Ratings Agencies' Mysterious Changing Forecasts

By James Kwak

Calculated Risk has a routine post about S&P increasing its loss projections for subprime and Alt-A loans and for the mortgage-backed securities built out of those loans. These announcements have been so common over the last several months that I usually don’t even think about them. But today I had a thought about them: these are forecasts, which means that they should not get worse just because the economy is getting worse. Forecasts should only change when there is new news that affects expectations about the future. So if you take these rating agency reports at face value, they imply not only that the economy is getting worse (by traditional measures such as the unemployment rate), but that there is new bad news about the future of the economy, despite all this talk you hear about green shoots and a recovery. If there is only old news, then that should have been “priced in” to S&P’s forecasts already.

So what gives? Do the rating agencies see some new perils in the economy that are being overlooked? Or are they just stretching out a writedown in their forecasts over several quarters? Under the latter theory, they should have known what would happen to subprime and Alt-A loans the same time people like Calculated Risk did – that is, several months ago – but it would be too embarrassing to do a massive writedown all at once, so they are spreading it out over time for respectability.

Comments

[Gtarras:]

thank you, James! about time people bring this issue up. I do believe that RAs are now under so much pressure to fix their reputation that they go overboard in different direction. It is evident not only in the forecasts you mention, but their corporate rating actions recently. They helped to inflate the bubble, now they are doing their best to hurt business.

Jul 07 11:37 AM

[notsosmart:]

they are bs & should be ignored.maybe these agencies will go away if nobody pays attention to the games they play.

Jul 07 12:22 PM

[Mark54:]

Another game that they are playing comes in the timing of the downgrades. I saw a slew of bonds downgraded this week. Convienently after quarter end. My thought is they are protecting bank quarter-end capital positions rather than issuing a downgrade when it is appropriate.

Jul 07 01:57 PM

[Graham and ...:]

The rating agencies "make it up as they go" (at best). They have zero foresight, which is why they should not be rating prospectively. And people don't usually pay for "retroactive" ratings.

Jul 07 02:15 PM

[BlackyBlack:]

Why do these exist again? I keep forgetting.

Jul 07 03:57 PM

[Tom Armistead:]

The last couple of days I have been wondering about models, whether anybody and that would include S&P, Moody's and Fitch has a model that can handle all the variables involved in the housing crisis and predict a turning point.

Back in 1985 in my area real estate prices turned on a dime, in January it seemed like it was impossible to sell anything, by summer there where bidding wars and houses were selling for more than the asking price.

Likewise in Property and Casualty Insurance prices are cyclical and can go down for years at a time, only to suddenly increase by 20 or 30% when the companies finally get tired of losing money. Too bad Moody's or S&P cn't predict that sort of thing - I wonder if they even think its possible.

Jul 07 07:48 PM