Trouble Tracks Far and Wide
Probe Is Urged As Slide Deepens From Paris to Tokyo

By Molly Moore
Washington Post Foreign Service
Friday, August 17, 2007

PARIS, Aug. 16 -- European officials called for investigations into whether conflicts of interest between credit-rating agencies and the banks they oversee contributed to the market slide that continued Thursday around the world.

As stock markets from Paris to Tokyo declined for a second day in response to an international credit crunch that started in the U.S. mortgage industry, European leaders scrutinized the cause of the fall. They paid special interest to an oversight system that failed to provide adequate warning to financial institutions and investors on the weaknesses in the subprime mortgage lending business.

"We have had a long period of greed," said Marc Ostwald, a strategist at Insinger de Beaufort in London. "Now there's a realization that people should have been a lot more careful, and the chickens are coming home to roost."

French President Nicolas Sarkozy, who is vacationing in New Hampshire, called on leaders of the world's largest economies to take steps to ensure the "transparency in the operation of the markets." He said the issue should be a priority at an October meeting of finance ministers from the Group of Seven industrialized nations in Washington.

The European Union's executive arm on Thursday ordered an investigation into the conduct of credit-rating agencies and their failure to respond more quickly to the impact of U.S. loan defaults on financial markets. The inquiry will specifically examine whether the agencies played down the potential for problems because of conflicts of interest, E.U. officials said.

Credit-rating agencies such as Standard & Poor's, Moody's Investors Service and Fitch Ratings are paid by banks to assess the creditworthiness of the securities that the banks issue.

The agencies have been under fire -- in the United States and Europe -- because throughout the housing boom they gave top rating to securities backed by risky mortgages, allowing Wall Street banks to easily sell those securities to investors. Those securities have plunged in value as defaults on subprime mortgages have jumped.

On Thursday, the three major rating agencies sped up their downgrades of mortgage-backed securities.

The E.U. investigation, which will be led by the office of Internal Market Commissioner Charlie McCreevy, will consider new regulations or legislation to oversee the industry, officials said.

Frederic Drevon, Moody's senior managing director, said his firm was "committed to continuing the constructive dialogue it has had with the regulators and policymakers," according to the BBC.

Investor anxiety prompted sell-offs around the globe, with Seoul's Kospi index taking the worst hit, ending the day down 6.9 percent. Indonesia's Jakarta composite index suffered a 5.9 percent loss on top of Wednesday's 6.4 percent drop. The London FTSE 100 was off 4.1 percent, its biggest one-day percentage drop since 2003. The French CAC-40 slipped 3.3 percent and the German Dax was down 2.4 percent. Japan's markets slid 2 percent.

[Asian stocks continued to fall Friday, with Tokyo's Nikkei index down 3.2 percent in afternoon trading and South Korea's main indicator down 2.1 percent, Bloomberg News reported. Hong Kong's Hang Seng index was down 3.3 percent.]

Some financial experts said concern over the unknown and the lack of transparency in world financial institutions is driving some of the chaos. "There is a credit fog," Ostwald, the strategist, said. "No one knows who has what, and people are worried that they may have losses in credit markets."

French Finance Minister Christine Lagarde cut short a vacation and returned to Paris Thursday "because of the stock exchange situation," a ministry spokesman said.

World leaders and financial analysts cautioned against panic, saying the world's largest economies and major international corporations are strong enough to weather the fluctuations. Sarkozy released a letter he sent to German Chancellor Angela Merkel saying he did not think the subprime mortgage crisis would affect economic growth in France and Germany.

Figures released this week by European Union officials showed that economic growth slowed across Europe in the second quarter, even before the latest global market turmoil.

Analysts said the greatest problem in curbing the slide is the psychological fear factor. "It's difficult to stop something like this," said Peter Westerheide, a specialist in international financial markets at Germany's Center for European Economic Research. "The problem is the chain reaction that has been set off. You see that there are fires starting in all possible corners, and that is what makes it hard to control."

He added, "The world economy is in good shape. Yes, this will slow it, but there is no reason to fall into a state of great pessimism."

Researchers Karla Adam in London and Shannon Smiley in Berlin contributed to this report.