Sunday, 9 October 2011

Credit Ratings Agencies, Part 2.


I discovered that John Moody & Company was founded in 1900 but did not survive the stock market crash of 1907. In 1909, Moody's was started and they initially published Analyses of Railroad Investments and then went on to extend coverage to US municipal bonds. In the 70s, Moody's expanded into commercial debt and began charging bond issuers for ratings, as well as charging investors. From 3 countries in 1975, its analyses covered over 100 countries in 2000. Announcements by Moody's of possible or actual downgrades of a country's bond rating can have a major political and economic impact, as we have seen. The irony is that until they went bankrupt in 2008, companies such as Lehman Brothers and AIG had AAA and AA rating.

In the publication “Business Insider”, a former senior analyst William J. Harrington, says that the ratings agency is rotten to the core with conflicts. See here for a full report He describes a culture of conflict that is so pervasive that if often renders Moody's' ratings useless at best and harmful at worst as the management and “compliance” officers do everything possible to make issuer clients happy. Of course they do......they are paying the agency

Here is a telling story about the German insurer Hannover R, who were offered a free rating by Moody's. The insurer refused. Moody's continued with the free ratings but over time lowered its rating of the company. Still refusing Moody's services, Moody's lowered Hannover's debts to junk and the company in a few hours lost $175 million in market value.

Furthermore, as the housing market collapsed in late 2007, Moody's Investors Services, whose investment ratings were widely trusted, responded by purging analysts and executives who warned of trouble and promoting those who helped Wall Street plunge the USA into its worst financial crisis since the Great Depression. A McClatchy investigation has found that Moody's punished executives who questioned why the company was risking its reputation by putting its profits ahead of proving trustworthy ratings for investment offerings.

I see there is a warning on the source of the previous and the following paragraph to the effect that the neutrality of these sections is disputed.

Portugal's foreign debt downgrade to the category Ba2 (junk) has infuriated the European Union and Portugal alike. Moody's has been accused of fuelling speculation and bias towards European assets.

Standard & Poor do not come out any better on closer examination. Credit ratings of AAA were given to large portions of even the riskiest pools of loans. Investors who trusted the low risk profile , purchased large amounts of collateralised debt obligations that later became unsaleable. Those that could be sold often took staggering losses. Companies pay S & P to rate their debt issues and some critics have contended that S & P are beholden to these issuers and its ratings are not as objective as they ought to be. A “paying to play” model makes their ratings meaningless.

Time” magazine wrote “when both S & P and Moody's granted AAA ratings to collateralised debt obligations that were chock-full- of- crap mortgages, thereby helping to precipitate the 2008 financial collapse. The Washington Post said that Standard & Poor didn't just miss the bubble, they helped cause it”.

When the US was downgraded, some have accused S & P of causing further damage for its own agenda. S&P acknowledged making a USD$2 trillion error in its justification for downgrading the US credit rating but stated that it “had no impact on the rating decision”. “A judgement flawed by a $2 trillion error speaks for itself” said a spokesman for the U.S. Dept. of the Treasury.

Finally, this is the bit that leaves me feeling as if I'm living in a global cesspit: an S&P rating, e.g. of the US government or any other national government can have – and has had – a distinct effect on a truly global scale. But the decisions on these ratings are made by the company's employees who are not elected by the public , and are not accountable for their decision-making process. There is no appeals process against a credit-rating decision.

William Harrington's story here bears further reading to discover what goes on behind the scenes.

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