S&P Questions during Senate Estimates Committee Hearings

Thursday 20 October 2016

Source : Senate Hansard, Economics Legislation Committee

Participants:  Senator Lambie & Mr Wayne Byres – Chairman of the Australian Prudential Regulation Authority (APRA).

Senator LAMBIE: In his effort to repair the budget, the Treasurer warned us about the risk to Australia's AAA credit rating. I think this morning he talked about visiting the ratings agency S&P—or Standard & Poor's. Do you know if that is correct?

Mr Byres: I know it is correct that he talked about it, and I understand that, when he was in New York, he did so, but I was not there for the discussion, so I cannot confirm that.

Senator LAMBIE: From your perspective, do you trust the rating assessments of S&P? Are they credible, truthful and accurate?

Mr Byres: They are a professional rating agency. They have, I think, a robust process, and they have a relatively transparent process for how they rate countries and sovereign debt. S&P is not the only rating agency, of course—there are Moody's, Fitch and other rating agencies that assess the creditworthiness of sovereigns—but they are an influential one. They are an important one.

Senator LAMBIE: With the studies that I have done, I have come up with the view that S&P do not have a great track record when it comes to being honest or accurate. For example, I asked the Parliamentary Library to do a fact check on some disturbing allegations in a Wikipedia article, and the library found most of the allegations about crimes or mistakes by S&P to be true. Firstly, one article said:

CRAs such as S&P have been subject to criticism in the wake of large losses beginning in 2007 in the collateralised debt obligation (CDO) market that occurred despite being assigned ratings by the CRAs. Is that true?

Mr Byres: You are correct in that. The rating agencies do not have a very good track record when it comes to what we would call structured products or sophisticated debt products. Clearly, their ratings were not very reliable, and many people will attribute criticism to them as a factor in the lead-up to the financial crisis.

Senator LAMBIE: The article goes on to say:

Credit ratings of AAA (the highest rating available) were given to large portions of even the riskiest pools of loans. Is that true?

Mr Byres: That is true. There were certainly risky pools of loans that were cut and diced up and packaged into new securities, and the rating agencies did assign the most senior portions of those AAA ratings.

Senator LAMBIE: The article continues:

Investors trusting the low-risk profile that AAA implies, purchased large amounts of CDOs that later became unsaleable. Mr Byres: I think that was in fact in the period of the financial crisis. Yes, many people who thought they had AAA paper subsequently found they incurred significant losses on those instruments.

Senator LAMBIE: The article continues:

Those that could be sold often took staggering losses. For instance, losses on $340.7 million worth of CDOs issued by Credit Suisse Group added up to about $125 million, despite being rated AAA by S&P. Mr Byres: Yes. I do not know the facts but the general proposition that people held structured products which the rating agencies had rated AAA did incur significant losses in the financial crisis.

Senator LAMBIE: The article continues:

Companies pay S&P to rate their debt issues. As a result, some critics have contended that S&P is beholden to these issuers and that its ratings are not as objective as they ought to be and that, in fact, this "pay to play" model makes their ratings meaningless at best and perhaps would more accurately be compared to the role of the "shill" in a game of three card monte. Can you tell me whether that is true?

Mr Byres: I have heard those criticisms. Certainly the fact that issuers pay rating agents in general and, in most cases, issuers pay rating agencies for the privilege of the rating agencies assigning a rating does create conflicts in the process. That is true. And that is why, since the crisis and since those criticisms came to the fore, the rating agencies have tried to be more transparent in the way that they assign ratings. So there is much more information available now by the rating agencies on their ratings methodology rather than it just being something that happens in a back room. You can actually go to the S&P website and they will give you an outline of how they rate governments, how they rate the Australian banks, how they rate different products.

Senator LAMBIE: The article continues:

In April 2009, the company called for "new faces" in the Irish government, which was seen as interfering in the democratic process. In a subsequent statement they said they were "misunderstood". Is that true or false?

Mr Byres: I do not know enough about the case, so I cannot comment on that one.

Senator LAMBIE: The article continues:

Some critics have pointed out that the company and other rating agencies were part of the cause of the global financial crisis of 2008–2009, for example when Moody's downgraded Freddie Mac or, to quote Time, when "both agencies granted AAA rating to Collateralized Debt Obligations ... that were

chock-full-of— crap— ... mortgages, thereby helping to precipitate the 2008 financial collapse". Mr Byres: Yes, that has been a significant criticism of the rating agencies.

CHAIR: Senator Lambie, we are covering issues that happened overseas that APRA has absolutely no jurisdiction over.

Senator LAMBIE: Actually, the Treasurer is using S&P a lot, so what I am trying to establish here is the credibility of S&P. That is what is going on here.

Mr Byres: There is one important distinction. The issues that you have talked about are undoubtedly all true and the criticisms of the rating agencies were made and, in many cases, were quite fair. I think the rating agencies have even acknowledged that there were flaws in their process and they needed to lift their game. Where the most difficulty came from and where most of these losses that you have touched on were incurred were in, as I have alluded to before, the structured credit products—the very sophisticated, complicated things that innovative investment bankers thought up to package and repackage securities. I think those criticisms do not necessarily apply to basic standard debt instruments of the sort that were issued by the Australian government or other government entities around the world. There there are many more people who have access to information and are able to form their own opinion about sovereigns, whereas with the structured products they are very opaque products. The ratings were very opaque and I think it is pretty clear there was too much hindsight and too much trust put in the ratings agencies for those structured products.

Senator LAMBIE: Thank you. The article continues:

With the US downgrade some have accused S&P of causing further damage for its own agenda. S&P acknowledged making a USD$2 trillion error in its justification for downgrading the US credit rating, but stated that it "had no impact on the rating decision".

"A judgment flawed by a $2 trillion error speaks for itself," said a spokesman for the United States Department of the Treasury. Is that true or false?

Mr Byres: I do not know enough about it to say it is true. I do not know whether the figure is right; I do not know the specific facts. Certainly they downgraded the US government and then there was a suggestion that there had been mistakes in the analysis—that is as far as I can say. Senator LAMBIE: Can you tell me whether or not at any time S&P have been fraudulent in their dealings in Australia?

Mr Byres: I do not know of any.

Senator LAMBIE: The article continues:

Perhaps more revealing and supportive of Paul Krugman's comment, David Wyss, who was chief economist at S&P till July 2011 noted to a reporter on August 17, 2011: "The credit agencies don't know any more about government budgets than the guy in the street who is reading the newspaper." Such insider comments lay fresh doubts about the key ratings decisions by S&P. Is that true or correct?

Mr Byres: I think that is a harsh criticism. They do employ professional people to do the work, so I would certainly hope that they have—

Senator LAMBIE: Do they know any more about government budgets than the guy on the street?

Mr Byres: I suspect they do know a little bit more about government budgets than the average guy on the street, if for nothing else then they have access to officials that the average guy on the street does not have.