Wednesday, July 21, 2010

Fixing the Broken

Back when I lived on the East Coast, I would often hear a motto primarily associated with Manhattan that advised: "Dress British; think Yiddish." Over in the People's Republic of China, a rather interesting variation of this theme seems to be emerging: "Live like a communist; invest like a capitalist." In other words it is all very well and good to think about such factors as return-on-investment; just make sure that any thoughts of personal gain account for the society within which you are embedded.

I found myself thinking about this variation while reading an interview that Guan Jianzhong gave to Jamil Anderlini of the Financial Times. Guan is Chairman of Dagong Global Credit Rating, which, while based in China, happens to be privately owned. In the context of the losing battle that Elizabeth Warren continues to fight over our own country's need for "financial regulation we can believe in," Anderlini's report makes fascinating reading:

The head of China’s largest credit rating agency has slammed his western counterparts for causing the global financial crisis and said that as the world’s largest creditor nation China should have a bigger say in how governments and their debt are rated.

“The western rating agencies are politicised and highly ideological and they do not adhere to objective standards,” Guan Jianzhong, chairman of Dagong Global Credit Rating, told the Financial Times in an interview. “China is the biggest creditor nation in the world and with the rise and national rejuvenation of China we should have our say in how the credit risks of states are judged.”

On the corporate side, Mr Guan argues Moody’s Investors Service, Standard & Poor’s and Fitch Ratings – the three companies that dominate the global credit rating industry – have become too close to the clients they are supposed to be objectively assessing.

He specifically criticised the practice of “rating shopping” by companies who offer their business to the agency that provides the most favourable rating.

In the aftermath of the financial crisis “rating shopping” has been one of the key complaints from western regulators , who have heavily criticised the big three agencies for handing top ratings to mortgage-linked securities that turned toxic when the US housing market collapsed in 2007.

“The financial crisis was caused because rating agencies didn’t properly disclose risk and this brought the entire US financial system to the verge of collapse, causing huge damage to the US and its strategic interests,” Mr Guan said.

Now we should read Guan's remarks in the context of a man promoting his own business, which just happens to have published its own sovereign credit rating; but, beyond any context of self-promotion there lies a sobering assessment of just how much the Augean stables of our own financial regulatory system are in need of a good cleaning (and how much those in power would prefer to have the rest of us live with what has accumulated in those stables).

The next time you hear one of your elected representatives go on a rant against socialism as a play for votes, think about this: There is no logical equivalence between sharing the wealth and throwing away your money. China is far from ideal in how it addresses the former; but, now that it finds that it has become a major economic power and creditor, it is learning very quickly about the latter. Think also about the former Soviet Union, which collapsed as a system that its own economy could no longer maintain. Then think about our own economic system and our failure to impose new regulatory measures that could both get us out of our present hole and impose at least some protections against falling into the next one. The bottom line is that, if we do not clean up our own filth, then an economic power that holds much of our debt may, in order to avoid throwing away their investments, exercise its leverage to do the cleaning for us; and that power is unlikely to have the best interests of our citizens in mind!

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