Big credit rating agencies face scrutiny

The Financial Times ^ | 4-26-03 | Vincent Boland

[AdamSelene235]

The international credit rating agencies, among the most influential arbiters of investment opinion on Wall Street, are to be investigated by Congress amid a clamour for the industry to be transformed after a series of credit market crises.

A subcommittee of the House Financial Services committee will hold a hearing next month into whether Standard & Poor's, Moody's Investors Service and Fitch Ratings, the three dominant credit rating agencies, offer investors unbiased advice.

Rating agencies provide opinions on the credit-worthiness of corporate and sovereign borrowers.

The agencies were excoriated after Enron collapsed at the end of 2001. They had rated the Houston energy company at "investment grade" until four days before it came crashing down, costing investors billions of dollars in losses.

Richard Baker, chairman of the House capital markets subcommittee, said the aim of the hearing was "to make sure that one of the main sources of information that people rely upon to make informed investment decisions functions with a level of integrity, independence and professionalism that the average investor should be able to expect".

The Securities and Exchange Commission is expected in the next few days to publish a review of the future of the rating agency business, which was called for in the Sarbanes-Oxley act, the controversial legislation on corporate governance passed last year amid a wave of post-Enron corporate and accounting scandals.

The industry is already changing under pressure from competitors and investors.

The SEC granted Dominion Bond Rating Services official "nationally recognised" status last month, allowing it to compete on an equal footing with the Big Three.

Moody's and S&P did not immediately respond to requests for comment on the hearing.

[AdamSelene235]

Good thing all the banks, GSE's,etc, are rated AAA.

[Southack]

Ratings will forever be "influenced" so long as corporations can get away with being "growth" companies rather than pay real, tangible dividends.

But the ratings for those who trade in mortgage backed securities are far less subject to subterfuge due to the fixed payouts of (most) mortgages, the backing by multiple insurance firms and re-insurers, the attachment of liens to real property (read: homes), etc.

[B4Ranch]

A month or so ago I found an article about corporations hiding debts in various ways so the debt would not show on the earnings reports. Honesty is what is missing from most public companies. I seriously doubt that the owners or even the board would not come up with these schemes. Somewhere in the system there is too many slimey accountants and lawyers working together.

[WaveThatFlag]

Notice to all little-guy investors: Get yourself a good financial advisor and listen to his advice. You can not possibly do it on your own, the advice he gives you is worth the added cost, and laws have basically evolved today to the point where you can sure him for just about any losses you incur. The brokerage houses are not advertising this fact, but 99% of all arbitration cases are awarded to the investor. most people just never file a grievance.

Discount brokerage services are for suckers. They make you feel like a genius in a bull market. You get crushed when there is volatitility.

[Southack]

"A month or so ago I found an article about corporations hiding debts in various ways so the debt would not show on the earnings reports. Honesty is what is missing from most public companies. I seriously doubt that the owners or even the board would not come up with these schemes."

These "schemes" only work on the paper books used to track the companies' accounting.

But such "schemes" don't work on dividends.

Either you have the money on hand to paid all of your dividends to your shareholders, or else you don't have the money.

And no amount of scheming is going to pay dividends.

Thus, the *answer* to corporate fraud is to first eliminate the double-tax on dividends, and then to hammer all companies that call themselves "growth" firms (so that they don't have to pay out any dividends).

[AdamSelene235]

So if S&P ratings and Moody's ratings are revealed as untrustworthy, what sort of impact on the markets would you expect?

[GovernmentShrinker]

The key problem, which will be politically very difficult to fix, is that accountants are not expected to detect fraud, and are not liable for losses due to their failure to detect it. "Audited" financials are explicitly based on just a random sample of items checked, and explicitly rely on representations made by management. It will hugely increase the costs of accounting services to change this, but it absolutely has to be changed. When an accounting firm is liable for 100% of losses caused by its failure to detect fraud, they'll suddenly get mighty good at detecting it. Right now, audited financial statements aren't worth the paper they're printed on.

[GovernmentShrinker]

If?

[Tacis]

Don't understand why they are doing this. This will turn into a grand stand event for the house saddamocrats, the Waxmans, Nadlers and fully sgregated, no-whites-allowed Congressional Black Caucus.

The commies will demand racial breakdowns of whaever the catagories are. And, at every level, blacks will have lower ratings than whites. Why?

Well, of course it race and years of slavery. The saddemocraps will demand an "affirmative action" approach where blacks are given 10 points because, well, they are black. The NYT will go berserk and demand a system that will force the price of granting credit way up. They don't care.

This will be one of those classic saddemocrap farces; the data will show blacks are less creditworthy and the commies will scream RACE! Facts don't count to thse racist pipms.

[AdamSelene235]

okey-doke, thank you for sharing.

