Ratings Agencies Should Be Downgraded
By Jeff Macke Sep 18, 2008 2:15 pm
They helped cause crisis. Now they're helping it continue.
I’ve traded stocks since the early 90s. I missed ‘87, but survived the Internet Bubble, the Homebuilding Bubble, the Crude Bubble and Long Term Capital Management. I’m not Methuselah, and don’t claim to have the wisdom of Solomon. But I’m still here.
Let me tell you how this crisis is the same as what came before, how it's different, and a modest idea for how to solve the current meltdown.
The Familiar Themes
There are many smart people who saw this coming. We all have our stories of having never made a dime, despite both dire outlooks and efforts to capitalize spending cash and time playing the short side of the various names imploding over the last few weeks.
Minyanville has been labeled a group of perma-bears for as long as I’ve been part of it, largely because the folks here have forecast this exact type of crisis. Now it's arrived, and is picking up steam. It’s curious, but a central frustration running through many of us is:
a) There isn’t any satisfaction in being right for when no one listened to your warnings, which would have averted the crisis; and
b) the same agencies and offices who enabled this problem to grow unchecked are now being relied upon to come up with the solution.
Those who see train wrecks coming tend to be a bit removed from the panic when it finally happens. We all suffer the collateral damage, but if you knew the risks and kept your discipline, you controlled your downside to a reasonable degree. At the very least, if you knew a train wreck was coming, you probably had the good sense to get off the train.
It’s frightening to watch -- and I feel terrible for the folks losing their jobs -- but portfolio risk can be controlled.
Is there another Bear Stearns out there?
Minyanville's Buzz & Banter- 14 day FREE Trial
Minyanville's Buzz & Banter- 14 day FREE Trial
Position in SDS
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2009 Minyanville Media, Inc. All Rights Reserved.
(14)
Reply
2008-09-18 14:45:05
The Agency Problem
This is a great piece, Jeff.
Pardon my ignorance, but precisely do we NEED ratings agencies at all? Why shouldn't buyers of paper do their own homework, i.e., think for themselves instead of outsourcing their brains to a third party?
If Moody's and S&P are fueling flames on the way down with their re-ratings, they surely kindled animal spirits on the way up with their over-ratings.
Perhaps I'm mistaken, but seems to me risk and reward are best balanced when buyers and sellers must think for themselves.
Humbly,
matty
Pardon my ignorance, but precisely do we NEED ratings agencies at all? Why shouldn't buyers of paper do their own homework, i.e., think for themselves instead of outsourcing their brains to a third party?
If Moody's and S&P are fueling flames on the way down with their re-ratings, they surely kindled animal spirits on the way up with their over-ratings.
Perhaps I'm mistaken, but seems to me risk and reward are best balanced when buyers and sellers must think for themselves.
Humbly,
matty
2008-09-18 14:57:09
You may be right, but they may make you walk the plank
This is a great topic, and it is a very tricky one.
On being right:
If you were in one of those firms and you openly and vigorously disagreed with the CEO, you would be tossed out. (This might be beneficial to you if held options that were subject to lock-out, and by being thrown out you could sell them, when others could not. But most likely no benefit)
So all you can do is disagree with the decision before it is being made ("Captain I don't think it is a good idea to go so fast in this iceberg infested waters; I recommend we stop for the night"). But once the decision is made, and you are not the power player, then you will get tossed out or sidelined.
So if the decision and path are really bad, you have no choice but to get out before you are just one more of the bodies floating in the sea.
But you can profit from the bad decision, and you can enhance your reputation elsewhere when you are vindicated.
There is a thing called "group think", where a group of people will go down the wrong path, and ignore the advice of the one true expert in the group.
I like to think of it this way. If I end up profiting, then I am in a better position to help those people who could not get off the ship.
I love Minyanville. I like the discussions going on, and then put them through the "is this a no-brainer filter", and then if it is make several investments in that direction. If you have someone on your staff who is good at filtering the discussions, and able to tell if it is a "no-brainer", then you will all profit quite well. Depew or Sedacca?
Got to go and make some real money.
On being right:
If you were in one of those firms and you openly and vigorously disagreed with the CEO, you would be tossed out. (This might be beneficial to you if held options that were subject to lock-out, and by being thrown out you could sell them, when others could not. But most likely no benefit)
So all you can do is disagree with the decision before it is being made ("Captain I don't think it is a good idea to go so fast in this iceberg infested waters; I recommend we stop for the night"). But once the decision is made, and you are not the power player, then you will get tossed out or sidelined.
