Europe Looks to Break US Ratings Monopoly

[icymist]

Few doubt that US ratings agencies contributed greatly to the global financial crisis. Europe is now worried that the euro could also fall victim to credit downgrades -- and is exploring the possibility of creating its own ratings agency.

People like Brian Coulton aren't exactly the most popular figures in the financial industry these days. Politicians, in particular, aren't particularly keen on him and his ilk either. Coulton, the European chief analyst for the ratings agency Fitch, was largely responsible for the downgrading of Spain's credit rating late last month. It was a move that once again sent stocks tumbling in New York and the euro down against the dollar.


Coulton doesn't accept any of the blame. "We performed our assessment, and that's it," he said tersely. The reason for the downgrade, he added, is concern that the austerity program announced by Spanish Prime Minister José Luis Rodríguez Zapatero on the previous Thursday would throttle economic growth. He declined to comment further.

<snip>
The effect means that governments have to pay more to borrow money. Spain, for example, will be facing much higher interest rates now when it seeks to refinance €16 billion worth of bonds which mature in July. The higher interest rates, in turn, makes borrowing riskier and makes the country more vulnerable to further downgrades, which in turn leads to even higher yields -- the beginning of a vicious cycle.

http://www.spiegel.de/international/business/0,1518,699564,00.html

[notesdev]

1. These ratings shouldn't be respected to begin with

They're just a shortcut for lazy investors not to do their homework and let someone else do the thinking for them.

Investors like that deserve to get it in the shorts, and lo and behold that's just what happened.

[unblock]

3. generally speaking it's true that investors should get what they deserve if they're lazy, however,

having worked on quite a number of rated transactions, i know that rating agencies can and do go on-site to investigate, and collect reams of documents and tons of data.

while that's no guarantee that they come to the right conclusion, it's not fair to put all the blame on the investor, who is limited to publicly and practically available information. if i, as an investor, were to call up a company's cfo and ask for the kind of information they give to the rating agencies (or, more to the point, the kind of information i believe the rating agencies SHOULD have asked for but didn't) i'd simply be laughed at (if i could even reach the cfo).


regarding specifically the real estate issues, it's true that a lot of the relevant information (in hindsight, at least) was essentially publicly available, in the sense that you could go to any bank and ask them what their lending standards and ratios were, but the key point was how systemic the risks were, so as a practical matter, i'm not sure how an investor should have known that "too many" banks were using "too loose" lending standards.

that's something the rating agencies were obviously in a great position to know about, since they rate so many banks and deals, but i'm having a tough time pinning this on every random investor.

[notesdev]

7. On lending standards

Anyone who understood the loan business would have been seeing the red flags all over the place. NINJA loans, no doc loans, option-ARMs as a mass market product, bubble valuations... heck, they had no fewer than 3 regular TV shows dedicated to "flipping" houses alone. Standards were so far off traditional lending standards that there is no excuse not to have seen it. Heck, *I* saw it as early as 2005, knowing next to nothing about the market at that time - the alarms were going off all over the place.

A cardinal rule in investing is "never put your money in something you don't fully understand".

[unblock]

10. agreed, banks were obviously engagining in risky loans, but it's the proportion that's hard to see

of course banks are going to have a portion of their assets in investments of varying degrees of riskiness, so of course they are going to have some of their loans in the riskier forms, presumably at superior spreads and fees to compensate for the extra risk.

the real question is how to determine if the portion invested in riskier loans was "too much". investing 20% of a bank's assets in option-arm loans wouldn't have killed anyone, but lehman essentially bet many multiples of their net worth on risky loans. THAT's the problem and that's not as easily determined by the average investor.

[notesdev]

11. Combine it with leverage ratios

The failed banks were all levered up 30:1 or more; Fannie and Freddie are levered up 80:1 (still).

edit (clarifying): a leverage ratio of 30:1 means that only a mere 3.3% of the instruments they held needed to go bad before the entire equity in these companies was wiped out!


Under Glass-Steagal, the law enacted during the Great Depression to prevent just this sort of thing and then repealed under Clinton, the maximum safe leverage was considered to be 10:1.

This whole situation was screaming "bubble". I remember clearly at the time, people were so greedy they thought that housing could never go down. They acted for the purpose of personal profit; that comes with risk. Eventually the downside of risk catches up, which is just what happened.

