Did you see what Raymond McDaniel, Moody's CEO, had to say in Davos last week about any blame the ratings agencies might deserve regarding the subprime mess? It's pretty shocking: "A lot of things could have been done better," he told a panel at the World Economic Forum. "Some are the responsibility of rating agencies, some of other participants in the market. In hindsight it is pretty clear to us there was a failure in some key assumptions supporting our analytics and our models. The key assumptions failed in part because the information policy, completeness and veracity feeding the work agencies were doing, was deteriorating." [Emph. added]
How pathetic. The rating agencies have long insisted they aren’t responsible for verifying the accuracy of the information they use to assign ratings. That may or may not make sense. But they are certainly free to ask for whatever information they think they need to make an informed judgment. That’s one reason we have agencies in the first place: they, and only they, are allowed systematic access to material non-public information about issuers. So for McDaniel to imply that the agencies were somehow victims in all this because they didn’t have the information they needed is a total and complete crock. If they didn’t have enough information, they should have asked for more.
For that matter, I don’t buy McDaniel’s implication that the agencies weren’t to blame for the mortgage CDO fiasco because some of the data they were given—like, say, about loans for homes that were supposedly going to be occupied by the borrower when in fact he was an investor/speculator—was incorrect. Maybe in normal times agencies shouldn’t be on the hook for the accuracy of the information they depend on. But the housing bubble, and attendant blizzard of CDO issuance, was not a normal time. The agencies must have realized that. Even out of a general sense of natural curiosity, didn’t anyone wonder whether, in the midst of a soaring, speculation-riddled housing market, some of the numbers they were relying on might be made up?
In my view, the rating agencies have behaved disgracefully throughout this whole mess. First, they played a large role in pumping up the bubble by blithely slapping AAA ratings on securities that, we now know, didn’t come close to deserving them. Now that the mortgage market has come crashing down, they have repeatedly tightened their models to absurdly conservative levels. Standard & Poor’s move to revise its models twice in a month is especially disturbing. How can a company know how much capital it needs to raise when the agencies keep moving the goalposts?
In theory, the agencies are supposed to be the disinterested players with the data and sophisticated models, who keep their heads when the markets are going crazy around them. No longer. Now Moody’s says it is taking “market sentiment” into account when it sets ratings on the monoline bond insurers. What’s market sentiment got to do with it? Either the insurers have the ability to pay claims in a worst-case scenario, or they don’t. By relying on sentiment as an input, the agencies create the upheaval and uncertainty that their ratings are designed to prevent.
We had an internal debate around here a few weeks ago whether the agency model would survive the current crisis. I came down on the side that it would survive. But if the agencies continue to act irrationally, I don’t know how the model can.
U.S. banking regulators made banks’ real credit problems worse in the late 1980s and early 1990s. The rating agencies are the ones exacerbating the credit crunch this time around.
Disclosure: Author has a position in Moody's.
Tom Brown is head of BankStocks.com.