While Warren Buffett is out tarnishing his reputation with quotes about how "phenomenal" the ratings agencies’ business model is, Bill Gross is accusing them of aiding and abetting the financial crisis.
Here’s a quote from Bill Gross’ latest monthly missive. In it, he is quite dismissive of the ratings agencies and implies they were enablers of the extraordinary popular delusions which were manifest during the bubble years.
In all of the hullabaloo over Goldman Sachs (NYSE:GS), a CQ analysis of the rating services – Moody’s (NYSE:MCO), Standard and Poor’s and Fitch – has escaped front-page headlines. Not that a number of observers haven’t been on to them for a few years now, including yours truly. Back in July of 2007 some of you will remember my description of their role in the subprime crisis. “Many of these good-looking girls are not high-class assets worth 100 cents on the dollar. You were wooed, Mr. Moody’s and Mr. Poor’s, by the makeup, those six-inch hooker heels and a ‘tramp stamp.’” Now, it seems, I was a little long on humor and a little short on the reality. Tramp stamp and hooker heels do not begin to describe the sordid, nonsensical role that the rating services performed in perpetrating and perpetuating the subprime craze, as well as reflecting the general deterioration of investment common sense during the past several decades. Their warnings were more than tardy when it came to the Enrons and the Worldcoms of ten years past, and most recently their blind faith in sovereign solvency has led to egregious excess in Greece and their southern neighbors. The result has been the foisting of AAA ratings on an unsuspecting (and ignorant) investment public who bought the rating service Kool-Aid that housing prices could never really go down or that countries don’t go bankrupt. Their quantitative models appeared to have a Mensa-like IQ of at least 160, but their common sense rating was closer to 60, resembling an idiot savant with a full command of the mathematics, but no idea of how to apply them.
But I come not to bury the rating services, but to dismiss them. To tell the truth, they can’t really die – they serve a necessary and even productive purpose when properly managed and more tightly regulated. A certain portion of the investment world will always need them to “justify” the quality of their portfolios. Governments and regulatory bodies say so – it’s the law. In 1975 the SEC officially designated the aforementioned three rating agencies as “Nationally Recognized Statistical Ratings Organizations.” For all intents and purposes, that meant that regulated financial intermediaries such as banks, insurance companies and importantly pension funds would be guided by the sanctity of their ratings.
Such services, however, while necessary in the ongoing scheme of financial regulation, are overpriced as well as subject to the influence of the issuer, which in turn muddles their minds and clouds their judgment to say the least. E-mails from S&P employees have been cited discussing massaging subprime statistics in order to preserve S&P’s market share relative to their two competitors. PIMCO’s Paul McCulley said it as only he can – “[The breakdown of our financial system] was about the invisible hand having a party, a non-regulated drinking party, with rating agencies handing out the fake IDs!”
Let’s take Gross’ analogy one step further. So, you have market party-goers on a pub crawl from the bars of the internet bubble to telecom overbuild to home builder stock to mortgage backed securities. The ratings agencies are outside the pubs handing out fake IDs. The regulators stand watch as doormen, letting practically anyone into the bar. And Alan Greenspan was the bartender pouring the alcohol down people’s throats. Sounds like a recipe for a big hangover, if you asked me. Is the bar of sovereign credits the end of the line for this pub crawl?
Lovin’ Spoonful – Bill Gross, PIMCO Investment Outlook, May 2010