October 24, 2011 8:47AM

Europe to Rating Agencies: Shut Up, or Else

Now I'm no fan of the current government created oligopoly we have among the credit rating agencies, but the EU's recent proposal to ban downgrades on government debt, when the country in question is undergoing a "rescue", shows why the answer is to deregulate the market for credit ratings.   

Of course the EU claims it wants to eliminate the "conflicts of interest" between the issuers of debt, who often pay for the ratings, and the agencies that provide those ratings.  If investors were truly free to decide on the merit of ratings, rather than required by regulation to use them, then this conflict of interest could easily be solved via reputational effects.  And while the EU proposal might lessen this problem, it does so at the cost of creating a far bigger one:  the conflict of interest between governments and rating agencies. 

As witnessed by S&P's treatment by the U.S. government, after it downgraded the U.S., having the rating agencies regulated by the very entities they are supposed to rate is a recipe for disaster.  Instead of Europe trying to create its own rating agencies, in order to avoid inconvenient truths about European government finances, Europe should do us all a favor by encouraging European-based rating agencies that would be beyond the reach of the U.S. government.