So if the decision and path are really bad, you have no choice but to get out before you are just one more of the bodies floating in the sea.
But you can profit from the bad decision, and you can enhance your reputation elsewhere when you are vindicated.
There is a thing called "group think", where a group of people will go down the wrong path, and ignore the advice of the one true expert in the group.
I like to think of it this way. If I end up profiting, then I am in a better position to help those people who could not get off the ship.
I love Minyanville. I like the discussions going on, and then put them through the "is this a no-brainer filter", and then if it is make several investments in that direction. If you have someone on your staff who is good at filtering the discussions, and able to tell if it is a "no-brainer", then you will all profit quite well. Depew or Sedacca?
Got to go and make some real money.
2008-09-18 15:58:36
Blaming the Auditors
Allow me to make a potentially long analogy...
Everyone surely remembers Arthur Andersen, the public accounting and audit firm. They blessed every financial statement coming out of Enron. When Enron was finally exposed for what it was, AA was torn into bricks to be sold to the nearest pavement company.
If the ratings agencies issued (or worse, allowed the purchase of) bum credit ratings on all these financial instruments, why SHOULD they be allowed to continue as if nothing ever happened? AA was not allowed to go back and say, "Oops, we were wrong; Enron's financials were bunk from the beginning." If the ratings agencies were viewed as auditors, they whould be awash in class action lawsuits and government investigations by now. Instead, they have all the power of an auditor in directly telling investors whether a company is reliable, but apparently none of the responsibility in performing due diligence.
I'm in full agreement, Jeff.
Everyone surely remembers Arthur Andersen, the public accounting and audit firm. They blessed every financial statement coming out of Enron. When Enron was finally exposed for what it was, AA was torn into bricks to be sold to the nearest pavement company.
If the ratings agencies issued (or worse, allowed the purchase of) bum credit ratings on all these financial instruments, why SHOULD they be allowed to continue as if nothing ever happened? AA was not allowed to go back and say, "Oops, we were wrong; Enron's financials were bunk from the beginning." If the ratings agencies were viewed as auditors, they whould be awash in class action lawsuits and government investigations by now. Instead, they have all the power of an auditor in directly telling investors whether a company is reliable, but apparently none of the responsibility in performing due diligence.
I'm in full agreement, Jeff.
2008-09-18 17:18:21
Well Said
Mr. Macke,
I am a 2nd generation mortgage and real estate broker with 20 years of experience. I tried getting congress and our regulators to wake up, but obviously was unsuccessful.
http:// www.fdic.gov/ regulations/laws/federal/2005 / 05comguide.html
#20
Note Herb Sandler's comments at 47
I could use some help prosecuting my case; are you interested in helping? It does involve the rating agencies.
http://www. michaelblomquist.com/ Docket/ Document145.pdf
I am a 2nd generation mortgage and real estate broker with 20 years of experience. I tried getting congress and our regulators to wake up, but obviously was unsuccessful.
http:// www.fdic.gov/ regulations/laws/federal/2005 / 05comguide.html
#20
Note Herb Sandler's comments at 47
I could use some help prosecuting my case; are you interested in helping? It does involve the rating agencies.
http://www. michaelblomquist.com/ Docket/ Document145.pdf
2008-09-18 18:56:47
The Agency Problem
This one is easy - it's easier to read "AAA" than it is to go read the prospectus. Thinking=work.
2008-09-18 20:39:22
Where is the penalty for the high paid execs that made these huge mistakes that will cost American Tax payer and shareholders trillions of dollars? Lets us take their homes, their retirement accounts, bank accounts golden parachutes, luxury yachts, hummers and such and give them what they give us. Give them $7.00 an hour to live on and let them figure out how they are going to buy shelter, health insurance, car insurance, transportation, gas, food, clothes and education for their kids. Put them in the slums and let them figure out how to survive and protect themselves. Make them move across the country to find new jobs every time corporate America out sources their jobs or ships their factory over seas or imports millions of illegal's to undermine their job security.
We have four famous crooks in prison and one dead from the last big fraud. Bernie Ebbers from world com, Kosloskie from Tyco, The Adelphia brothers, Martha Stewart is already out and Ken Lay whom everyone says is dead.
Looks like we should export millions of criminals back to their home land and put half of corporate America and Wall Street behind bars. Instead we are bailing them out of their own cesspools. Oh happy days!
