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What the Ratings Agencies really do. Liars Lexicon - Support Uplift
Golem XIV - Thoughts | Tuesday, 26 July 2011 | David Malone

Posted on 07/26/2011 11:47:39 AM PDT by JerseyHighlander

Tuesday, 26 July 2011

What the Ratings Agencies really do. Liars Lexicon - Support Uplift

The news of the last week or so has been full of Ratings Agencies downgrading banks, bonds, debts and even entire nations. So now seems like a good moment to look at what it is the Ratings Agencies, Moodys, S&P and Fitch, actually rate? What do they consider in coming to their conclusions and can they be said to in any way be objective?

What people like me used to think, if we ever considered the subject at all, was that the Ratings agencies looked at the details of financial products, such as bonds and securities, and much like "What Car?" does for cars they would give an informed, expert review based on lots of technical comparisons and standards. It was nerdy stuff for finance wonks.

If that was ever really the case, it certainly isn't now. And the key to understanding why not is the term "Support Uplift".  Support Uplift is the term used to describe how much financial "support" a national government is giving or is likely to give to its banks. By 'financial support' the agencies mean any and all of the various bail-out and bail-in measures from buying of bonds to taking bad debts on to the public purse - anything which 'helps' the bank. 

On one level this seems both straightforward and reasonable. The agencies are trying to ascertain the likely health of a bank, or some bonds or a Nation and since part of that calculation is figuring in any help the banks, bond issuers or nations can expect to receive, it's only reasonable that the agencies take it in to account. 

The problem is that 'support uplift' is actually quite unlike the rest of the data the agencies use. When Moodys 'measures' and figures in the amount of 'support uplift' a bank is expected to get  from a government what is being measured? Here's a quote from a Daiwa Securities research note looking at ratings and downgrades.
According to Moody’s, the senior debt ratings of European banks incorporate an average of 2.5 notches of systemic support uplift.
It sounds reassuringly professional, financial and technical, but is it?  The ratings in question do incorporate lots of technical financial numbers: Interest rates being paid, durations of liabilities, risk quotients on those loans, capital holding risk weighted by type etc.  But "systemic uplift" is a 'measure' of what a government might do and how likely it is to do it. What the government 'might do' might be considered financial but how likely it is to do it and for how long it will have the political mandate to do it is political and ideological. And yet it is being slipped in with the rest of the data.

This might not be important when 'support uplift' is a very minor consideration - when all is well. But we all know that for the last three years and for the foreseeable future 'support uplift' is the difference between solvency and death for the banks. 

From the same report,

The below chart highlights the number of notches of support factored into Moody’s senior unsecured ratings for some of Europe’s largest banks.
The reliance of UK bank ratings on support uplift is notable. It was, therefore, unsurprising to see Moody’s place the senior ratings of the majority of UK banks on review for possible downgrade just this morning as it seeks to reassess the level of support it incorporates into these ratings.
Moody’s senior unsecured ratings and “notches” of systemic support uplift 
Source: Moody’s and Daiwa Capital Markets Europe Ltd.

A notch is one whole rating level from say, Aaa to Aa1 in Moody's terminology. So for RBS for example to have 'support uplift of 5 notches means actually the fate of the bank is determined by this one non-technical political part of the assessment. Remove government support for RBS and it drops 5 notches which would kill it.  Here a chart of the ratings so you can see for yourself what 5 notches is.

Moody's S&P Fitch
Long-term Short-term Long-term Short-term Long-term Short-term
Aaa P-1 AAA A-1+ AAA F1+ Prime
Aa1 AA+ AA+ High grade
Aa3 AA- AA-
A1 A+ A-1 A+ F1 Upper medium grade
A2 A A
A3 P-2 A- A-2 A- F2
Baa1 BBB+ BBB+ Lower medium grade
Baa2 P-3 BBB A-3 BBB F3
Baa3 BBB- BBB-
Ba1 Not prime BB+ B BB+ B Non-investment grade
Ba3 BB- BB-
B1 B+ B+ Highly speculative
B2 B B
B3 B- B-
Caa1 CCC+ C CCC C Substantial risks
Caa2 CCC Extremely speculative
Caa3 CCC- In default with little
prospect for recovery
C D / DDD / In default
/ DD
/ D

Thus while the ratings agencies do all the financial number crunching and present their findings as the product of technical know-how and expertise, giving them a patina of objective quasi-scientific respectability and objectivity, they are neither.

The key factor in their ratings is a 'measure' of ideological belief (the belief that supporting a bank is the 'best' thing) and of the political will and brute power to enforce the decision. I put measure in quotes because it isn't actually a measure at all. It is a guess of the political current. The problem is when that guess is incorporated into a rating on a bank it becomes a very powerful comment upon the political decisions and mood of an entire country. If the rating agency thinks the support uplift is solid the banks and their debt are boosted up and the bank gets a 'good' rating. If the political current seems to be ebbing away then the notches of support uplift is subtracted and the bank gets downgraded to a 'bad' rating.  

The Rating Agencies have, by this means become a very powerful lobby group for a particular ideological and political commitment to bailing out the banks. If that is how we clearly understood their rating s I would have no problem with it. They would be like any other bank lobby  group and think tank, trilling about how we must save the their clients. We would say to ourselves, "Well they would say that wouldn't they" and weight their opinion accordingly. But the Ratings Agencies, the banks, the media and our governments have not been at pains to make sure we understand the real nature of what the Ratings Agencies do. They have been, it seems to me, rather happy to allow us to think the agencies offer objective scientific assessments as if they were 'Which Bank" magazine.

They aren't. I think they are far better seen as a sophisticated part of an aparatus for justifying and propping up the political and ideologial prejudices of the global financial class.

So when the Daiwa report conludes,

We don’t expect systemic support uplift to be entirely removed from the senior unsecured ratings of Europe’s biggest banks as they will remain so large and complex that governments are likely to be reluctant ultimately to subject them to the same resolution process as smaller, less systemically-important, institutions.
what I read is a concise summary of a political not a financial situation. To me it says, "The European political establishment can be counted on to let the banks remain too large to be controlled and thus continue to feed off the public purse for as long as the banks deem it necessary. "

And this from a Moodys' report from 24th May 2011,
Current levels of systemic support account for two to five notches of uplift for the large UK banks and one to five notches of uplift for the small to medium-sized financial institutions. Moody's expects to retain a high level of systemic support uplift in the senior debt ratings of the major UK banks, as the rating agency believes that the regulators do not currently have all the tools necessary to resolve such institutions without causing financial instability.
"Do not currently have all the tools necessary" or 'have been persuaded not to adopt them'? And the key to it all "...without casuing financial instability."  We don't want financial instability do we? So systemic support uplift for the banks must be essential?

But is the support uplift we are ginving to the banks at our expense causing a greater financial instability? Moody's doesn't mention that. They don't measure it either. So it does not appear in their 'objective' reports.

The ratings agencies are a paid and bought lobby group who work for the banks. Their job is to create spurious pseudo-scienctific justifications for what the banks want our governments to do.

TOPICS: Business/Economy; Extended News; Government
KEYWORDS: banking; fitch; moodys

1 posted on 07/26/2011 11:47:46 AM PDT by JerseyHighlander
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