Ratings Agencies as Dr. Kevorkian
Some recent headlines:
"Morgan Stanley (MS) Extends Drop as Moody's Says Rating May Be Cut": MS sells off more in Europe this morning.
Yesterday at about 3PM ET: "S&P May Cut GM to Junk". General Motors (GM), already down some 20%, drops another .75 in the last hour to close at a 60 year low
Yesterday at 3PM ET: "S&P Cuts Outlook to Negative". Alcoa (AA), already down sharp on the day falls another 10%.
The S&P 500 fell over 50 points, more than 5%, in the last 70 minutes of trading yesterday. The Dow Jones Industrial Average fell 490 points in the last 70 minutes. If you think there's no connection between the actions of the ratings agencies (S&P, Moody's (MCO) and Fitch, for the most part) and the final hour plunge on Thursday, in my opinion you either aren't a professional trader or you simply aren't paying attention. There are no coincidences in financial markets.
When an already weak market goes into free-fall in the last hour it isn't because of "traders panicking." It isn't a buyers' strike. Traders only sell stocks which are already down sharply for a reason. In this case, I believe "The Reason" consists of a bunch of a sub-par analysts with the ability to make press releases and the power to kill any company in America.
Corporations' cost of capital is determined by two forces: What the market will bear and what the agencies price it at. What the market will pay is largely seized. When the Fed throws money at the banks they, in effect, are trying to unlock the gears of corporate America bidding for each other's debt.
What Moody's and S&P did last night and this morning illustrates, to me, the futility of Fed actions to date. By noticing the glaring and obvious long-standing problems of General Motors and Ford (F) last night, S&P effectively raised GM and F's cost of capital infinitely. GM is in the middle of a "capital raise." It was going to be expensive before S&P raised the price of GM paper. Now, after S&P's downgrade threat, it's going to be impossible.
GM is dead, in my view. It may have died anyway but it's almost certainly dead now. S&P killed them.
Despite their huge drops over the last few weeks, stocks still aren't "cheap." Their price of doing business continues to rise. The Fed actions and the public "lynchings" of ex-CEOs like Lehman's Richard Fuld may be gratifying to the masses but I feel they fix nothing. They are a day late and billions of dollars short.
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As long as faceless, nameless drones at credit agencies are able to capriciously raise the price of capital of already ailing corporations, particularly on such mind-numbingly observations as "we've noticed difficulties in General Motors' business model," there's simply no way to effectively make a valuation argument for any American corporation. The agencies' analysts are underpaid, arguably under intellectually-horsepowered agents of destruction. As I've said before, I believe they are like 3-year-olds with hand guns: They have no idea what kind of damage they can cause but you are a fool if you don't give them a wide berth.
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Imaging how different things would be if the rating agencies had been responsible and rated GSE debt as not Government backed. Recall "Implicit" Government Backing? How rude sounding that phrase is to my ears today.
"Get your money for nothing, and your chicks for free" as Dire Straights put it.
A distinction here: Dr. Kevorkian only killed those who wanted to die. I hardly believe GM and Ford are willing stepping into the gallows. The credit agencies are acting as judge, jury and executioner. Segments of the financial industry have too much unchecked power!
1. Macke says that the Rating Agencies price capital. This is not correct they just rate debt. It is the capital markets that have decided to price capital in line with ratings.
2. Macke says that the RAs can kill companies like GM and AIG by raising their cost of capital when they need this most. Did he seriously write this? Has he forgotten about risk/reward? If GM and AIG deserve to get their ratings cut (which they did) then their cost of capital should go up because they are riskier. If the RAs don't cut ratings soon enough then everyone jumps on them when things eventually go wrong and scream "why didn't you tell me this before I inveted".
3. Macke then says we need to suspend RAs so the market can go transparent? How. Don't you think part of the reason RAs exist is because the market can't go transparent on its own?
4. If RA analysis is so bad the why does the market continue to price risk in accordance with ratings? The markets are full of smart people right why would smart people continue to back a consistent loser. I'm sure the RAs have not always got it right or got it right on time but I'm also pretty sure they are doing some things right.
The only thing that is clear from this article is that you shouldn't invest with Macke.
WHERE IS OUR PRESIDENT???
Oh, the one that was on vacation playing golf when Katrina hit? So he's no help at all. Not to say anything against the shorts because that would usually include me, but I do have a solution. The SEC could make a ruling that would force all shorts to not only cover, but to also buy a second helping of as many shares as they were originally short. This would be nice, and it would really help GM. At any rate, I was really surprised that the Fed rate was cut only 1/2 point. I think the Fed will cut another 1/2 point, after the shorts are trapped really, really good.
A little different perspective on your points:
1. The RAs do indeed rate debt -- but that debt rating is filtered directly into the cost of capital. It happens because the capital markets are taking the RAs specifically at their word and allowing the RAs' ratings to determine their decisions. The result is the same: A change in the RA rating directly results in a change of the cost of capital.
2. Macke is saying that the RAs can kill companies by "suddenly" deciding that they are in much worse shape. Has GM been right as rain or at least floating above water for the past few years and now all of a sudden, on October 9 at 3:xx PM, they are in critical trouble? Coupled with point 1, this "sudden" degradation of the company's credit rating makes it impossible for them to raise money, even when the PREVIOUS HOUR people were willing to pay a higher price.