Where are those hate charts and trust charts I have ask for? It not the fear factor anymore. It too late for that.
We have four famous crooks in prison and one dead from the last big fraud. Bernie Ebbers from world com, Kosloskie from Tyco, The Adelphia brothers, Martha Stewart is already out and Ken Lay whom everyone says is dead.
Looks like we should export millions of criminals back to their home land and put half of corporate America and Wall Street behind bars. Instead we are bailing them out of their own cesspools. Oh happy days!
Where are those hate charts and trust charts I have ask for? It not the fear factor anymore. It too late for that.
2008-09-19 00:00:31
Rating Agencies
Now we all know that the Tripple A ratings that the bonds linked to sub prime loans came from Standard and Poor and Moodys. We also know now that those ratings were pure fiction. I don't see either firm suffering much from having written that fiction; though like most of you I used to think that bond ratings were, and should have been more nonfictional than fiction. It never occurred to most of us that fiction was even warranted in the case of rating bonds.
But now that it is plain that fiction is acceptable, even desireable in rating bonds, I think the door is wide open to some of us writers who have considerably more imagination than these two 'venerable' old firms.
Therefore I propose the founding of the Bender Flimflam Itsascam Bond Rating Corporation. I don't know how or why Tripple A should demark the best, or most desireable bonds. Hell, I think if a company wants more than three A's, and it can afford our rating service, it should be able to buy more than three. It should be a matter of how many A's can you really afford, shouldn't it? If you want to give me enough money for me to retire on comfortably, I'll give you an even dozen A's. That's free enterprise at work is it not?
But now that it is plain that fiction is acceptable, even desireable in rating bonds, I think the door is wide open to some of us writers who have considerably more imagination than these two 'venerable' old firms.
Therefore I propose the founding of the Bender Flimflam Itsascam Bond Rating Corporation. I don't know how or why Tripple A should demark the best, or most desireable bonds. Hell, I think if a company wants more than three A's, and it can afford our rating service, it should be able to buy more than three. It should be a matter of how many A's can you really afford, shouldn't it? If you want to give me enough money for me to retire on comfortably, I'll give you an even dozen A's. That's free enterprise at work is it not?
2008-09-19 01:04:42
Rating agencies to be Ratted out!
Jeff,
I agree with on all points but would like to draw attention to the LTCM event.
In hopes of creating a solution to the LTCM blowup the Fed stepped out of it's purview to regulate inflation through subtle manipulations of the funds rate and began to try to regulate the economy with extreme manipulations of the rates in hopes of altering the direction of the economy. By doing this they hoped that growth of the economy would fix the problem. In short they targeted the economy and not inflation.
LTCM was none of their business.
That was the beginning of the end and ushered in the Greenspan Put and all the complacency that came with it . . . which spun out of control and brings us to today.
We are now into it deep and the only way out is with the help of the very people that got us here in the first place.
LTCM was really the first highly leveraged hedge fund to threaten the world economy . . . the feds actions would likely have a been non event were it not for the tech bubble that was unfolding; in the fed chairmans own words "irrationally exuberant".
I agree with you completely. The rating agencies should be held accountable. This is a lesson we have learned before where during the tech boom the very same investment banks that facilitated the IPOs and "follow on" offerings also provided the "ratings".
Human nature is what it is and that's what regulation is for.
Also I think as this unwinds with operations like AIG and Lehman and Bear the "whole" is really the problem and the "parts" are the solution. Buried within each of these companies are truly fine jewels and mining them is the art of stock picking.
As you say those who follow the pages of Minyanville are prepared for this. I for one have "wrapped my head around" this and continue to search for opportunities.
The first thing a therapist will tell his patient is "you can't solve the problem without first recognizing there is a problem" . . . the industry has finally made that breakthrough.
And with out waving the flag . . . I believe that this country is unique in that we'll take the bull by the horns and come to solution much sooner than people think.
Minyan Terry
I agree with on all points but would like to draw attention to the LTCM event.
In hopes of creating a solution to the LTCM blowup the Fed stepped out of it's purview to regulate inflation through subtle manipulations of the funds rate and began to try to regulate the economy with extreme manipulations of the rates in hopes of altering the direction of the economy. By doing this they hoped that growth of the economy would fix the problem. In short they targeted the economy and not inflation.
LTCM was none of their business.
