Thursday, March 12, 2009

And my rating is "SS"...

[That's for "so-so"]

My goodness, the financial rating business is slowly being exposed as about as impartial and independent as 4-H livestock judges.

Yeah - tell me about it.

So this morning we have GE losing its top tier debt rating from Standard & Poor's.

On Mar. 12, Standard & Poor's Ratings Services lowered its long-term ratings on General Electric Co. (GE) and units, including General Electric Capital Corp. (GECC), by one notch to AA+ from AAA. S&P affirmed the A-1+ short-term credit ratings. The outlook is stable.
The main factor in the downgrade was our assessment of the stand-alone credit profile of financial services unit GECC, which we now view as A, compared to the A+ we had indicated before. [More]

At least initially, the market yawned when the news broke. But maybe after what we have seen lately, if a rating falls in the forest, does it make any sound in the market?
However, there has been serious criticism against the credit ratings by the credit rating agencies. According to experts, in the wake of increasing cases of well rated financial filing bankruptcy has raised the concerns of investors and other regulatory authorities, who heavily depend on these rankings.

Credit rating agencies found to be lax in downgrading companies. Taking the example of Enron, which had filed its bankruptcy, was having investment grade mere four days before its bankruptcy. More interestingly, the credit rating agencies were said to be aware of the company’s financial problems for months before.

In addition to this, many rating agencies have been found to be having familiar relationship with company management, which may lead them to undue influence and thereby fall prey to the investors’ wrath.

The ratings given by the agencies affect the company’s performance, especially when a company is downgraded. The fall in the credit rankings is most often considered as a fall in the credit worthiness of that company. Several recent examples of downgraded ratings of the companies include Goldman Sachs and Lehman Brothers.

According to experts, these financial institutions once held AAA or higher ratings by the rating agencies but later, as their financial conditions started getting into trouble, the rankings started tumbling. But the trust worthiness of these ratings itself has come under doubts, as the rating system is not transparent and the agencies take a suspicious stand while taking about the system of giving ratings to the companies.

These agencies are sometimes accused of being oligopolistic, while sometimes their rating methodology was placed under question, particularly assigning AAA ratings to structured debt, which in a large number of cases has subsequently been downgraded or defaulted. [More]

Investors can choose for themselves, but the incestuous nature of the Big Three agencies and their clients has not changed, nor have new regs been prepared to prevent the obvious conflicts of interest similar to what we have discovered in organic certification.

More damning yet is the panicky legal spin being used by Moody's to cover their liability as irate and much-impoverished investors seek redress from bogus labeling of corporate debt.
So it is with Moody’s Corp. Over the years, the credit- rating company’s constant refrain has been it’s an independent body that publishes its opinions accurately and impartially. Never mind that it gets paid by the same companies it rates. Moody’s says it can manage that conflict of interest.
“The market’s trust in and reliance upon Moody’s” are part of the “raw materials that support our business,” the company said in its 2005 annual report. “Independence. Performance. Transparency,” it went on. “These are the watchwords by which stakeholders judge Moody’s.” Moody’s also cites its code of professional conduct, through which it seeks “to protect the quality, integrity and independence of the rating process.”
Now compare that with what Moody’s told a federal judge in New York last September in response to accusations made in a shareholder lawsuit, which said Moody’s claims of independence were false.
“Generalizations regarding integrity, independence and risk management amount to no more than puffery,” Moody’s said in court papers. As such, alleged “misstatements of this nature are insufficient to sustain a claim under the securities laws.”
Puffery, huh?
Making Sense
Finally, Moody’s has delivered a sensible explanation for how its ratings became so unreliable: It didn’t believe its own platitudes, or at least it didn’t think they would be binding in court. The defense hasn’t worked, though. On Feb. 18, the judge in the case rejected Moody’s puffery argument, and ordered that the lawsuit proceed.
In legalese, puffery refers to an expression of opinion by a seller that isn’t made as a representation of fact. It may be a salesperson’s exaggeration about a product’s quality that isn’t a legally enforceable promise. Or it might be an ad that claims a company’s product is superior, as Black’s Law Dictionary explains it. Think of a dealer who says a car “drives great,” or a beer commercial with the slogan “less filling.”
For all the toxic mortgage-backed securities and structured- finance garbage that Moody’s rated as AAA, I never imagined Moody’s would use the word puffery to characterize the principles it brought to the job of grading investments that wind up in the portfolios of retirement funds and money-market accounts. It would be like the pope revealing that his belief in God was just fluff, or Mister Rogers complaining that small children were awful to be around.[More]
As our financial industry evaporates the presumption of trust in investor minds with breathtakingly slip-shod - if not outright fraudulent - work, there could arise opportunities for rating agencies based on another model.  Maybe the investor should pay, for example.

The rating agencies also argue that even an “investor pays” business model can involve some conflicts, since investors would prefer lower ratings (and thus higher yields) for newly issued bonds, as would anyone who has sold short any other security of the issuing entity. With respect to subsequent downgrades, investors who already own the bonds would disfavor them, while short sellers would welcome them. Nevertheless, the potential conflicts seem substantially less severe than for the “issuer pays” model. [More]
As things now stand I wouldn't let the current market raters judge a skating competition.

Thank goodness the auditing companies uncovered the ill-founded grades in time, huh?

No, wait...

4 comments:

Anonymous said...

The only investment I think is really safe is good midwest farmland. It may fall in value, but it will never go to nothing like Enron and Worldcom. And it pays a dividend every year. And is job security for a farmer!

John Phipps said...

anon:

I hear ya talkin'. I don't think other investments are inherently bad, but land is all I know about, and we're learning something about investing in things you don't fundamentally understand.

As for the job security, it actually gets more important with succeeding generations.

Anonymous said...

Hey now!!!!!! It's hard enough for the Extension service to find judges without you bashing them on the internet. The last 4-H show I judged a fist fight broke out because one of the exhibitors mothers thought that the fix was in. Funny thing is that her kids were the most respectful and considerate showmen. Needless to say I have not judged since.

John Phipps said...

anon:

I understand your defense of Extension, but my local experience has been similar to yours. Because of incidents like yours, judges are hard to find, and the subjective nature of judging, not to mention the hot-trait-of-the-year syndrome make it an insider game too often.

I think it's a farce, not unlike wine competition. If it weren't for the subsequent tractor-dealer-extortion auction, it probably would have died a natural death years ago.