[AdamSelene235]

If?

Well,as you must know, our wise congressmen routinely hold hearing,years, if not decades, before a crisis occurs.

[WaveThatFlag]

Obviously, credit-sensitive product would sell off, in the short term. But there are several redundant ratings agencies, who police themselves through competition. One default on an investment-grade rated bond would wreck the reputation of an S&P, or Moodys, or Fitch, or Duff & Phelps. But, they are not corrupt, just like the GSEs are in no financial straits, so this point, too, is moot.

[GovernmentShrinker]

Trust me, the market already takes the rating agencies with a huge grain of salt -- it's not waiting for Congress. Much of the drop in the market to date is attributable to the widespread realization that companies with investment grade ratings are very nearly as likely to be on the brink of bankruptcy as those with junk ratings.

[GovernmentShrinker]

One default on an investment-grade rated bond would wreck the reputation of an S&P, or Moodys, or Fitch, or Duff & Phelps.

You make it sound as if this scenario is in the future.

[razorback-bert]

Notice to all little-guy investors: Get yourself a good financial advisor and listen to his advice. You can not possibly do it on your own, the advice he gives you is worth the added cost

The national known and respected firm that administers my 401k, offers only national known and respected mutual funds run by national known and respected financial advisors, who had returns ranging from 1.47% to -33% with more than 80% of funds having a > -10% return.

Meanwhile, my own investments outside the 401k has returned me > 30% return.

I will return to the "experts", when they start producing some real added value to me.

[WaveThatFlag]

You make it sound as if this scenario is in the future.

How so? I pointed out that police themselves specifically because they know this. AdamSelene is in the business of economic fearmongering. I am hear to tell you that the ratings agencies are working just fine, thank you.

[razorback-bert]

The agencies were excoriated after Enron collapsed at the end of 2001. They had rated the Houston energy company at "investment grade"

Enron's "investment grade" bonds aren't in default?

[AdamSelene235]

AdamSelene is in the business of economic fearmongering.

Not at the moment, all my shorts are closed out. I'd love for the market to rally a bit.

Fannie Mae is a great buy. All the analysts say so. Why Yahoo predicts it will hit 90 a share. The banks are in great shape too. Von Mises is a kook. Buy Buy Buy !!

[WaveThatFlag]

The national known and respected firm that administers my 401k, offers only national known and respected mutual funds run by national known and respected financial advisors, who had returns ranging from 1.47% to -33% with more than 80% of funds having a > -10% return

That is not what a Financial Advisor is. If you are not talking to someone intelligent who you trust on a regular basis, then you might as well be on your own. And talking about your 30% return these days is like talking about "the girl from Niagra Falls" back in highschool. You need to put that into context, because it does not sound very plausible. If you were able to generate 30% returns over the last 3 years and you are doing anything other than running a hedge fund right now, you are an idiot. You could be earning millions from people just for keeping their returns positive in a bear market.

[WaveThatFlag]

You're right. All the credit ratings agencies are corrupt. Our economy is in the toilet, and we are headed for the downfall of Western Civilization.

I really have no interest in doing this every week. You people need a hobby.

[GovernmentShrinker]

Oh sure, they did just fine on Enron, NSFE, etc.

[GovernmentShrinker]

NSFE = NCFE

[AdamSelene235]

You're right. All the credit ratings agencies are corrupt. Our economy is in the toilet, and we are headed for the downfall of Western Civilization.

Happily, the cure for decadence is known: Renaissance.

[Starwind]

One default on an investment-grade rated bond would wreck the reputation of an S&P, or Moodys, or Fitch, or Duff & Phelps

I am hear to tell you that the ratings agencies are working just fine, thank you.

Isn't Moody's in fact already guilty of 'defaulting' on it's 'investment grade' rating of Enron, 4 days prior to Enron's collapse? Why hasn't Moody's reputation been wrecked? Are you assuring me Moody's is working just fine or that Moody's rating of Enron was just fine?

[Moonman62]

Either you have the money on hand to paid all of your dividends to your shareholders, or else you don't have the money.

What's to stop a company from going into debt to pay dividends? Utilities, which are traditional dividend payers are loaded with debt.

And no amount of scheming is going to pay dividends.

Didn't the scheming Worldcom pay dividends on its MCI stock right to the very end?

[WaveThatFlag]

What's to stop a company from going into debt to pay dividends? Utilities, which are traditional dividend payers are loaded with debt.

Oh brother...

[zechariah]

But there are several redundant ratings agencies, who police themselves through competition. One default on an investment-grade rated bond would wreck the reputation of an S&P, or Moodys, or Fitch, or Duff & Phelps. But, they are not corrupt, just like the GSEs are in no financial straits, so this point, too, is moot.