That was the beginning of the end and ushered in the Greenspan Put and all the complacency that came with it . . . which spun out of control and brings us to today.
We are now into it deep and the only way out is with the help of the very people that got us here in the first place.
LTCM was really the first highly leveraged hedge fund to threaten the world economy . . . the feds actions would likely have a been non event were it not for the tech bubble that was unfolding; in the fed chairmans own words "irrationally exuberant".
I agree with you completely. The rating agencies should be held accountable. This is a lesson we have learned before where during the tech boom the very same investment banks that facilitated the IPOs and "follow on" offerings also provided the "ratings".
Human nature is what it is and that's what regulation is for.
Also I think as this unwinds with operations like AIG and Lehman and Bear the "whole" is really the problem and the "parts" are the solution. Buried within each of these companies are truly fine jewels and mining them is the art of stock picking.
As you say those who follow the pages of Minyanville are prepared for this. I for one have "wrapped my head around" this and continue to search for opportunities.
The first thing a therapist will tell his patient is "you can't solve the problem without first recognizing there is a problem" . . . the industry has finally made that breakthrough.
And with out waving the flag . . . I believe that this country is unique in that we'll take the bull by the horns and come to solution much sooner than people think.
Minyan Terry
2008-09-19 01:54:49
Get the message to DC
"The argument that âthe shortsâ are behind the drops in bank stocks is simply ludicrous. The stocks are falling because of a genuine unwinding of improperly priced risk" - Jeff Macke
Here !@#$ing HERE!
This message needs to get to Washington to counter all the whining for bailouts... I am hoping there is a "silent majority" that agrees with me/you that needs to start speaking up while we still can speak at all...
As the NY AG investigates rumors talking stocks down, he needs to look at not just rumors but ratings agencies, Federal Reserves and Treasuries talking stocks up...
Americans have lost sight of the fact that we went parabolic in the late 90's and we never really reverted to the mean... This isn't crashing, this is unwinding exuberance...
Here !@#$ing HERE!
This message needs to get to Washington to counter all the whining for bailouts... I am hoping there is a "silent majority" that agrees with me/you that needs to start speaking up while we still can speak at all...
As the NY AG investigates rumors talking stocks down, he needs to look at not just rumors but ratings agencies, Federal Reserves and Treasuries talking stocks up...
Americans have lost sight of the fact that we went parabolic in the late 90's and we never really reverted to the mean... This isn't crashing, this is unwinding exuberance...
2008-09-19 09:28:26
Game Changer
Thanks for all the nice thoughts, folks. Obviously, the government opted for a slightly less nuanced approach to the problem. In short, the US Government dropped dumptrucks and declared negativity illegal.
Rule #1 of trading is "Play the market you have, not the one you wish you had". Fighting the tape here, when the other side is using unlimited resources to destroy shorts, is ill-advised (as much as I fear for the long-term implications).
Rule #1 of trading is "Play the market you have, not the one you wish you had". Fighting the tape here, when the other side is using unlimited resources to destroy shorts, is ill-advised (as much as I fear for the long-term implications).
2008-09-19 14:11:00
Replace the ratings agencies with a transparent CDS market
CDS prices are Mr. Market's estimate of the risk of default -- much better than corruption-prone ratings by the agencies.
Kill the ratings agencies and build a public CDS market.
Kill the ratings agencies and build a public CDS market.
2008-09-19 15:16:50
Game Changer
Hello Jeff-
I enjoy your blog and your television presence. Thank you for all that you do.
I have no clue what to do, now that the strategies I crafted so carefully are lying at my feet in pathetic, twisted wrecks.
Indeed... how can one craft a strategy in a game where the rules are subject to violent, whimsical change? It's almost worth it to move to Borneo and trade banana leaves and polynesian rats.
So long, free markets - we hardly knew ye.
I enjoy your blog and your television presence. Thank you for all that you do.
I have no clue what to do, now that the strategies I crafted so carefully are lying at my feet in pathetic, twisted wrecks.
Indeed... how can one craft a strategy in a game where the rules are subject to violent, whimsical change? It's almost worth it to move to Borneo and trade banana leaves and polynesian rats.
So long, free markets - we hardly knew ye.
Get real-time options trading ideas from Steve Smith, veteran options trader and newsletter author, plus let him show you the way to cut risk and boost your returns through the strategic use of options. Click here for a free 14 day trial to OptionSmith by Steve Smith.
Copyright 2009 Minyanville Media, Inc. All Rights Reserved
