bondboy

The Rating Agency Scapegoat Cycle

The reference to Egan Jones is badly misplaced. That firm employs a total of nine credit analysts and three supervisors (including Jones and Egan) who cover some 800 corporate credits. While stretched awfully thin, they apparently do a good job on corporates. But the firm conducts no analysis of asset backed securities (source: 2008 SEC filings at Egan Jones website). There are more than 100,000 individually rated asset backed bond issues outstanding; staffing needs are huge to be in that business.

In Search of the Next Big (Widening) Thing

"often ridiculed Egan Jones" ???

When, where and by whom has Egan Jones been ridiculed? Please provide specific references; I've seen none of that.

Your article is interesting and well written, though Egan Jones conclusion of a 42.8% worst case recovery is a head scratcher.

Should We Abolish Credit Rating Agencies?

It's been a while since I worked at a rating agency, but we were privy to non-public data from virtually everybody we covered.


On Jan 11 11:56 AM Freund Investing wrote:

> "As to your second point, the conflict inherent in the "issuer pays"
> model has been debated for at least the past 35 years and will probably
> be debated for the next 35 years. It is the same conflict faced by
> the accounting profession; shall we do away with audited financial
> statements?"
>
> No, we shouldn't. We rely on folks like PwC to look at the things
> we cannot look at (such as internal controls over data) and make
> a decision as to whether or not they cooked their books. The difference
> is that all the data PwC looks at is mostly private, whereas all
> the data the rating agencies look at is public. Can I go look at
> a company's security policy and determine whether segregation of
> duties exists within individuals access over financially significant
> - and bottom line affecting - data? No. Can the market make the determination
> over whether a bond should be rated AAA or AA? Yes. Not perfectly,
> but at least the incentives are aligned.
>
> And in a perfect world, we would do away with financial auditing,
> it's just not feasible. Take a look at Satyam.

Should We Abolish Credit Rating Agencies?

You ask 'why bonds can't be rated the same way equities are: the free market?' Well the short answer is that they already are and have been for many decades! All larger sell side firms employ scores of bond analysts who make very lucrative careers out of second guessing the agencies' ratings; such analysts research is typically available to the firms' institutional bond customers. Aside from the institutions being bombarded with sell-side bond research, such institutions employ a huge number of bond analysts doing research in house. As to the rating agencies themselves, the SEC's "nationally recognized" list totals around 10 outfits, at least three of which appear to exclusively use the "investor pays" business model. The difference between the major rating agencies and their sell-side, institutional, and "investor pays" competitors, is that most competitors tend to cherry pick the market, focusing on only the largest, most actively traded bond issues and issuers, and ignoring most of the market. As to your second point, the conflict inherent in the "issuer pays" model has been debated for at least the past 35 years and will probably be debated for the next 35 years. It is the same conflict faced by the accounting profession; shall we do away with audited financial statements? I don't mean to say there is no potential for conflict, but I never once saw it happen. On this latter point, making errors in analysis does not count; indeed, the openness (transparency) of S&P and Fitch in 2007 in fully revealing their real estate asset price risk assumptions in their structured bond rating models allowed sharp non-agency bond analysts having a more negative view of such assets to literally make billions of dollars. Bond market participants like having research and ratings from the major agencies for two reasons: (1) it's a place to start for their own analysis and (2) the agencies cover the waterfront, including obscure issues and issuers on which nobody else wants to spend time or resources. So I'll end today's lesson where I ended the last one: none of the authors of the articles cited appear to have any serious bond market experience.
(Lewis spent six months as a trainee at Salomon Brothers 20 years ago, but he got the rating symbols for commercial paper wrong in his NY Times article - he get's an "F") It's just irresponsible for people having no serious experience or credentials to be calling for someone else's head.

Blaming the Ratings Agencies: Too Convenient

Now retired, I spent the better part of 30 years in the bond business, largely splitting my time between first one of the agencies and then a major sell-side firm. Yours is about the sanest, most thoughtful comment I've read on this subject. Nonetheless, as to the conflict of interest argument, I'll take a modest exception; if the argument were valid, it should have shown up in corporate and muni ratings at some point in the past 35 years - it simply hasn't, at least not in any statistically significant fashion. I think the agencies' aggregate failure in the mortgage-related/CDO area is quite simply a failure to anticipate the full potential of the real estate crash; the modelers had nothing in US history - not even the Depression - on which to hang their hats. That's not an acceptable excuse for blowing the analysis - which they did by being strictly backward looking, but the conspiracy theory stuff strikes me as misplaced.

Should We Abolish Credit Rating Agencies?

Ok, so the agencies got egg all over their collective faces for failing to model the full potential for the real estate crash (and failing to model in some $20 billion of bogus marks by Lehman on its real estate related assets); all of which tarnished their collective reputations. However, the agencies in aggregate employ roughly 2,000 (maybe 3,000?) securities analysts engaged in rating many thousands of different pieces of paper issued by thousands of corporations and political subdivisions around the world, in addition to more than 100,000 individual pieces of structured loans. Overall they do a credible, if quite unspectacular, job. Getting rid of the agencies would seem to just make make it a lot tougher and more expensive for the vast majority of (if not all) borrowers to tap the public markets. Of course, the capital markets could just continue to migrate away from New York, perhaps to London where ratings seem unlikely to be outlawed.
It does not appear that any of the authors in the articles cited have any serious bond market experience.

Help for the Guarantors - From an Unexpected Source

Tom,

Interesting analysis, but why have we yet to witness a single such transaction? Are the financial/reporting incentives in your example large enough? What are the possible impediments to getting a deal done?

Ambac, MBIA Are Still Shorts Amidst This Wink-and-Nod

I tip my cap to Dincensen. Only one who has labored in these markets would seem to be capable of providing such insight. I encourage others to reread his post.

Thoughts on Ambac Bailout, MBIA, Berkshire's Muni Bond Backing

Mr. Sullivan, stop whining!

As ABK and MBI stock prices declined 90%, the talking heads at CNBC trashed the monolines all the way down, repeatedly using such words as "insolvent" (Cramer) and "bankrupt" (Gasparino). Do you think someone assisted CNBC's thinking and profited in the process?

On friday morning , Gasparino reports that downgrades are imminent sending the stocks down another 10%.

On friday afternoon, Gasparino reports that an equity infusion for ABK is in the works, and the stocks rally.

To which incident of maipulation should we object?

MBIA Dismisses Ackman: Got A Better Plan?

Let's review. Mr. Ackman is heavily short both Ambac and MBIA. Mr. Ackman suggests that those companies' insurance subsidiaries be prohibited from sending dividends to their parents, thus benefitting policy holders (and Mr. Ackman). Mr. Ackman is hyper critical of fresh infusions of equity into these companies (throwing good money after bad), notwithstanding that such infusions would mightily benefit policy holders (and harm Mr. Ackman). I understand Mr. Ackman's position of self interest on these matters. Your position, sir, is baffling (unless you are also a fellow short).

MBIA and Ambac Fight for Their Lives

Both Ambac and MBIA have about $10 billion each of liquid assets with which to pay claims. How do they go bankrupt in the next five weeks?