Ratings Agencies: Utterly Corrupt, In Need of Overhaul

This article could have so many titles:

Who's to Blame?

Why are the wrong people being blames?

The one reform the market desperately requires?

Where was the free market watchdog? No not the SEC......

Why are the rating agencies not owning responsibility for their mess?

Should AIG and Madoffs investors be allowed to sue the Rating Agencies?

Who owns the Rating Agencies and is keeping them out of the press???

The Rating Agencies have held themselves out as our guiding lights in investment they have built a huge business in the niche of advising us what is safe and what isn't and then hung us out to dry. They do the hard work and the heavy lifting providing us with the due diligence we require to make educated and astute investment decisions. As an savy investor you wouldn't dream of loading your pension fund with NR (unrated) or "D" grade bonds months before retirement. It is their commitment to you that your "AAA" investment will be the "best grade, reliable and stable" yet how are they held accountable when these investments prove to be anything but.

In any self regulating system there are checks and balances, many of which relate to the manner in which the market carries out due diligence and how it assesses risk. The more risk one takes the higher the return, which mitigates losses when there is some kind of implosion. The investor normally is philosophical and says, hey I took a risk and had I won the return would have been worth it. It is very true for anyone investing in speculative oil exploration drilling the returns will be huge and you will only invest a small portion of your portfolio. A less speculative investor will wait until oil has been hit and invest in the secondary wells drilled to tap the known reserve, you would naturally be willing to invest more in this than in the exploration. The risk averse investor will invest in the pipeline from the known field to the known refinery, this is where the majority of investors have the majority of their money, including; pension funds, insurance companies, charitable foundations, banks.

The financial implosion we are currently witnessing is the result of the self regulating bodies that held themselves up as our due diligence experts telling us that we were buying a pipeline to an existing oil field from a refinery. This was the coveted "AAA" rating or even slightly lesser rating such as "A" and "AA." They failed us and if anyone should be imprisoned, punished or found fault with it is the heads of these companies who held themselves up as independent and then earned their very revenues from the companies and assets they were supposed to independently rate. This is why the market has no trust now; what was seemingly secure and therefore had such a large proportion of wealth in it is now clearly seen to be unsecure, and investor confidence is shaken to the core.

This confidence must be restored and there is truly only one way to achieve this. The checks and balances need to be trustworthy and more than anything else the current Government needs to make the organizations that decide who we should believe in be honest again. Would I be mistaken in thinking that these agencies are avoiding the limelight due to their owners (McGraw Hill (MHP) owns Standard and Poor's) and the vast profits (often 50% or more) this company makes for them. They are the most culpable entities in the current society. Whilst Madoff is vilified and the SEC is chastised, the rating agencies (Stand & Poor's, Fitch, Moody's) should have been the natural whistleblowers, they have skated by with barely even a mention.

I couldn't believe it when one of my potential investors asked me recently what my bonds "credit rating" was. The worthless piece of paper it would have been written on would have cost me nearly $500,000 to obtain and would have been almost entirely dependent on the information I provided carefully formatted by one of the ex-credit rating agency employees who charge $100,000 or more to guarantee you obtain certain ratings. The system is corrupted, "power corrupts and absolute power corrupts absolutely." These companies have absolute power over which investments flourish and which never make it, yet what is their process, ability and knowledge in handing out these ratings. Need I point out that Enron, Lehman, WorldCom, Texaco, Conseco, Global Crossing, United Airlines (UAUA), GM, GMAC, Countrywide, KMART, Fruit of the Loom, Continental Airlines (CAL), Citibank (C) all held high ratings and the consumers found out before the rating agencies that these were wrong.

I propose that the very first thing the government does before any more bailout money is handed to banks etc is that this system is ripped apart, either nationalize these companies or imprison anyone who gets ratings wrong due to personal gain. Make these entities culpable, why should AIG lose so much money and its investors too when they entrusted their risk quite logically to the rating agencies. People should still do what they are good at and be able to have the confidence to trust other companies in their fields of expertise. I was able to work out that Countrywide's Chairman/ CEO Angelo Mozzilo was selling his stock as fast as he humanly possibly could, it was public information, why couldn't they have raised a red flag 6-9 months earlier when I did..... it's basic due diligence...... When Harry Marcopoulos raised the red flags why didn't they investigate it, it is not the SEC we turn to, to tell us if something is a good risk or a bad, it isn't the SEC that "RATES" something as "LOW RISK".

