Among the culprits to our current financial meltdown are the ratings agencies. In fact one can point back to the summer of 2007 and the initial down-grading of large tranches of repackaged debt products linked to sub-prime exposure as the initial convulsion in our current economic paralysis.
Investment banks, commercial banks, insurers and the Fed have been the culprits in the spotlight around the financial crisis to date. Admittedly we are still at a point where solutions should trump finger pointing. However, we cannot ignore all of the complicit constituents to the current financial crisis if we are hoping to avoid seeing a recurrence of it in the future.
I have seen few intelligent discussions in the media regarding the incentive problems at the big-three ratings agencies: Fitch, Moody’s and S&P. However, an article by Tom Sullivan in this weekend’s Barrons does a nice job of highlighting the misguided rules, the missteps, and the poor incentives of the big-three ratings agencies.
Sullivan points to the pending vote by the SEC to review the regulation surrounding the ratings industry which has historically been subject to self regulatory rules. He also distills some of the dramatic differences between ratings among the big-three agencies and some of the newer, smaller players. There is a straightforward depiction of the agency-problems around having issuers (vs. investors) paying for ratings, and a number of clear examples of the results of such problems.
As Late as March 13, Moody’s and S&P, by comparison, rated Bear as single-A, while Fitch was a notch higher at A-plus — both are investment grade ratings. Three days later JPMorgan said it was buying Bear. Sean Egan, Egan-Jones managing director, explains that his firm noticed that the fundamentals for the mortgage business had started to falter and “killed a major source of profitability” in January, when it stripped Bear of its single-A-status.
S&P, Moody’s (a unit of Moody’s Corp. , MCO), and Fitch, a unit of Fimalac (FIM.France) all rated Lehman Bros. at single-A or better in September, before it crashed, while Egan-Jones had it at triple-B-minus, Rapid Ratings at the equivalent of a high triple-B and Gimme Credit at “Underperform.”
The biggest split between the majors and the alternatives is in the ratings for bond insurer MBIA (MBI), also caught up in the subprime mess. Egan-Jones has the company rated triple-C, a weak, non-investment-grade rating, since mid-May. Moody’s has it at Baa2; S&P two notches higher at A-minus. That’s a difference of 11 notches. Fitch yanked its rating in April as the scope of MBIA’s problems became more apparent. [More]
This will be an important story to monitor. This issue will have a major impact of the recent deployment of TARP dollars and a major impact on navigating future government intervention.
Rating Agencies Under Review for Downgrade
Tom Sullivan, Barrons, November 29, 2008