Sorry, have to disagree with you there. S&P, Moodys, and Fitch (which bought out Duff & Phelps) DID NOT provide unbiased ratings of insurance companies in the early 1990s. They often did not downgrade FAILED insurance agencies until AFTER the companies had failed.

The US General Accounting Office issued a report on these shenanigans in a 1994 report.

An even more outrageous game is being played with Tax-Exempt bonds. The deal goes like this: when a city or municipality wants to issue bonds, they can buy a AAA rating by issuing the bonds through an insurance company. Then the bond issue gets to advertise the insurance company's rating and supress the rating of the bond itself. The insurance companies, of course, make sure that they get AAA ratings from all the ratings agencies.

Which is not to say that there is necesarily a problem with the ratings of corporate bonds--bond ratings have been falling like the Iguacu falls--but it makes you go "hmmm".

Martin Weiss writes about these and other failures of these ratings agencies in his book The Ultimate Safe Money Guide. Martin, of course, runs his own ratings agency, www.weissratings.com, but I found his book to be a real eye opener.

[z]

[razorback-bert]

You could be earning millions from people just for keeping their returns positive in a bear market.

I am comfortable and don't need the stress of worring about OPM.

[Southack]

"Didn't the scheming Worldcom pay dividends on its MCI stock right to the very end?"

No.

Worldcom paid no dividends at all, and their spinoff stock MCI balked at making their last dividend payment. The final dividend payout to shareholders for MCI was to be in the $100 million range. Their failure to pay that one hundred million (or close to it) Dollars caused an IMMEDIATE drop in the market capitalization of MCI of more than half a Billion dollars.

...And that's *precisely* how the market should treat companies that fail to deliver dividends. They should be hammered immediately, and they should be hammered disproportionately (i.e. their market cap should drop MORE than the amount of the welched dividend payment).

In contrast, a non-dividend-paying company can simply "fudge" its accounting books to continue the charade (until a whistle-blower finally stops the ride). Shareholders are none the wiser because they have no ca$h feedback from such "growth" firms.

[razorback-bert]

You're right.

Yes.

All the credit ratings agencies are corrupt.

No.

Our economy is in the toilet, and we are headed for the downfall of Western Civilization.

Possible, but I don't think so.

You people need a hobby.

We seem to have one in tormenting shills.

[GovernmentShrinker]

Companies need to maintain an optimal level of debt to maximize tax efficiency (built into the tax system -- the companies didn't write the IR Code, but they have to deal with it. Dividends should be covered by earnings; there is no reason there should be any relationship between dividends and debt levels.

[WaveThatFlag]

I would gladly pay you $1mm a year if you could offer me even 10% returns, but that's not my point. My point is that you are full of shit. Its fine to be claiming success in investing. When you you start talking about your 30% returns in a down market, you just sound like an idiot.

[B4Ranch]

LOL Well, life is just a perspective. I just wish I was much more ignorant of all the problems.

[Liz]

The international credit rating agencies, among the most influential arbiters of
investment opinion on Wall Street, are to be investigated by Congress amid a clamour for the industry to be transformed after a series of credit market crises.

Yawn. Ho-hum.......then again, might not be be a total loss.

Gives Dumbocrats something to do - might smell out a
campaign issue or two for their lackluster 2004 candidates.

[WaveThatFlag]

I give up trying to talk sense with these monkeys.

[Starwind]

I give up trying to talk sense with these monkeys.

Perhaps you'd forebear with this monkey a little longer?

Is it not true that Enron has defaulted on Moody's 'investment grade' rating of Enron? Why is not Moody's reputation wrecked? Why do you insist everything is fine at Moody's?

[WaveThatFlag]

No you're right. Moody's is about to go belly-up. Sell your bonds now, while you can. If you need me I'll be in my hillside shack in Montana waiting for the rioting to start.

[Starwind]

No you're right. Moody's is about to go belly-up.

The first red-flag that goes up is when I get flippant or non-responsive answers to sincere questions, from someone who claims to have trustworthy information or experience.

You've had similar non-responses to my desire to understand the derivative exposure faced by FMAE and FMAC.

You advise others to get sound investment advice, but your judgement is to be trusted at face value? LOL! I can imagine the conversation I'd have with my financial planner. "So, Starwind, why are you so sure Enron would be a good investment?"

"Well, because Moody's rates them investment grade, and some guy on the internet said I could trust that information."

[razorback-bert]

When you you start talking about your 30% returns in a down market, you just sound like an idiot.

You make a lot of false assumptions in your rants, I never said, I made these type of returns in the market. There are other places to invest other than Wall Street.

My return from Wall Street last year was 1.46% , does that low return make you happy?