It is wonderful that these organizations create huge barriers to entry making only mega deals viable and pushing fund managers towards the limits of efficiency where returns will be compromised due to the sheer scale of the investment fund requiring investment. Warren Buffett has underperformed in recent years due to the sheer scale of his fund, and the fact that opportunities are not as bountiful he can't even look at smaller deals as the economies of scale no longer make sense. While he will now make a killing because of his heavily cash weighted position is proof of that.

My call is out to the people - we should punish those who should be punished even if the media won't focus on it, as they own them. The people who told us to trust in garbage are not people we can trust. This sector of the system is utterly corrupt and needs a complete overhaul or else we will be right back here again before you can say next generation.

Long-term credit ratings

Fitch Rating' long-term credit ratings are set up along a scale from 'AAA' to 'D', first introduced in 1924 and later adopted and licensed by S&P. Moody's also uses a similar scale, but names the categories differently. Like S&P, Fitch also uses intermediate modifiers for each category between AA and CCC (i.e., AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB- etc.).

Investment grade

AAA: the best quality companies, reliable and stable

AA: quality companies, a bit higher risk than AAA

A: economic situation can affect finance

BBB: medium class companies, which are satisfactory at the moment

Non-investment grade (also known as junk bonds)

BB: more prone to changes in the economy

B: financial situation varies noticeably

CCC: currently vulnerable and dependent on favorable economic conditions to meet its commitments

CC: highly vulnerable, very speculative bonds

C: highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations

D: has defaulted on obligations and Fitch believes that it will generally default on most or all obligations

NR: not publicly rated

Short-term credit ratings

Fitch's short-term ratings indicate the potential level of default within a 12-month period.

F1+: best quality grade, indicating exceptionally strong capacity of obligor to meet its financial commitment

F1: best quality grade, indicating strong capacity of obligor to meet its financial commitment

F2: good quality grade with satisfactory capacity of obligor to meet its financial commitment

F3: fair quality grade with adequate capacity of obligor to meet its financial commitment but near term adverse conditions could impact the obligor's commitments

B: of speculative nature and obligor has minimal capacity to meet its commitment and vulnerability to short term adverse changes in financial and economic conditions

C: possibility of default is high and the financial commitment of the obligor are dependent upon sustained, favorable business and economic conditions

D: the obligor is in default as it has failed on its financial commitments.

Comments

[john s. gordon:]

in 2001-2008 as long as the rating agencies were beholden financially to the entities submitting their garbage to be rated, what you should expect? a little corruption maybe?
the analog occurs in 'independent' stock analysis where if a brokerage firm gives a poor outlook report on a company's stock, it gets no more new issue business from that firm.
there is always the tendency (read financial incentive) to 'upside' the rating above where it should be. sometimes way above.
> jack

Apr 07 08:32 AM

[henarl:]

Amen Brother Amen! Now that the tide is out, the rating agencies are standing naked on the beach. But somehow these proven inept and corrupt entities are still being relied upon by the financial industry as arbiters of credit worthiness. Old habits and old profitable connections are hard to break, especially if one was in on the take.

Apr 07 01:12 PM

[BerkeleyBob:]

I have repeatedly stated that the rating agencies aided and abetted the fraudulent sale of CDO's, with enormous and adverse collateral consequences. Their opinion as to the value of the underlying assets was wrong, and they have zero credibility when reporting on what they do know and understand, say muni bonds. They provided legitimacy to the transactions of AIG and the investment banks and the structural conflict of interest has been present since the outset. Of course, when everyone is making money, no one complains...

Apr 07 02:23 PM

[THofler:]

While I hate congress' recent actions in re-defining the conditions imposed on those corps. taking TARP money retroactively, I think congress should use any legal means to eviscerate these rating agencies.

Apr 07 03:13 PM

[Fabien Hug:]

The solution would be to invest in BBB rated securities and spread your risk amongst as many issuers as possible and take only senior bonds. For the rest you take gvmt bonds and FDIC insured CDs.
You can't trust rating agencies and you can expect any major overhaul of the system. Enron couldn't make it happen and C or BofA will not make it happen. Look at all the recent talk about GE's rating. It is business as USUAL, like if nothing ever happened.

Apr 07 03:16 PM