Moody's et. al Credit Ratings of Banks, Nations, Etc...Why does it matter?

[titaniumsalute]

So I see a headline that Moody's might cut 17 global banks credit ratings. The question is "Who cares?" Part of the reason the credit ratings system was put into place was to show benchmarks of credit worthiness. But with SOOO many downgrades and cuts the benchmark is just generally getting lower across the board. By cutting so much I think many people are just ignoring the ratings agencies.

[closeupready]

1. Personally, I don't pay any attention to what they say anymore. They rated toxic mortgage sludge

as AAA. I mean, I'm not making that up, that's what happened, that's what they did with their ratings. So, I mean, once bitten...

[unblock]

3. most people are (still) not aware that ratings do NOT say anything about fraud risk.

while rating agents do pay attention to fraud risk and to look for "reasonable" and "adequate" controls to reduce fraud risk (regular collateral audits, etc.), their ratings are ultimately based on the assumption that the data and answers they based them on are and will continue to be truthful.

so aside from the "it's just our opinion" argument, the fact that for the most part, those deals blew up because originators put in fraudulent mortgages also (technically) gets them off the hook.

the problem was NOT that moody's gave those securities a "Aaa" rating. that was probably the technically correct rating -- the reserves were large enough so that investors were likely to suffer principal losses only under very rare circumstances, barring fraud. the real problem (and the rating agencies may have contributed to this) is that most people don't understand what a rating is and isn't.

- it's NOT a guarantee.
- AAA/Aaa does NOT mean bullet-proof.
- ratings can change so that a Aaa rating today might be a Bb3 rating tomorrow based on (remarkably) bad news.
- no rating protects an investor from fraud or officially suggests an opinion on the presence or likelihood of fraud.
- there has never been any concept of knock-on or group implications -- each rating stands on its own. if a 1 in 500 event is what it takes to cause a AAA/Aaa rating to suffer a loss, that same 1 in 500 event could cause one, some, several, many, or virtually all AAA/Aaa rated securities to suffer a loss.

i'm not defending the rating agencies in this matter; they didn't do an adequate job. on the other hand, the media has done a terrible job in describing what the ratings were designed to represent and what they were not designed to represent.

at the end of the day, the entire concept of issuer-funded rating agencies are rather silly and transparently prone to corruption. either investor groups should take on that role or the government should do it, or some combination (e.g., private or quasi-public entities designed to provide investor services rather than issuer services, funded by a tax on trades or issuance fees).

[closeupready]

4. I agree with a lot that, except I respectfully disagree that the rating agencies were

off the hook, due to originators fraudulent actions. The agencies made a LOT of money on these deals, just like everyone else who had a hand in putting them together. If you make money on a deal, you have a responsibility to 'trust but verify' particularly with regard to that portion of such deal over which you are offering guidance.

And also with regard to these ratings which we are talking about, I'm trying to think of the analogy - I think rubber stamp is a good one. Seems like, in exchange for a healthy fee, they were simply rubber stamping these instruments. That is not a rating agency whose ratings are worth much more than the paper they are printed on, is it?

[unblock]

6. their role is to rate highly only structures that are designed to properly address investor risk.

their role is not to actually address those risks themselves.

the TRUSTEE and the AUDITOR of the deal are supposed to make sure that the terms of the securitizations are being followed and that the collateral being sold into the deal properly conforms to the requirements of the deal and isn't fraudulent. they're the ones who had the direct responsibility and who, inho, were most clearly negligent in their duties.

the rating agencies had to make sure that there WAS a trustee and there WERE routine audits and that there were provisions to remedy any issue (or terminate the deal) if any fraud or other problems were detected. but they're not the ones who actually do these things.


and the rubber stamp analogy doesn't work. i've gotten quite a few securitizations rated, and also had quite a few deals not meet the standard. they insist on quite a lot of data and analysis. for each deal, we literally write a 100-150 page book describing the company, the transaction, the data, and the structure. and often they read it and ask for follow ups as well. they may have gotten a rating wrong, or they may have completely missed an essential part of the analysis, but i've never heard of the process of getting any rating, certainly not their highest rating, being a walk in the park or a rubber stamp.

if they missed something, it's more like airport tsa doing a metal detection, body screen, strip search and a cavity search on a terrorist but forgotting to check their belt. then when that turns out to be a disastrous lapse, going back and accusing them of doing absolutely nothing and letting anyone through without checking them at all.

[closeupready]

8. Okay, I think we generally agree. Don't want to get pedantic, and stop the discussion.

Cheers.

[unblock]

2. it may not matter much to individuals, but it certainly matters to investors and to companies

investors, especially institutions, have constraints in terms of the rating of companies they can invest in.

companies have constraints in terms of the rating of banks they can use.

banks below certain ratings have difficulty raising funds for their clients.


some of our deals have collections running through affected banks. our clients need have their customers pay to a better rated bank or else get a waiver from investors if they're willing to take the extra bank risk. just a small example of the real impact of these things, even if they're widely expected, even if the bank's actual risk hasn't changed. a lot of things are triggered by rating downgrades.

[Nuclear Unicorn]

5. If someone is a credit risk

That means they may not repay the loan. In order to attract lenders willing to accept that risk they have to be willing to accept a higher interest rate. Higher-interest lenders are attracted because the borrower pays more money as interest is front-loaded into amoratized (sp?) payment schedules. If the borrower pays in full the lender makes a killing and any risk of default is mitigated by the higher amounts in the regularly scheduled payments.

For governments the scheme is the same but what they pay for interest immediately translates into inflation for the citizens. Every time a factory uses revolving credit to pay vendors or make payroll they have to borrow that money from a commercial bank. Commercial banks in turn get their money issued to them by the central bank.

If the central bank (CenB) had to borrow because the government is running a deficit then they have to make sure they get back more money to cover their bonds. If, for sake of discussion, the CenB sell bonds for 10% because the nation's rating is downgraded they in turn sell a few points higher to the CommBs for, say 10.5%. Of course the CommBs add to that for the same reason: cost recovery-plus. So now the factory owner is paying 11% MINIMUM even though his credit is stellar.

To cover his costs he has to raise prices. Hopefully, his customers can still afford his products or he can afford to discount. If he's already selling at near-break-even margins he's going to lose customers because 1) his prices go up and 2) the higher interest rates are sapping the customer's buying power.

Guess what happens when the factory starts losing money?

You guessed it! LAY-OFFS!

So now there are more unemployed workers, less money in the economy, less tax revenue from payroll and sales, and more people needing public assistance from a government already so pressed by debt it started the financial cascade.

And no, central, planned economies are not the solution. Apart from being historically wasteful and poor planners they always operate at near-break-even margins. It takes a deep, deep, deeeeeep down-cycle to impose such a calamity on a market-based system but planned economies hover at the precipice every moment of every day. They also lack the fluidity to adjust to economic impulses as every move literally takes an act of congress.