State is the real threat to ratings
Credit rating agencies came away from the global financial crisis with damaged reputations. They have since taken a step forward in redeeming themselves by showing their independence from their government regulators. To wit, Standard and Poor's recently placed a negative outlook on the U.S. government and Moody's warned that the United States will need to reverse its expansion of debt if it hopes to keep its current rating.
With sovereign debt being a large part of the investment portfolios of pension funds and other institutional investors, the creditability of external ratings is important, even though ratings agencies have shown themselves to be lagging indicators of problems behind markets.
Prior to the global financial crisis, credit rating agencies were already under scrutiny because of corporate scandals such as Enron, where the agencies failed to detect financial irregularities in companies that later collapsed. These scandals resulted in regulatory initiatives such as the establishment of a code of conduct by the International Organization of Securities Commissions (IOSCO), an international umbrella group of securities regulators. The code of conduct includes four principles, one of which is "rating decisions should be independent and free from political or economic pressures and from conflicts of interest arising due to the agency's ownership structure, business or financial activities, or the financial interests of the agency employees."
The global financial crisis prompted regulators to apply the accelerator to their regulatory agenda for credit ratings agencies. With a G20 commitment to extend regulatory oversight to credit rating agencies to ensure they meet the IOSCO code (with emphasis on conflicts of interest), G20 members have introduced new regulations, often going well beyond what the G20 called for.
Ironically, aggressive regulatory intervention may have done more to create a new conflict of interest than resolve existing ones, since the governments that make regulation rely on their ratings to borrow cheaply. Rating sovereigns is a core business of the agencies; therefore, they need to be free of the threat of regulatory retaliation for their ratings actions.
However, Europe demonstrated last June that it is not shy about coercing ratings agencies. Following a downgrade of Greece to junk status by Moody's, an EU commissioner said the decision raises questions about the role of rating agencies in the financial system. This was followed by EU Commission proposals for a publicly funded sovereign rating agency to rival the big three rating agencies.
Despite a new regulatory regime coming into force last December to implement the IOSCO code, the EU nevertheless chose to consult on further regula-tory actions, on the basis that the euro debt crisis has renewed concerns that financial institutions and institutional investors may be relying too much on external credit ratings. These institutions and investors are likely patting themselves on the back now for their reliance on ratings: The risk of a Greek sovereign default is higher than ever, despite European officials insisting last June that financial markets were wrong about Greece.
The EU behaviour towards credit ratings agency may have left management at Standard and Poor's and Moody's nervous, particularly with the new powers that regulators have under the Dodd-Frank Wall Street Reform and Protection Act. The legislation also directs regulators to publish reports on potential further actions, including a review of alternate compensation structures for the rating agencies.
However, an announcement by the manager of the world's largest bond fund that it was shorting U.S. treasuries, as well as other recent criticisms of the U.S. fiscal situation, probably took some pressure off Standard and Poor's and Moody's, in the sense that their own announcements simply affirmed what everyone has already realized. Nevertheless, the rating agencies deserve credit in showing the capacity to act independently on sovereign ratings despite the potential for regulatory retaliation. To ensure the integrity of sovereign ratings in the future, G20 members need to develop standards to regulate their own behaviour.
Stand up to U.S.
From May 23 to June 10, 2011, softwood lumber producers and importers in the United States will be canvassed through a referendum organized by the U.S. Department of Agriculture to get them to agree to a tax designed to increase softwood lumber usage in the United States. A majority of the 595 U.S. producers and 883 U.S. importers of softwood lumber probably will agree to a specific tax designed to fund about US$100-million worth of market research and generic advertising over the next five years, starting in 2012, partly because they will not have to pay the whole bill.
Even though the promotional campaign will be controlled and directed by the U.S. government, Canadian exports to the United States will be taxed at the border to help pay for the American program. Canadians will not vote on whether they want to be taxed, nor have anything effectively to say about how the money will be spent.
The Government of Canada in 2006 collected US$1-billion from the Canadian softwood lumber industry and turned over the money to the United States in order to settle the most recent round of the softwood lumber dispute. Some of that money now has been used to develop this newest plan to tax Canadians and turn over still more money to the United States.
No one in the lumber industry would quarrel with the idea of promoting the use of wood, especially as less "green" materials -such as steel and plastic -have begun to compete successfully with a renewable resource. But who should pay? The designers of the U.S. "check-off program" for softwood lumber have admitted that they could not get the industry to pay voluntarily over a long period of time but they believe that Americans, who will control and run the program, will volunteer to pay part of the bill as long as they can force Canadians, who will have no say, to pay a significant part. After years of accusing Canada of subsidizing Canadian industry (something never proved), the United States, and really the U.S. industry, is coercing Canada to subsidize a program meant to promote the U.S. industry.
