Inside Money: Why ratings are over-rated

The Christchurch earthquake prompted another 'another pointless' ratings alert. Photo / NZ Herald

Are you swelling with national pride? New Zealand has once more been granted Aaa status by international credit-ratings agency Moody's.

(I had to read over the ratings jargon to make sure that this was good news. In Moody's talk Aaa equates to long-term senior debt of the 'highest quality' - so we are good for it.)

But how much attention should anybody pay to these ratings anyway? Much less than they used to, according to the latest Global Financial Stability Report from the International Monetary Fund (IMF).

After proving themselves useless, and somewhat conflicted, assessors of the risks inherent in complex financial products, credit ratings agencies lost some of their allure. And the IMF wants to dilute the influence of the agencies even further, pointing out that investors rely much too heavily on credit ratings from the big three - Moody's, Fitch and S&P.

"Sovereign credit ratings have inadvertently contributed to financial instability," the IMF report says, as investors react to them in a knee-jerk, unthinking fashion.

The IMF recommends that investors remove mechanisms that automatically "hardwire buy or sell decisions to ratings".

"[Investors] should continue their efforts to reduce their own reliance on credit ratings, and wherever possible remove or replace references to ratings in laws and regulations, and in central bank collateral policies," the IMF says. "They should discourage the mechanistic use of ratings in private contracts, including investment manager internal limits and investment policies."

This advice is only for the big boys, however, as "smaller and less sophisticated investors and institutions will continue to use ratings".

Meanwhile, another pointless ratings alert came my way this morning. A M Best, another international ratings agency that dominates the insurance business, has placed the New Zealand Local Authority Protection Programme Disaster Fund (LAPP) "under review" as a result of the Christchurch earthquake.

I had never heard of the LAPP Fund but Christopher Munden, the fund's administration manager, explained to me that the $40 million charitable trust acts as a collective infrastructure insurance vehicle for about 60 NZ local councils in the event of a disaster such as the Christchurch quake.

LAPP will be affected by the quake - as intended - but what sort of value does the A M Best rating review bring in these circumstances? None is the answer.