Chillin'Competition

The rating agencies “oligopoly” has been trashed by virtually all EU policy makers in the past days.

The big question on the policy agenda is now: how to regulate them?

Here’s a first taste of my answer, which I will further articulate in a forthcoming paper with my assistant N. Neyrinck. This paper will make extensive use of my prior research on oligopolistic dominance.

Let’s start with two propositions.

Proposition 1: The market for rating services exhibits a bunch of features which makes them prone to antitrust scrutiny. Market structure is oligopolistic, with essentially three big players (Moody’s, S&P and Fitch). Conduct is close to coordination (tacit or explicit), with quasi simultaneous and identical downgrading cycles. Performance is welfare decreasing, with borrowers paying a steep price in terms of interest rates (not to talk of the price to pay for taxpayers, called to rescue downgraded countries)

Proposition 2: The toolbox of antitrust agencies comprises a variety of flexible remedies which could be instrumental to regulate the rating agencies oligopoly (e.g., structural and behavioral remedies). Moreover, competition policy is an exclusive EU competence. Hence, those Member States that are reluctant to regulate the rating agencies cannot undermine Commission action under the competition rules. Finally, the EU competition rules can be enforced in a timely fashion (think of Article 9 proceedings) and also apply to non-EU firms.

Obviously, the main outstanding issue is to build a case around those two basic propositions. This implies devising a credible theory of harm, in other words a scenario of anticompetitive conduct that would allegedly explain the rating agencies’ behavior.

On this, and out of pure speculation, an hypothesis with both a collusion and a foreclosure component can be floated. Together with a number of banks, the rating agencies may be trying to harm other rival banks that have purchased Greek and Portuguese paper. Of course, the main problem here would be to (i) explain why rating agencies have an interest in siding with certain banks and not others; (ii) establish a  link, convergence of interests, concertation between the rating agencies and those banks.

But even in the absence of a strategic link with banks, one may still consider that the rating agencies conduct is amenable to antitrust scrutiny. After all, with their self-fulfilling prophecies, the rating agencies risk injuring the structure of banking markets by pushing certain players to bankruptcy.  In turn, this will increase market concentration, weaken competition and harm consumer welfare. Note that scenarios of this kind are often found in secondary line injury price discrimination cases (where the seller places some third parties at a “competitive disadvantage” (a sort of negative externality?) in a related market). Hence, it would not be crazy for antitrust regulators to run a theory of this kind. Moreover, the explanation for the rating agencies’ conduct can perfectly be framed in the words used by (i) behavioral economists to describe irrational conduct – why hammer Greece and Portugal, and meanwhile maintain the US’ AAA?- in markets where players are excessively risk averse; or (ii) conventional economists to describe information imperfections and reputation dynamics (to stay credible, agencies need to be tough on rating).

Happy to have your comments on this.

PS: I had initially decided to use a picture of Cassandra to illustrate this post. I changed my mind given (i) the fact that Cassandra was often right, but never believed; and (ii) my musical tastes.