Credit ratings: wealth transfer mechanism from taxpayers to private corporations

London riots provide a perfect attention diversion, or rather a smokescreen, of financial looting of the taxpayers currently implemented by the financial industry that goes largely unnoticed. As the first article on this blog, "The largest heist in history", showed the financial system was turned into a giant global pyramid scheme. Nearly three years ago, in the fall of 2008, it was obvious that "Unless and until the governments identify, isolate and write off toxic instruments held by financial institutions every pound put into “rescue” is very likely to end up being good money thrown after bad."

The current financial system has been operated as a giant global pyramid scheme (where lending with loan to deposit ratio greater than 100% is a pyramid mechanism) for at least last 15 - 20 years. It assures that the liquidity shortage is a systemic feature of the financial system. The excessive debt is not at the heart of the current crisis. The politicians and the "eminent" financial pundits that repeat this constantly to justify the public spending cuts (which quite often can be a very good idea as living beyond the means is disastrous) show the lack of competence on a massive scale. In the current crisis the debt is a manifestation of something far more lethal: too high money multiplier. No wonder that with such leadership the financial situation of the western world is going from bad to worse and whilst politicians are talking about solving the problems they keep creating new ones. The exception in the West is the German Chancellor Ms Angela Merkel. She appears to understand what it is all about and is very skilfully navigating for the benefit of Germany amongst her peers who are clueless.

All the money pumped into the system by the governments, since September 2008, in form of bail-outs and quantitative easing was wasted (as predicted). Basically it was used to prop up the financial industry itself - paying massive amounts for lavish offices, salaries and bonuses - whilst the rest of the economy kept on struggling. But as it was obvious over two and half ago years the financial industry keeps returning for more of taxpayers money.

The first ongoing form of financial looting is the bailouts of countries like Greece. The private banks that took on the risk themselves when they lent money now expect the taxpayers to underwrite the risk that they took. It is a perversion, an absolute distortion of the principles of free market economy which made the western world so successful for most part of 20th century despite two disastrous world wars and indeed social tensions. It is a version of a communism for the rich where the profits go to private coffers whilst the losses are underwritten by the taxpayers. It is a mechanism of funnelling taxpayers money to private pockets.

The second ongoing form of financial looting that appears to be gathering pace now is the use of credit ratings. It is quite crude and primitive. But, boy, it works.

For many years credit rating agencies have been assigning ratings both to private corporations debt and state sovereign debt. If it was just a matter of opinion it would not matter. Anyone, including the author of this blog, is entitled to his/her opinion. However credit ratings are a part of the fabric of the financial system. They dynamically determine the costs of borrowing: what a debtor has to pay to the creditor. The higher the credit rating the lower the costs of debt and vice versa. It has been clear that for some years the credit ratings of sovereign debt was, using the same standards based on historical statistical review of default occurrence, too low compared to credit ratings to the private corporations debt. For example the world has seen no default of AAA rated countries whilst many AAA-rated financial products turned out to be lethally toxic (and it was manifestly clear they were toxic at the time they were assigned AAA). With the downgrade of the US sovereign debt from AAA and the prospects of downgrading other countries', also the prospects of downgrading cities and local governments, this trend of underrating countries' debt in comparison with the private debt looks more prevalent.

The fact that, based on the same methodology, countries are underrated in comparison to private corporations is not just a matter of opinion as President Obama seemed to naively suggest putting a brave face over a big problem. It means the states (countries, taxpayers) pay more money for servicing their debt than if they were private corporations in the same circumstances. In the financial markets of global capital allocation the effect is profound. This asymmetry of the costs of debt constitutes a global wealth transfer mechanism from states (countries, taxpayers) to the private corporations. It is not an ideological opinion or a matter of political ideology but a financial fact. This does not imply whether it is morally right or wrong which is for each reader to decide (or even not decide at all). It is the way the financial industry works.

This wealth transfer mechanism of underrating the sovereign debt in comparison to private corporation debt, is basically a bailout by stealth provided by the taxpayers to the financial industry. It is yet another method that the financial industry is implementing to extract money from the taxpayers. It is not a conspiracy: simply it makes good business sense for the financial industry, whilst making politicians' financial competence look rather questionable. However due to the pyramid nature of the financial system this will also not be enough. Sooner rather than later money will end up in private hands as a way of wealth transfer. It will prolong the crisis, make the pyramid bigger and impoverish the countries and the societies. More austerity. And it will make the final implosion of the financial system even more spectacular than what you can observe with the LHC in CERN.