Understanding S&P Global: The Root of the World Financial Crisis

S&P Global Ratings holds significant influence in the world’s financial markets. A single rating decision from this agency can help determine investor confidence in a private asset or even a country, including Indonesia. However, the prominent name of S&P is not without a dark record. The rating agency was implicated as a cause of the global financial crisis in 2008, which is considered one of the world’s greatest economic crises since the Great Depression of the late 1920s. At the time, many US housing credit-based financial products received high ratings, even though the underlying assets contained considerable risk. When a wave of mortgage defaults occurred, products that previously appeared safe collapsed, dragging the global financial market into crisis. Before the global financial crisis erupted, many US housing credit-based financial products received high ratings from rating agencies, including Standard & Poor’s, the former name of S&P Global Ratings. These products included residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs). Essentially, an RMBS is a debt security formed from a pool of home loans, whilst a CDO is a financial product containing a collection of debt assets, including bonds or mortgage-based debt securities. The problem was that many of the home loans underlying these products came from high-risk debtors, known as ‘subprime mortgages’. When many debtors began to default on their home instalments, the value of these financial products also fell. However, before the crisis fully broke, many of these instruments had already been given high ratings and sold to global investors. On paper, the products looked safe. In reality, the risk within them was far greater than many investors understood. The Financial Crisis Inquiry Commission, an official commission formed by the US government to investigate the causes of the 2008 crisis, cited the failure of rating agencies as a key part of the crisis. The commission assessed that the three major rating agencies were essential enablers of the explosion in mortgage-based financial products, as these products were difficult to market without the stamp of a high rating. Criticism against the rating agencies arose because their business model was seen to harbour a conflict of interest. In many cases, the issuer of the financial product paid the rating agency for a rating. This meant the party whose product was being assessed was also the one paying the assessor. This led to criticism that rating agencies could be incentivised to maintain high ratings to avoid losing clients to competitors. Scrutiny of S&P continued even years after the crisis. In 2015, the US Department of Justice, along with 19 states and the District of Columbia, announced a US$1.375 billion legal settlement with Standard & Poor’s Financial Services. The settlement related to allegations that S&P had issued ratings that were considered overly high for RMBS and CDOs before the 2008 financial crisis. US authorities also stated that S&P acknowledged certain conduct related to its ratings of RMBS and CDOs during the 2004-2007 period. The 2008 case led to increased oversight of the role of rating agencies. Ratings remain an important reference for investors, but the crisis experience showed that a rating is not an absolute guarantee. A credit rating is an opinion on risk, not a warranty that an instrument or country is definitely safe from default. Therefore, when S&P gives a rating to a country like Indonesia, the market does not just look at the rating number. Investors also read the rationale behind the rating, the outlook given, and the risks mentioned by the rating agency. A credit rating is an assessment of the ability of a country, company, or institution to meet its debt obligations. In the context of a country, this rating is called a sovereign credit rating. Rating agencies assess the ability and willingness of a government to repay its debts, both in local and foreign currencies. The higher a country’s rating, the lower the risk of default assessed by the rating agency. Conversely, the lower the rating, the higher the risk perceived by investors. S&P Global Ratings explains that a credit rating is a forward-looking opinion about the creditworthiness of a debt issuer or instrument. This rating does not guarantee that a country or company will not default, but it serves as an important reference for investors in making decisions. In the rating scale, ratings are typically divided into two broad groups: investment grade and non-investment grade, or speculative grade. Investment grade indicates that a country or debt issuer is assessed to still have a sufficiently strong capacity to meet its financial obligations. Meanwhile, non-investment grade indicates a higher credit risk. On the S&P Global scale, the investment grade category starts from BBB- up to AAA. This means countries with ratings of BBB-, BBB, BBB+, A, AA, and AAA are still in the investment-worthy group. With a BBB rating, Indonesia is two notches above the lowest boundary of investment grade, as S&P’s lowest investment grade boundary is BBB-. This means Indonesia is still viewed as having adequate capacity to meet its debt obligations. However, the BBB position also means Indonesia is not yet in the high-rating group such as A, AA, or AAA. In addition to the long-term BBB rating, S&P Global also provides a short-term rating for Indonesia.