Monday, 8 June 2009

Credit Rating Agencies are Punks!

Paul Sweeney: Ireland’s sovereign credit ratings were cut for the second time in just three months on Monday 8th June 2009 because of concern about the soaring cost of bailing out the country’s ailing banking sector.

Standard and Poor’s has cut Ireland’s long-term sovereign credit ratings to double-A with a negative outlook. It was double-A plus. Ireland had lost its prized top-notch triple-A rating in March.

S&P also warned that Ireland could suffer further downgrades should the banking system deteriorate further.

But who are these rating agencies? They are private corporations whose bosses are paid in much the same way as the CEOs of most MNCs – by pumping up share (or other) values. S&P, Moodys and Fitches are the major ones and these are the same rating bodies that labeled junk loans as AAA rated. The buffoons in the banks, who should have know better, trusted these three agencies and bought vast sums of junk debts, paid much too much for it. Now and for many decades to come the taxpayers of the world bail out their mistakes. In the meantime, the rating agencies push up the price of money for us by cutting our countries’ ratings. Are they still getting it seriously wrong?

In the US, instead of being punished for their enormous economic crimes, S&P, Moodys and Fitches have been rewarded for bad behavior (just like the banks with state rescues). The US Federal Reserve will now only accept collateral for its Term Asset-backed Loan Facilities (TALF) if it has been rubber stamped by one of the major rating agencies, i.e. one of the Nasty Trio. This upsets seven other rating agencies which have been recognised by the US SEC.

A year ago, Securities and Exchange Commission (SEC) concluded that the Credit Rating Agencies failed to properly manage conflicts of interest in assigning top ratings to bonds backed by subprime mortgages and other assets. It set new rules for governing the credit rating industry after its probe into the three big agencies, Standard & Poor's, Moody's Investors Service and Fitch Ratings.

While any casual listener to RTE knows the names of at least two of the Trio, few would know the names of the other seven. We are so used to reverential homilies from the Stockbroker Economists and financial commentariat on radio, groveling to the supposed pearls of wisdom from the Nasty Trio Rating Agencies, that we all know at least two of their names (Fitches is less well known, being newer).

It is estimated, according to the Economist, that fees of around $400m will be paid to the Nasty Trio of Rating Agencies for work as the exclusive club of “advisors” to the TALF. The Inspector General of the US government’s bank rescue wants the US Treasury to stop using rating agencies and to undertake the screening of loans itself. But the era of privatisation and outsourcing to incompetent private firms lives on, yet.

Angel Merkel, not a radical, called for a European credit ratings agency to balance the dominance of Moody's and S&Ps. "Europe has developed a certain independence thanks to the euro" but "in terms of the rules, the transparency guidelines and the entire standardisation of financial markets, we still have a strongly Anglo-Saxon-dominated system,” she said - last year!

Various authorities in Europe have been highly critical of the role of rating agencies in the credit crisis - especially of their facilitation of the boom in complex structured bonds. The European Commission and other bodies have been working to push through legislation before the European parliament to curb them and regulate them. Credit rating agencies might be regulated in Europe by a single body. Ratings for debt granted outside the EU would be endorsed by an EU-registered credit rating agency unless the third-country rating complies with an "equivalence criteria", meeting the standards set by the EU legislation. Not before time.

But industry insiders are fighting against such regulation and are opposed to Brussels' plans for regulating the credit rating agencies, arguing that they threaten to bring in financial protectionism in debt markets!
Internal emails from the Rating Agencies reveal a lot. They show that the rating service employees knew they were acting fraudulently. Employees at Moody's told executives that issuing dubious creditworthy ratings to mortgage-backed securities made it appear they were incompetent or "sold our soul to the devil for revenue,'' according to e-mails obtained by U.S. House investigators. The Securities and Exchange Commission last year found the credit-rating companies improperly managed conflicts of interest and violated internal procedures in granting top rankings to mortgage bonds.

An e-mail that a S&P employee wrote to a co-worker in 2006, obtained by committee investigators, said, "Let's hope we are all wealthy and retired by the time this house of cards falters."

Here are emails from two unidentified Standard & Poor's officials which tell all. They are about a mortgage-backed security deal:-

“Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right...model def (definitely) does not capture half the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we would rate it.”

And yet government officials in sovereign nations still quake in their boots when these punks (what else are they?) make a pronouncement on our economic health!
Why government officials should still be in such awe of these discredited Ratings Agencies today tells us much about the subservient, cap-doffing, attitudes that still prevail in high places of government. Instead of groveling, sovereign nations should cooperate together on rating debt and make Credit Rating Agencies history!


Pavement Trauma said...

Undoubtedly influenced by the fat fees they made from such things, the credit ratings agencies were disasterously wrong on their ratings of 'toxic' CDOs - but they were wrong on the lenient side, giving out AAA ratings when they should have been BBB or worse.

While the people that issued the downgrades might all be a terrible shower that enjoy downgrading small vulnerable countries and never call their mothers, it does not mean their opinions are actually wrong. They have recalculated what they think the costs to the country will be to support the banks and found it a lot higher than they previously thought. Therefore the chance of defaulting on our bonds is higher than they previously reckoned. Therefore the ratings were downgraded.

The article is a straight ad hominem argument. Is there any case that we don't deserve our credit rating to be lowered?

Donagh said...

The whole point behind the rate set by the agencies, and the reason we are told its something to be concerned about is because the rating is supposed to be indicator to investors whether it is a good idea to buy a certain country's debt or not. However, these days, the rating agencies are so cautious that all they are trying to do is reflect what investors already think, by following the Credit Default Swap rates. The agencies are dropping their rates for the same reason that the price of Credit Default Swaps are rising. Because they still don't know at what price NAMA is going to put on the assets it takes from the banks.

Also, have they really recalculated what they think the costs to the country will be to support the banks? If so they should let us know. It would clear up a lot.

Pavement Trauma said...

From the FT:
"S&P said in a statement: “We have lowered the long-term rating on Ireland because we believe that the fiscal costs to the government of supporting the Irish banking system will be significantly higher than what we had expected when we last lowered the rating in March.”

The cost of rescuing Irish banks may rise to as much as €25bn (£21.6bn) against S&P’s previous forecast of between €15bn and €20bn.

S&P took its decision after the recent announcement that losses at the nationalised Anglo Irish Banks were at the upper end of its expectations.

The agency fears the scale of the government’s bad-bank plan, in which the Irish state will start taking on the liabilities of bank loans and assets with a book value of up to €90bn from July, could cause national debt to surge past 100 per cent of gross domestic product next year from about 41 per cent last year."

We take heed of changes in ratings because the institutions / people who buy Irish Government debt pay close attention to them, indeed some are not allowed buy debt below a certain rating. While it might be tempting to ignore them, stick our fingers in our ears and shout 'not fair, it's just not fair', credit ratings matter. We ignore them at our peril.

paul sweeney said...

My point on the Rating Agencies is that they really screwed up in the past. They undervalued risk and it is possible as Donagh says, they are cautious now because they are over-valuing risk. The so called "Markets", which are supposed to tbe "out there" somewhere, objective and all-knowing (I heard yet another Financial journalist, John Murray Browne of the FT, on Vince Browne bowing to their infallibility on TV3) of course, very often, get it wrong. And did "The Markets" get it wrong on the under-pricing risk, on the value of property, on the value of shares, on the value of banks - for years! The rating agencies re too important tt be in the private sector and should be natinalsied eg as part of an international body like the IMF or OECD. Why world leaders are not implienting this now beggers belief. It bodes badly for all our economic futures.