This program circumvents NAFTA, which forbids new tariffs at the border, and the trade laws, which provide recourse. Once enacted, there is no legal recourse, at least not under the trade laws. The check-off program is being created under the U.S. 1996 Farm Bill for the benefit of U.S. industry. Benefits to Canadians would be coincidental.
Some $350-million of the $1billion turned over to the United States in 2006 were supposed to be committed to "meritorious initiatives," including the promo-tion of green building materials. These funds remain, five years later, largely unspent and available should there be consensus for a new promotional program. Canadians should not surrender their sovereignty to a unilateral American decision to impose new taxes on Canadians, especially when, however virtuous the purpose, the funds already are available.
Canadian forest industries have been experiencing the most severe economic challenges in their history. While their markets collapsed they have had to pay export taxes for the privilege of supplying the shrinking U.S. market. Now they will be coerced to pay for a U.S. government promotional program designed principally to subsidize their American competitors.
Canada's newly elected parliament needs to address this important issue in defence of Canadian sovereignty, and the integrity and economic well-being of Canada's forest industry, which employed 238,000 Canadians in 2009. Canadian politicians ought to declare their opposition to this circumvention of international trade rules.
Fear and hope for Ontario's Liberals
For the federal Liberals, the shock of Monday night's electoral disaster probably hasn't worn off yet. But that's OK. They have four long years to let it sink in. Their counterparts in the Liberal Party of Ontario have no such luxury, however. Looking at an electoral map of Ontario, with blotches of red noticeably lacking, one can't help but suspect that the already bleak situation facing the Ontario Liberals seems a lot grimmer than it did six weeks ago.
Of Ontario's 106 ridings, a mere 11 went red on Monday night. For a party already widely believed to be out of gas and with unenviable poll numbers, it's not a good position to be in. The next provincial election is only five months away. They have that long to diagnose what went wrong and figure out how to combat it. But the blue wave that swept through Ontario on Monday night might actually be their best hope for re-election.
The most recent Ontario budget, brought down in March, speaks to the problems facing the provincial Liberals. It was shockingly sparse in goodies for a pre-election budget. Ontario is $200-billion in debt, and having run up provincial expenditures by 50% since taking office in 2003, Dalton McGuinty found himself simply unable to afford any major vote-buying measures. A few hundred million was approved to provide greater mental health care to young Ontarians, and access to breast cancer screenings will be improved, but there were no grand societal projects that Liberals seem genetically hardcoded to pursue. What the province got was a largely stay-the-course, tighten-our-belts budget. McGuinty, after years of showering money on the province's public sector unions in exchange for "labour peace," isn't a particularly convincing salesman for a message of restraint.
Especially when there's an energized Progressive Conservative party that can promise exactly the same while satisfying the electorate's demand for change and escaping the worst of McGuinty's "Premier Dad" reputation for intrusive nanny state promotion. Not even the Liberals' emergency contingency plan -shout loudly and often that the provincial Tories will destroy health care and education -seems to be working. Polls have shown the voters trust both major parties equally on those files. That, more than anything else, had to set off alarm bells at Ontario Liberal HQ.
But perhaps they now have something they can campaign with, and win. Ontario voters are often contrarian in outlook, reluctant to give one party too much power at any given time. This could prove doubly true next time, as Toronto Mayor Rob Ford, clearly identified with the right, might make Toronto voters think long and hard before giving the provincial Tories the same kind of support they were willing to give Harper's Conservatives in and around the province's largest city. With the party needing to make up at least 30 seats in order to win a majority mandate, the Tories will need strong support in the Greater Toronto Area. There are no other realistic roads to victory. On Monday, it was in large part the strength of the NDP in many Toronto ridings that gave the Tories the edge they needed to win. There's no reason to believe that a similar surge in New Democrat support will be in the offing come election day in Ontario.
Those tactical issues aside, there is still of course the question of the overall campaign narrative. Pundits and politicos in Ontario have been musing for months about polling that shows that Ontario voters are eager for change and that Dalton McGuinty would likely pay the price for that urge. But that was before the federal election was called, and change came to Canadian and Ontario politics by the bucketful. It's entirely possible that the average Ontario voter, struggling to come to grip with the virtual annihilation of the federal Liberals and Bloc Quebecois, might decide they've had all the change they need right now, and park their vote with the tired, but affable, Mr. McGuinty. Much will depend on how provincial Tory leader Tim Hudak connects with voters. To date, they have seen puzzlingly little of him.
Conservatives in Ontario, and especially in Toronto, have every right to feel good about what happened on Monday, and to look forward to the next campaign in October. But they should remember that the other guy always has a plan, too. Come election day in Ontario, the provincial Tories might have cause to wish they'd saved some of their wins this week for another day.
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