3. You are over-generalizing. The article's point is that troubled financial institutions in the current markets cannot become transparent because if they do, the RAs would immediately put them on "Death Row" status, thus ensuring that they cannot possibly recover. Re point 2, re point 1. ... and to ward off specific responses to this (not necessarily from you): Yes, some of them might "deserve" it, but how badly do we want the financial system to collapse more than it already has?
4. If the RAs are so good, then why did all of them rate all the financial institution, hedge fund, and Joe's Investor Service debt as AAA from 2003 to 2007? Particularly when several very intelligent economists were predicting the very thing we are going through right now? It's too much power in the hands of people who apparently did not know what they were analyzing.
My point from previous comments on this topic: When Arthur Andersen failed to point out Enron's mistakes, the audit firm was dismantled and sold as bricks. When Moody's, S&P, and Fitch botched their ratings for years, everyone said, "That's okay, just don't do it again." There is no accountability, no check of the process, and people treat the ratings as the gold standard. THAT is the problem. We do need someone like the ratings agencies, but we also need some accountability.
these guys got a cut of the action to rate the debt well. their business model is inherently flawed. they serve absolutely no purpose that the market couldn't do on its own. all their fancy models and research they develop to rate someone can easily be deduced by any investor without the stupidity of having to pony up 14.5 billion in margin calls over night when they downgrade someone -- when that company is obviously working towards a solution if they turn on the news
The only way the ratings agencies could really deal with such shifts would be to automatically downgrade everything as each leverage ratio in the economy as a whole is passed, effectively building in the risks of fractional reserve lending into the models. At the apex of a credit expansion pretty much everything should be rated as junk.
Perhaps that would be one way to ameliorate the risks and negate some of the damage of fractional reserve banking. Or we could just move to full reserve banking with market pricing for capital and get rid of the whole boom-bust cycle at the source.
What I'm saying, simply to be clear, is that Moody's is unjustifiable as a company. They add no societal value. They profit no one. They shouldn't be allowed to make money in a free market.
S&P and Fitch are different entities. To they extent they are in the business of rating debt, and consulting on how to get that same debt highly rated, then allowed to downgrade those same products, they should also be put out of business.
But Moody's is a freestanding company, making the majority of their income rating debt then downgrading companies because the first part of their income stream was corrupt and inept. It's an insane business model which was unjustifiable when I declared Moody's "the worst company on earth" over six months ago.
At this point, the existence of Moody's et al is simply a capitalist humiliation.
Big Boy Bobby can use all the circular reasoning in the world. Moody's itself can try to oppress my opinion. I'm stating plainly, clearly and with ample justification that the ratings agencies should not only not exist, they should be examined by the House to explain what havoc they have wrought.
If that seems confusing or "dumb" to anyone... well... I'm more than happy to debate the point all day long.
And sorry that you think analysts are not smart or well known. Have you ever actually had a conversation with one? Well there is an entire investor community that has and continues to find value in their analysis. And they don't have to go on scripted business news shows like you to prove otherwise.
The rating agencies provide their best opinion on the credit-worthiness of a specific entity issuing debt. Granted the system we have created very heavily weighs that opinion, but who is to blame for that? Your implications that these agencies are evil is mind-boggling to me. Ironic that you claim complex corruption among this group of underpaid and "sub-par analysts." In their shoes, I'm not sure the combination of being unintelligent and underpaid drives me to initially rate a corporation's debt higher. There are several checks and balances within each agency that simply don't allow for unjust ratings to be published.
Again, it's their opinion, and while they make their best judgment they too cannot accurately predict every possible credit event. While I'm not advocating that the system is perfect, I certainly do not impute this entire crisis to the rating agencies. Too many parties involved in the debt capital markets share equal blame.
Now we need to work together to come up with the solution that will not allow this to happen ever again in the future. Why don't you write an article with your genious solution?
Bear is gone.
Lehman is gone and Richard Fuld is getting humiliated on television.
Morgan Stanley is more or less a Japanese firm.
The rating's agencies have been discredited to the point that a corporations' "rating" means nothing in terms of their ability to issue capital.
The ratings agencies are currently adding no particular value, other than opinion. They were paid to help structure the debt that the above firms used to start this fire.
Several folks here have accused me of "Piling On" the RA's. Near as I can tell, no one else is even mentioning them as a factor in this.
My genius solution: Treat Moody's like Arthur Andersen and let the free market rebuild the "credit rating" system.
Doesn't seem complicated.
Opinions aren't always going to be right. That's why companies like Bear, Lehman and MS should not have relied solely on the ratings of specific securities.
What you aren't understanding is that "companies like Bear, Lehman and MS" did not "rely solely on the ratings of specific securities" for their own investment decisions. They did it to sell product to others. Moodys and the like sold financial indulgences in exchange for those firms being enabled to sell overpriced securities to assorted customers of all sorts, including pension funds and municipalities.
Don't confuse providing an opinion on financial television with what the RAs did for a living. My calls, holdings, financial stakes and interests are stated publicly every night. It's called transparency and accountability. When I talk my book, I say so. When I'm wrong, I say so. I've never, ever, taken money from a company in exchange for my opinion.
The credit markets are closed for the purposes of issuing debt at the prices the RAs suggest. If you can tell me what value the RAs are adding to the financial process, either in a macro or micro sense, I'm all ears.
Otherwise, as was offered tonight by a fellow panelist, the agencies should simply be ignored.
