The Nonsense From The Rating Agencies Just Won't Stop

 |  Includes: MCO, MHFI, ZION
by: Tom Brown

The ratings agencies continue to find new ways to make themselves look ridiculous. At its analyst day last week, Zions Bancorp (NASDAQ:ZION) disclosed that as one of the inputs to the model Moody’s (NYSE:MCO) uses to value TRUP CDO securities, the agency assumes that—and this is not a typo—1,200 banks will fail in the U.S. this year. That’s right 1,200. That’s not just a conservative assumption. It’s an idiotic one. For perspective, here is the number of failures, by year, since credit crunch began:

2008: 25

2009: 140

2010: 157

2011: 92

So the worst year for bank failures in recent memory got to just 13% of Moody’s assumption. What’s more, there are only 844 banks on the FDIC’s Problem Bank List at the moment--and that number has been falling since the first quarter of 2011. Even if every bank on the FDIC’s list were to fail (which won’t come remotely close to happening) the FDIC would have to find another 356 to shutter to get to Moody’s number. Moronic.

It gets worse. Moody’s model also apparently assumes that if a bank misses a single TRUP dividend payment, it will subsequently fail. Yet over the course of this cycle, roughly 40 banks have suspended TRUP dividends and but later resumed paying them and are still operating. The assumption is preposterous.

All this would all be humorous if it didn’t have the potential for such dire real-world consequences. It was a similar disconnect from reality, for example, that led the agencies to devise the models that concluded that portfolios of subprime residential mortgages should be stamped AAA. We all saw how that ended. And what went into the model at Standard & Poor’s that arrived at the conclusion last August that the United States Government—which, regardless of what your view is of its finances, still presides over the world’s biggest, most productive economy and is the proprietor of the world’s reserve currency—should be rated anything other than AAA? Yet that downgrade put the stock market into such a tailspin that people started talking about the start of a second recession.

These people are unhinged. It’s not that they were perhaps too liberal in their assumptions before and are compensating by being too conservative now. They’re just wrong. The ratings agencies simply can’t be counted on to know what they’re talking about.

What do you think?