As I am writing this, President Obama announced a deal to avoid default on US government debt. If lawyers think in terms of courts, then what would be the legal consequences of the US default? While the legal issues of government’s failure to pay its debt to domestic lenders are unique and complex, the default in respect of foreign nation-state lenders such as China is probably even more interesting. There are no courts of international jurisdiction that can declare the US bankrupt, administer its assets, or enforce their judgment. The US is an independent country subject no one’s will despite the international law. But since the international law is a legal system, there must be some consequences for the US. One such factor is international rating agencies. You could hardly hear about the debt crisis in the US without learning that its excellent credit rating would likely suffer as a result. Apparently, private international rating agencies are filling some of the void in the international legal system that courts usually occupy within nation-states.
The three most important international credit rating agencies are Standard & Poor’s (S&P), Moody’s, and Fitch Group. S&P and Moody’s are American, and Fitch Group is controlled by a French corporation.
The biggest difference between credit rating agencies and courts is that rating agencies do not adjudicate disputes. But under the surface this difference is not so important. We can view events affecting credit ratings as disputes between the debtor and the lending community. Such events include defaults, budget deficits, and so on. The lending community wants some objective basis, for example, to charge a different interest rate as a result of one of the events above. And the debtor government wants to minimize its borrowing cost. Often these interests would come into conflict giving rise to the need for a third party to establish an objective basis for new lending terms. It sounds awfully like adjudication.
In theory, credit ratings are such independent, impartial, and objective assessments of the most optimal relationship between lenders and a borrower in accordance with generally accepted rules. Credit ratings basically result from applications of such rules and principles to a given debtor.
In practice, credit agencies are hardly accountable to anyone. They are for-profit, private organizations whose decisions are final and are not subject to review. The ratings’ impact is fast and powerful, and it usually directly affects interest rates available to the borrower. There is a good overview of other criticism of rating agencies on Wikipedia.
When countries, which desire to keep as much of their independence as possible, fail to establish formal and binding international governance and adjudication bodies, private organizations fill the legal void. It’s not necessarily a bad or a good thing, but it’s important to recognize the legal and enforcement role that these organizations play. Their existence also supports the view that international law exists.
Pulat Yunusov is a Toronto litigation lawyer.