereign team since the beginning of the financial crisis.
In 2008, Moody’s also introduced a new methodology for evaluating countries. “It was called a methodology, but it was more of a checklist,” said Ms. Bertin, who said she feared the word “methodology” suggested the evaluation was based on deep empirical analysis, which it was not.
Mr. Cailleteau, who introduced the methodology, said it provided a clearer way of thinking about the rating of a country, based on factors like government institutions and the wealth of the country. Analysts may have been encouraged to spend slightly less time on visits to a country, for example two days instead of three, he said, but only so that resources could be directed toward high-level thinking back in the office.
By late 2008, Greece was in turmoil. A national strike froze the country late that year, the government was in chaos and riots erupted after the police killed a youth in Athens. Nervous investors pushed up Greek interest rates.
In February 2009, a month after a competitor, Standard & Poor’s, knocked Greece down to A— from A with a negative watch, meaning the rating was in peril of sliding further, Moody’s modestly altered its A1 outlook to stable from positive.
Joan Vidra, who worked in the Moody’s sovereign debt group from 1995 until early 2009, said there were “disparate voices” but they did not win out to those who saw no need to lower Greece’s rating to levels that would indicate a default risk.
“Going into the global credit crunch, the perspective held by the agency was that Greece had a relatively low rating,” she said. “The agency was very, very delayed in changing its viewpoint.”
Meanwhile, Greece hit the credit markets hard in 2009, raising $67 billion, more than double what it raised a year earlier, according to Thomson Reuters.
The differences inside Moody’s resurfaced again that fall in a hastily arranged conference call with 15 analysts from around the world after a new Greek government admitted that the country’s finances were far worse than the previous government had revealed.
Some of the analysts on the call argued that Greece needed to be downgraded swiftly. But others worried about worsening Greece’s position, or did not want to make a call that they might later have to reverse.
Ultimately, the analysts decided to wait, but agreed to a three-month review with a downgrade in mind.
The interest that Greece had to pay on its debt began spiking higher in early December as investors shied away amid rumors that the European Central Bank would stop accepting Greek government bonds from banks as collateral for short-term loans.
On Dec. 2, 2009, Moody’s rushed out a report, “Investor Fears Over Greek Government Liquidity Misplaced,” arguing that only if the European Central Bank tightened its criteria or if Greece’s rating fell by several notches “would liquidity risk be material.”
Days later, another competitor, Fitch Ratings, which had downgraded Greek debt in October, cut it again to the lowest investment-grade levels. The next week, Standard & Poor’s followed suit.
Mr. Cailleteau convened another conference call from Moody’s Canary Wharf offices in London. The roughly 15-member group had one analyst designated as a prosecutor to test the debate and specialists from other divisions, including emerging market specialists, brought in to provide outside perspective. It made its votes verbally.
While some still believed Greece needed time to turn itself around, the group agreed on a downgrade, but only by one level, to A2, with a negative outlook.
But the group began meeting monthly throughout 2010 as some analysts wanted to downgrade further and faster. The meetings grew more argumentative but the majority, including Mr. Cailleteau, still believed that richer European countries would support Greece.
“The timing and size of subsequent downgrades depended on which position would dominate in rating committees — those that thought the situation had gotten out of control, and that sharp downgrades were necessary, versus those that thought that not helping Greece or assisting it in a way that would damage confidence would be suicidal for a financially interconnected area such as the euro zone,” Mr. Cailleteau wrote in an e-mail.
Rating Takes a Steep Drop
Finally, in June 2010, shortly after European leaders had agreed to a $147 billion rescue package for Greece, Moody’s downgraded the country’s debt by four notches, knocking it into junk territory. Standard & Poor’s had downgraded Greece weeks earlier, but Fitch waited until January 2011.
The rapid descent of the ratings was labeled a “failure” of the credit ratings agencies in a report issued last year by the International Monetary Fund.
In June 2011, just before European leaders agreed to a second rescue for the country, which included the acceptance of losses by private bondholders, Moody’s knocked the rating down by another three notches, to Caa1.
A spokesman for Moody’s said in an e-mailed statement that its ratings actions reflected the impact “of rapidly evolving credit conditions during this time.”
While Greece was always one of the lowest-rated countries in the euro zone, the Moody’s analysts felt that the strongest would drag along the weakest, said David H. Levey, a co-head of the sovereign debt group at Moody’s until 2004.
“When you get multiple ratings or large ratings downgrades, it is fair to say as a criticism that the ratings were too high in the first place,” Mr. Levey said. “Looking back, that indicates that the assumptions being made in the past were too optimistic.”