In the post-1945 world war, the fight for dominance could be literally boiled down to two interrelated factors. The first factor is the protection of sea routes from pirates. This was easy for the West, since the Americans had naval superiority, thanks partly to their own strength and partly to Operation Paperclip, in which they employed more than 1600 German scientists, engineers, and technicians. The second factor is keeping newly emerging economies under indirect control. That is where the concept of rating agencies comes in handy.
On the basis of their own whims and fancies, these agencies have largely defined the economic journey in the post-western colonial world. But, you know what? Nothing could be more flawed than these agencies. While Brad Pitt’s “The Big Short’ did a phenomenal job of exposing them, so-called experts still rely on them. The shutting down of Silicon Valley Bank (SVB) should serve as another grim reminder to them. It is time to stop considering them relevant. Under PM Modi, India has already done the same.
Another one bites the dust
On Friday, March 10, 2023, Americans shocked the world again with the announcement that SVB had been shut down. The Federal Deposit Insurance Corporation (FDIC) informed the public that the bank’s assets have been seized.
In a statement, the FDIC said, “Silicon Valley Bank, Santa Clara, California, was closed today by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect insured depositors, the FDIC created the Deposit Insurance National Bank of Santa Clara (DINB). At the time of closing, the FDIC, as receiver, immediately transferred to the DINB all insured deposits of Silicon Valley Bank.”
Those whose deposits were insured will get full access by March 13, while those whose deposits were uninsured will get an advanced dividend payment. As it turns out, the FDIC guarantees the security of deposits only up to $250,000.
Given the fact that more than 90 per cent of depositors in the bank have deposited more than that amount, only 10 percent of depositors can sit on their couches and watch the Federal Reserve crib about it on CNN in a carefree manner. For 90 percent of these depositors, regulators have decided to send them receivership of the remaining amount.
It will depend on the valuation of bank assets as to whether they get their money back or not. The bank has a total deposit of more than $175 billion. For context, it is 43.75 times that of Pakistan’s forex reserve. On the eve of the new year, its total assets were valued at $209 billion. It is yet to be seen how much is left.
Importance of rating agencies
The question is: who is guilty? Operators of the bank? Yes. Regulatory bodies? Yes. Woke the US Federal Reserve? Definitely Yes. All of them are well-established in bureaucracy. You can’t expect them to think well of average consumers. So, on whom should consumers rely? A credible answer is rating agencies. They are there to guide investors, both retail and institutional, against any kind of fraud practices going on in companies and governments all across the world.
Currently, there are 3 main rating agencies that enjoy reputation in the ranks of global corporate bureaucracy. They are Moody’s, Standard & Poor’s, and Fitch. They combined rates for over 95 per cent of all the bonds and fixed-income instruments. It is a very strong oligopoly, something even the biggest regulators have not been able to breach. The picture summarizes how their rating system works.
These agencies mainly divide companies into two categories: investment-grade and non-investment-grade. Anything above a BBB- or Baa3 rating is considered investment grade. Even in the investable category, there are subdivisions with high, lower, and upper grades.
Did it work efficiently in warning investors and bank depositors against the crisis unfolding at SVB? There is no need to speculate that it did not work. Even if we consider that these rating agencies are among the dumbest in the world, there were too many red flags for them to not sniff something wrong with the bank. One of the biggest red flags was the domain itself that it operated in.
SVB is located in the heart of Silicon Valley in the USA. It is like a parent bank for tech companies located there. After the dot-com bubble burst, the bank was willing to provide funding to companies that were not profitable. To put it simply, banks’ willingness to fund budding startups made them famous. Nearly half of venture-backed technology and healthcare companies were financed by SVB. It was active in the cryptocurrency domain too, which should have sent alarm bells ringing in the New York headquarters of these rating agencies. But No.
One may argue that it is part and parcel of a developed economy. Then how would one ignore the rating agencies’ negligence towards lending and fund-raising activities at SVB? The bank was in a fizz over rising interest rate regimes in the last couple of years. For the first time after the 2008 financial crisis, the Fed did this, and it had a massive effect on technology companies all across the American Continent. In 2022 alone, more than $3 trillion had been wiped from the market.
These companies needed money and had to run to SVB. The bank, on the other hand, was busy raising money through the purchase of bonds using the deposits of these tech companies. The problem is that, compared to those times, bonds are paying more in 2023. The value of money bought earlier through bonds went down, and to add insult to injury, tech companies started withdrawing money. Basically, they did not have enough money to pay back all of their depositors.
Even a noob can sniff out the problem, but not Moody’s or S&P. Even two days before this, Moody’s had given an A3 rating to the bank. On the very same day, the bank announced a $1.8 billion loss. For Moody’s, that loss, coupled with harakiri by consumers to take their deposits out, was not enough to send their ratings down to junk. Even on the day it collapsed, Moody’s had ranked them at Baa1. Moody’s neighbour S&P had given the bank a BBB- rating, which is again an investment grade.
That is like Deja vu. It happened during the 2008 financial crisis too. Both rating agencies are headquartered in close proximity. They are paid for their ratings. So, if you want to get an upgrade, you just need to pay one rating agency. If that agency refuses, you have the option of going to another. This scene from the movie ‘The Big Short’ is good enough to clarify the rut in which rating agencies work. Coincidentally, the two rating agencies quoted above have been realistically depicted here.
India has reasons to doubt them
Every agent, institution, politician, bureaucrat, and corporate bureaucrat knows this phenomenon. By virtue of working with western companies during his days as CM of Gujarat, PM Modi and his cabinet are aware of it too. This may be one reason why the Modi Cabinet has rarely given a dime about these rating agencies.
There are other reasons for the Indian government to be apprehensive of them too. These rating agencies have been known for their inherent bias against emerging market economies all across the world. Harvard University economist Carmen Reinhart covered their ratings between 1972 and 1999.
She found out that for any crisis, these agencies are more severe against emerging economies and are more likely to downgrade them. Moody’s outscored everyone by being 10 percent more biassed. It was well reflected when Greece was in crisis. Moody’s said that the cash crunch in Greece was not a concern. Everyone knows what happened after it.
In 2013, Andrea Fuchs and Kai Gehring of the University of Heidelberg showed that these agencies favour their home countries and countries friendly to them. So, if China is friends with America, it can rest assured that no matter how bad the investment climate is, it won’t get severe treatment from them. That is how China survived until Trump took them head-on. They got favourable treatment from agencies, while India did not, especially during the Modi years.
The Modi government introduced a plethora of changes, which include improved law and order, loosening of bureaucratic control, liquidity in banks, and steps towards improving NPAs and other things. These steps did not prove enough for these rating agencies. Between September 2014 and June 2022, their outlook towards India was positive only twice. Thankfully, investors have woken up from this mirage, and despite India’s not-so-good ratings, they are pouring money into the country.
On its part, the government chose to highlight this escape from the maze in the 2021 economic survey. The survey read, “As ratings do not capture India’s fundamentals, it comes as no surprise that past episodes of sovereign credit rating changes for India have not had a major adverse impact on select indicators such as Sensex return, foreign exchange rate, and yield on government securities. Past episodes of rating changes have no or weak correlation with macroeconomic indicators.”
No, it’s not braggadocio. It is called taking a bull by its horns. It came decades after meekly accepting their dual standards. With SVB’s failure, you may hope things will change. Though, certainly, we don’t.
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