Pressure On Ratings Agencies As Governments Try To Manage Opinions

Includes: MCO, SPGI
by: Larry Trefz

Over the last couple of years the Federal Reserve has made an unprecedented public relations effort to increase their appearance of transparency.

In January 2012 the FOMC named an explicit, numerical interest rate target of 2 percent. At the same time the Fed started releasing the 17 committee participants' forecasts of when the federal funds rate would go up.

In December of 2012 the Fed tied interest rates to a 6.5% unemployment rated target. Chairman Ben Bernanke essentially said that using this threshold will make the Fed's moves more transparent.

The ECB has likewise undertaken similar measures to promote the notion of transparency.

Parallel in timeframe with these unprecedented moves toward promoting central bank transparency, we see the ratings agencies coming under scrutiny by both the European Union and the United States Government.

The US Government recently sued Standard & Poors, alleging that the ratings agency ignored their own guidelines in regard to rating Mortgage Backed Securities prior to the housing bust. Several states are expected to join the Justice Department's suit.

While it is obviously true that the rating agencies missed the dangers of the subprime mortgage bubble. It is also true that the Fed was far behind the curve in response to the financial crisis. This is evidenced by the recent release of documents from the Fed that chronicles their response to the unfolding crisis in 2007. Neither party has a crystal ball. Transparency does not necessarily translate to accurate forecasting and truth.

For the very reason that no one has the monopoly on future knowledge, it is important to have as much information available from as many sources as possible. At the end of the day, all a rating from a ratings agency is, is an opinion (hopefully honest and well-informed). In past times, these agencies were largely judged and valued on their reputation. A monopoly on giving information or warnings is a recipe for corruption.

Recent controversies involving ratings agencies and governments have regarded the ratings agency's ability to push sovereign bond yields up by downgrading a country's debt. Muzzling the ratings agency's could be a major ingredient to further creating a dangerous sovereign debt bubble.

Punishing the messenger is generally not the best solution. The messenger will be discredited if they cry "wolf" when not needed. When the dust has settled, the opinions from the ratings agencies will likely continue to flow freely, as this is a mark of a free society.

In the long-run it is unlikely that the long tradition of services that the ratings agencies provide will be significantly altered by the current actions against these agencies. McGraw-Hill and Moody's are both broad based companies and the current action in these stocks may be a great entry point. As the negative news cycle takes its course, a potentially profitable opportunity is being presented to go long these names.

McGraw-Hill (MHP) is the owner of the Standard & Poors ratings agency mentioned above. The stock has risen steadily since its sub-$20.00 per share 2009 lows to almost $60.00 per share prior to the announcement of the Justice Department's suit. After the announcement of government action MHP has fallen dramatically. MHP is trading at about a 12.5x forward looking earnings ratio and about 29x trailing earnings.

Chart forThe McGraw-Hill Companies, Inc. (<a href=

Moody's Corp. (NYSE:MCO) has fallen in sympathy with MHP even though MCO has not been sued--at least so far. MCO reported stellar earnings last quarter. It is trading at about 12x forward earnings and about 15x trailing earnings.

Chart forMoody

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.