Credit Ratings Agencies

DR editor Dan Denning is beavering away on the July issue of the Australian Wealth Gameplan. Filling is today is Diggers and Drillers editor Dr. Alex Cowie.

Here’s a question for you: What do you call credit ratings agencies without any credit ratings?

The answer? Standard & Poor’s, Moody’s or Fitch.

An unexpected last minute change in the US Financial Reform Bill, being signed by President Obama this week, means that the credit rating agencies are now going to be accountable for the ratings they issue. This means that if any of their ratings are too high, too low, or just plain wrong, then investors can sue. According to the press release:

“Investors can bring private rights of action against ratings agencies for a knowing or reckless failure to conduct a reasonable investigation of the facts or to obtain analysis from an independent source. NRSROs will now be subject to “expert liability” with the nullification of Rule 436(g) which provides an exemption for credit ratings provided by NRSROs from being considered a part of the registration statement.”

So, the law is now taking away the credit rating agencies’ immunity from the law, and what they all do in response? They weigh up the potential cost of litigation and sent a message to all their clients: DO NOT USE OUT RATINGS!

It’s all beer and skittles dishing out ratings willy-nilly, but the music stops suddenly when they have to put their money where their mouth is. That says a lot about how good they think their stuff really is.

An absence of ratings also removes one of the central benchmarks within the debt markets, for everything from municipal notes, to corporate bonds, and sovereign debt. As you can imagine, parts of the debt markets have just ground to a halt as a result.

It’s a bit like when both the metric and imperial systems were suddenly outlawed. What do you measure with then? What is your mutual point of reference with business partners? That bathroom renovation just got a whole load more stressful.

The only problem with this analogy is that the metric and imperial systems are efficient and honest. Whereas the credit ratings agencies are a bunch of shonky power-trippers on the pay-roll of the investment banks.

It was always going to be a disaster putting that much quasi-regulatory power into the hands of profit-making private businesses. The temptation to overlook problems, do a sloppy job or take back-handers was there from the start. It has often been said that the guys working in the credit ratings agencies were the people who weren’t smart enough to make Wall St.

When the B-minus students are given the power to downgrade entire government’s credit ratings, but with no accountability, what could we expect? A quick recalculation and yes, we’re going to downgrade Portugal’s credit rating this morning. After a long lunch we might do Greece as well. What’s that, they’re having some problems at the moment? Whatever. Downgrade the UK soon? Hmmm it’s probably about time isn’t it! We’ll see what kind of kick backs they’re offering first shall we?

These are the same guys that gave investment grade ratings to Mortgage Backed Securities that were nothing more than sub-prime mortgages put through the blender, baked at 240’C for 30 minutes, and then sold in expensive looking packaging. The subprime mortgages were pretty much given to anyone that could sign their signature, as well as some that couldn’t. But with the seal of approval from Standard & Poor’s, Moody’s or Fitch, brokers could sell the resulting mortgage backed securities to institutional-investors world-wide.

The rating agencies have a lot to answer for. So, like the teenager who has been told in the future they will pay for home repairs after house-parties, the ratings agencies are so terrified about the potential costs they have told their buddies they are not going to have any more parties.

Until now, they have been one of the very few ‘financial gatekeepers’ that have not been exposed to litigation. It is a quirk of the system. If a bank manager gave his most unscrupulous customers great ratings and massive loans, his days of long lunches and lifelong golf membership would be cut short.

It is simple human nature: the threat of reprisals keeps your actions honest. You play with fire, you get burned. Without the feedback loop, players can get sloppy.

So what happens next? This is hot off the press so it’s hard to see. What happens at the next sovereign debt issue if the ratings agencies have told the government issuer that they can’t use their AAA rating?

You’d like to think that it would be a case of the ratings agencies going back to business, whilst embracing the principles of honesty and transparency. That would clearly take a major cultural change, so don’t hold your breath.

Dr. Alex Cowie
Dr. Alex Cowie is the editor of Diggers and Drillers, Australia's premier resource stock tip sheet.

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The credit rating of Portugal is still decreasing in the eyes of the rating agencies. This is really dangerous for the country and can cause problems with the debt crisis.

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