What Constitutes a Greek Default? And Who Decides?

The wall street journal

By ART PATNAUDE

The euro-zone crisis is bringing ratings agencies once again into sharp focus, with euro-zone governments eager to avoid anything that could be considered a default as they try to restructure Greece's debt. After several failed attempts, euro-zone officials are now saying the plan could be to allow a default.

But how do the credit ratings agencies decide whether a Greek restructuring plan constitutes a default? Who are the decision makers? And what criteria do they use to make such a decision?

While there are a multitude of ratings companies, market participants tend to look to the opinions of the three largest: Moody's Investors Service Inc., Standard and Poor's Corp., and Fitch Ratings Inc. These companies are paid to issue ratings on different types of bonds, including those issued by companies and banks.

In many cases, sovereign-debt ratings aren't paid for by the country. For instance, in February S&P converted its ratings on Belgium, France, Germany, Italy, the Netherlands, Switzerland, the U.K. and the European Central Bank to "unsolicited," saying it has enough reliable public information on the countries and that there is significant interest in their ratings. It wasn't immediately possible to confirm whether Greece pays for its rating.

A rating on a company is based on factors including its financial strength, its past performance and the environment in which it operates. However, sovereign ratings assess a much more complex web of factors.

In its most recent sovereign methodology report, Moody's said sovereign ratings require an assessment of both quantitative and qualitative factors, "whose interaction is often difficult to predict."

"A mechanistic approach based on quantitative factors alone is unable to capture the complexity of the interaction between political, economic, financial and social factors that define the degree of danger, for creditors, of a sovereign credit," Moody's said.

So just who decides on the part this complex interaction plays?

At Moody's, a committee decides. The committee is made up of ratings analysts, including the analyst responsible for the country on which the committee is deliberating. However, it may also include analysts who might normally look at other entities such as companies or banks.

The committee deliberates and then votes. The lead analyst on the country gets the same single vote as other committee members. However, the most junior analyst on the committee votes first, going through to the most senior person last in an attempt to avoid any top-down influence.

Crucially, part of the decision on a sovereign-rating change is based not just on the ability but also the willingness of a government to pay.

"Sovereign risk analysis is a synthesis of quantitative and qualitative judgments that capture the willingness as well as the capacity to pay," according to Fitch Ratings' sovereign methodology report.

Moody's and S&P are based in New York, while Fitch is has dual headquarters in New York and London.