The essence of risk, which is inherent to any type of investment, is that there is a chance that things will go against you. I remember quite clearly people from all walks of life not only ignoring but mocking the idea that risk might come back to bite them. It was free money and the people who weren't on board (like me) were stupid for not getting in on the gravy train.

All the data that presaged the crash was out there, there were quite a number of people screaming their heads off about it warning people, people didn't want to listen to those crashing the free-money gravy train.

[On the Road]

4. You are Kidding, Right?

Before you buy a security, you send a team of accountants to analyze every piece of public information to estimate the risk of bankruptcy? Otherwise, buyer beware.

("Jeez, I should have known that MCI treated capitalized software as an expense item.")

Good libertarian principle. Very friendly to companies that are less than honest.

:eyes:

[notesdev]

6. Nope I'm not kidding

"Very friendly to companies that are less than honest."

Tell me, how could that be any friendlier to dishonest companies than the system we have been using? As it stands now, a company can be lying wholesale about its financial position and still get a AAA rating.

If its books are so complex that you need a team of accountants to analyze them, then that should be a red flag that tells you the risk is a lot higher than is advertised.

Ownership comes with responsibility. If a company wants an investor's money then the company should be able to provide assurances that the investor's profit seeking, by way of making the investment in that company, is honest business. If they can't then no one should buy the stock.

[Statistical]

9. No AAA company has defaulted in last 20 years.

There currently are only 4 companies in entire world with AAA rating from all 3 major agencies:
Automatic Data Processing (NYSE:ADP)
Johnson & Johnson (NYSE:JNJ)
Microsoft (NASDAQ:MSFT)
ExxonMobil (NYSE:XOM)

When it comes to sovereign debt there are less than 2 dozen countries with AAA (out of 256).

Country        Rating   Date Rated      Outlook
Australia      AAA	16-Feb-03	STABLE
Austria        AAA	9-Jul-75	STABLE
Canada         AAA	29-Jul-02	STABLE
Denmark        AAA	27-Feb-01	STABLE
Finland        AAA	1-Feb-02	STABLE
France         AAA	25-Jun-75	STABLE
Germany	       AAA	17-Aug-83	STABLE
Guernsey       AAA	10-Feb-09	STABLE
Isle of Man    AAA	29-Feb-00	STABLE
Liechtenstein  AAA	2-Dec-96	STABLE
Luxembourg     AAA	28-Apr-94	STABLE
Netherlands    AAA	1-Oct-88	STABLE
Norway	       AAA	9-Jul-75	STABLE
Singapore      AAA	6-Mar-95	STABLE
Sweden	       AAA	16-Feb-04	STABLE
Switzerland    AAA	1-Oct-88	STABLE
United Kingdom AAA	28-Apr-78	NEGATIVE
United States  AAA	1-Jan-41	STABLE

Now I agree the agencies utterly fucked up on MBS but credit ratings of companies has been historically very accurate.

Cumulative Historic Default Rates (in percent)
------------------------------------------------------------------------
                                        Moody's               S&P
        Rating categories        ---------------------------------------
                                    Muni      Corp      Muni      Corp
------------------------------------------------------------------------
Aaa/AAA.........................      0.00      0.52      0.00      0.60
Aa/AA...........................      0.06      0.52      0.00      1.50
A/A.............................      0.03      1.29      0.23      2.91
Baa/BBB.........................      0.13      4.64      0.32     10.29
Ba/BB...........................      2.65     19.12      1.74     29.93
B/B.............................     11.86     43.34      8.48     53.72
Caa-C/CCC-C.....................     16.58     69.18     44.81     69.19

[notesdev]

12. Timely news

http://preview.bloomberg.com/news/2010-05-14/s-p-cuts-to-junk-home-mortgage-bonds-that-it-rated-aaa-quality-last-year.html

From AAA in 2009 to junk in 2010... anyone who relies on these ratings rather than doing their own homework is a fool, and likely a poor one.

[On the Road]

5. dupe

[depakid]

2. Since the Obama administration has no intention whatsoever of holding them accountable

more power to the EU.

[closeupready]

8. Competition is good. The rating agencies failed miserably.

We need more players.