In Canada, where the Big Six banks look after so much of our money, it is reasonable for Canadians to ask the question first asked by the Roman poet Juvenal: "Who guards the guardians?"

Most Canadians may imagine that is the job of government regulators including the Bank of Canada and the Office of the Superintendent of Financial Institutions. And they are right.

But in the world of private sector global finance, that role has traditionally been shared by three main credit ratings agencies, Moody's, Fitch and Standard and Poor's, plus DBRS, which was founded in Canada.

Black mark

Yesterday one of those agencies, Moody's, handed out a black mark to Canada's biggest banks, saying Canadians were over-borrowed.

Unlike the regulators, ratings agencies have no power to set rules for how banks operate. But in a world where money counts, their power is in some ways even greater.

Housing Affordability 20100525

Canada's frenzied housing market has Moody's concerned that consumer borrowing rates are too high and not sustainable. (Nathan Denette/Canadian Press)

They decree how likely any borrower, sometimes a company, sometimes a government, is to repay money that others lend to it.

In a series of complicated rating categories that are slightly different from each other, the agencies collect all the data they can get their hands on and give those companies or governments a score. Those scores matter in at least two ways.

More costly borrowing

To oversimplify a little, the higher the rating, the lower the borrowing costs for the corporation or government being rated. A lower rating means borrowing costs rise.

And for Canadian banks that's exactly what happened. After the Moody's announcement, the interest rates on bonds of Canadian banks went up

Also, falling below investment grade can mean safer investment funds are no longer permitted to own the bonds of the lender in question.

But can the ratings agencies be trusted?

RBC, Scotia, CIBC

Moody's has downgraded Canada's Big Six banks, but ratings agencies don't always get it right. (Canadian Press)

"We believe that the Canadian banking sector is encountering incremental pressure from headwinds facing the Canadian economy, which is heightening economic risk in the banking system."

That comment did not come from Moody's yesterday, but from its competitor Standard and Poor's as quoted by CBC News and The Canadian Press in 2012.

Agencies not always right

Since then, of course, the Canadian banks have had a series of startling results as they have gone from strength to strength.

An internet search shows a whole series of downgrades over the years by the ratings agencies. In January 2015 the British bank Barclays downgraded four Canadian banks.

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After Moody's announcement the value of the Canadian dollar fell and the interest rate on New York borrowing by Canadian banks rose. (Reuters)

Others have accused the agencies of piling on after a company gets into trouble.

Ratings agencies have had a checkered history, notoriously before the 2008 banking collapse that was widely blamed on bundles of subprime debt that had been repackaged into things like collateralized debt obligations.

Those CDOs and similar instruments called mortgage-backed securities got the highest debt rating just before they crashed in value, bringing down three giant investment banks and sending the world into a credit crunch and recession.

One of the obvious flaws in the system was that the agencies were being paid by the companies they were rating.

Difficult job

Apart from that, the credit-rating agencies have a difficult job.

As we have seen repeatedly, even the best informed people have difficulty predicting the path of a business.

If Canadian oil companies had realized the price of crude was going to plunge by more than half, it's likely they would have done things differently. But despite their huge wealth and their ability to buy the best information, almost no one in the world's petroleum sector anticipated the 2014 oil crash.

Royal Bank, Soctiabank with TD's black tower in background at King and Bay, Toronto

Despite repeated warnings by ratings agencies, Canadian banks have gone from strength to strength. But when the Big Six are so powerful, it is useful to hear an outside voice. (Don Pittis/CBC)

As Michael Lewis described in his book The Big Short and in the film of the same name, predicting which way the market is going to jump is extremely lucrative. But it is also rare.

While almost everyone else scoffed, the real-life characters in Lewis's book made billions by betting that those triple-A rated CDOs would crash.

As Forbes commentator Roger Aitken once asked, who rates the rating agencies?

Of course, in place like Canada where banks are so influential, the views of outside experts should not be ignored.

"Continued growth in Canadian consumer debt and elevated housing prices leaves consumers, and Canadian banks, more vulnerable to downside risks facing the Canadian economy than in the past," said yesterday's Moody's release on the more detailed report.

Yesterday the Bank of America added its voice, recommending that Bank of Canada governor Stephen Poloz start raising interest rates to restrain consumers.

While the Bank of Canada remains reluctant to raise rates, the statement by Moody's will have a slowing if slight effect on Canadian borrowing, since the banks will eventually have to pass those higher bond costs on to their borrowers.

And while ratings agencies have shown they are far from infallible, Moody's is one more voice of warning, amid many others, that Canadian consumer borrowing is out of whack, and efforts must be made to rein it in.

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