[WaveThatFlag]

My return from Wall Street last year was 1.46% , does that low return make you happy

No, but at least it is realistic. When we are having conversations about securities markets at you say you are up 30% you ought to clarify. My apartment has doubled in value over the last 5 years. Does that mean I'm up 50%?

[WaveThatFlag]

Look enron was giving out falsified information. If you're right, were're all screwed anyway, correct? I don't believe that to be the case, so I don't see much point in continuing this conversation. Do what you think you need to do with your money, I really don't care.

Buy, honestly, in what way was I ever not forthcoming about Fanniemae? Please explain what sort of "derivative" you think Fanniemae is exposed to and I will tell you what the potential risk are. If I feel like it.

[Conspiracy Guy]

Now my 4th question, Who investigates the investigators?

[Starwind]

Look enron was giving out falsified information. If you're right, were're all screwed anyway, correct?

Yes Enron gave out false information. Are we all screwed because Moody's got duped? Not necessarily. But absolutley yes if these corporations are beyond the rating agencies ability or inclination to do the diligence and get a truthful rating. Might the auditor's be culpable? Yes. Might Moody have dug a little deeper, at least at the end? Absolutely. Why didn't/couldn't they? That's what an investigation of the rating agencies ought to determine. Can and will they not make the same mistakes again?

Please explain what sort of "derivative" you think Fanniemae is exposed to and I will tell you what the potential risk are.

Again, in a similar vein, the issue is sufficient disclosure to find out what the risk actually is. A GSE on the scale of FMAE and FMAC ought not to simply be trusted. At their levels, we need to know what the facts are. The issue with derivatives, as I'm sure you're aware, is not so much the contractual language with which they're written, but the statistical and monetary valuations (and underlying assumptions) on the various parametric provisions of the derivative. Many people familiar with options and contracts could read and understand the language, but are the valuations within them realistic? Are the counterparties solvent? Do we trust what the rating agency says about the counterparty?

The devil, as always, is in the details, and I for one have seen too many of the "here's the view from 50,000 feet" assesments go bad.

And while GSE's may in fact not have a contratual binding bailout guarantee from the government, you know the market assumes such a backing exists for a GSE and has priced it in to the FMAE and FMAC. As we have seen with Enron, Worldcom, AA, etc, when executives are comp'd on stock prices and there is no one policing their management, things go badly wrong. When they think they have the government's deep pcokets and secrecy behind them, why should I believe they are likley to be more prudent? If it goes bad we're all on the hook, as taxpayers. And if the GSE's think their governemnt backing isn't needed or important, then perhaps they and the government should announce a no-bailout policy and see what happens to their stock prices.

That is why disclosure and investigation are necessary. Not because of what we should find, but because of what we can't afford to overlook.

And Enron did default, and Moody's gave them a good rating, and Moody's reputation was not wrecked thereby (in contrast to your assertion that one such default would) and I balked at that inconsistency.

[Liz]

That's when you thank your lucky stars for FR.

It's all right here if you surf hard enough.

[razorback-bert]

When we are having conversations about securities markets

No, you and I were discussing "Financial Advisors".

My apartment has doubled in value over the last 5 years. Does that mean I'm up 50%?

That is your call, I am in the camp that a home is a liability.

[WaveThatFlag]

As I've said before, go nuts with it. In the past I have been in a position to know exactly what FNMA was buying and selling. I'm not anymore. But I'm not concerned with it, because I know the nature of what it is they buy and sell and why. They do not buy options or contracts. I am not interested in educating you on the incatrices of the mortgage backedf securities market or the role of GSEs. All I can say is that I am comfortable with the current state of FNMA, and if you have less respect for me because of that, I think I'll survive.

[WaveThatFlag]

This is what I've been trying to say all along. You are right America and I are wrong. Sell you stocks. Sell your bonds. Sell your home. Sell your daughters. Buy gold. Head for the moutains. The end is near.

[razorback-bert]

You forgot guns and ammo.

Just for the record (once again), I am not a gold bug or a doom or gloomer.

I am long on the country and ecomony in long term.

I am in the Buffett-Graham camp, so I look hard at the down side of things.

[Starwind]

All I can say is that I am comfortable with the current state of FNMA, and if you have less respect for me because of that, I think I'll survive.

And the current state of the rating agencies as well it would seem. That is no crime, and I do not think less of you for your honestly held position.

The issue of the anchor article on this thread, and the ones about investigating derivative risk of FMAE/FMAC is simply one where I holding a different opinion, simply seek the facts and the investigation as discussed by the article.

But when you belittle an equally honestly held opinion that an investigation into those companies and transactions seems appropriate, and you evade attempts to highlight your belittling, then you do lose my respect, not that you'll have any trouble surviving without it.

The issue has never been your comfort level with these companies, it has been your belittling others lack of comfort with same.