Why rating agencies keep tripping


CREDIBILITY PROBLEM: Four years into the global financial crisis, credit agencies' predictions remain as off-target as ever

Kamrul IdrisA FUNNY thing happened as the fourth anniversary of the 2008 financial crisis in America sped by this month.

A couple of rating agencies declared they were souring on American debt -- and the markets did not budge, at least not in the direction they were meant to.

Moody's, which makes up the triumvirate of United States agencies with Standard and Poor's (S&P) and Fitch, warned of a downgrade should Washington remain unable to pass a budget next year, thereby triggering automatic spending cuts and tax hikes collectively dubbed the "fiscal cliff".

Not to be outdone, and bristling at its eclipsing by the Big Three, Egan-Jones took the logical step further by lowering its estimation of US government bonds for the second time in five months -- from AA+ to AA-.

Unlike S&P's US debt downgrade a year ago, the mid-month notices did not provoke so much as a ripple. Instead, the markets rose for precisely the reason that Egan-Jones based its negative assessment (as it well knew): the Federal Reserve's third round of "quantitative easing" or QE3.

In August last year, the S&P decision plunged the Dow Jones Industrial Average nearly six per cent the next day. Fast forward 12 months, and the kerfuffle seems, according to the Associated Press, a "non-event". The Dow has gone up around 25 per cent since and, more tellingly, interest rates have trended down.

(The same knee-jerk response to warnings of a sovereign rating cut also tripped up Bursa Malaysia in the first week of the month. But it soon resumed groping for new highs.)

So why are the rating agencies not being listened to? In a word -- or rather the one used by Nobel economics laureate Paul Krugman in his New York Times column on Aug 7 last year -- they have lost "credibility".

"America's large budget deficit is, after all, primarily the result of the economic slump that followed the 2008 financial crisis. And S&P, along with its sister rating agencies, played a major role in causing that crisis, by giving AAA ratings to mortgage-backed assets that have since turned into toxic waste," he said.

That major role in the subprime implosion has been written about exhaustively, but never grabbed the headlines as much as the 2008 drama's leading (and bankrupt) stars: the mortgage securitisers Fannie Mae and Freddie Mac, the insurer AIG, and the investment banks Bear Stearns and Lehman Brothers.

Krugman's fellow NYT columnist Joe Nocera and the Los Angeles Times' Bethany McLean, for example, in their 2010 book All the Devils Are Here, allege that the agencies had been less than painstaking in their pursuit of the enormous profits to be made from rating derivatives.

They were among many in the profession to connect the conflicts implied in the agencies' fee-based "business model" with how much the latter got wrong.

"The rating agencies had missed the near default of New York City, the bankruptcy of Orange Country, and the Asian and Russian meltdowns. They failed to catch Penn Central in the 1970s and Long-Term Capital Management in the 1990s," McLean and Nocera remind.

And then there was the mother of all misses: the failure to downgrade Enron debt until a few days before the energy trader's spectacular collapse in December 2001.

Mark Weisbrot of London's Guardian newspaper went beyond accusing the rating agencies of having been suborned by their clients.

In a Sept 13 comment, he dismissed the latest warning as serving "a right-wing agenda" of radical deficit reduction.

In the Academy Award-winning 2010 documentary Inside Job, former Moody's managing director Jerome Fons captured how far off-target the agencies were during the crash in the following exchange:

"Lehman Brothers, A2 within days of bailing; AIG, double-A within days of being bailed out; Fannie Mae and Freddie Mac were triple-A when they were rescued; Citigroup, Merrill, all of them had investment grade ratings."

"How can that be?"

"Well, that's a good question," Fons replied before breaking into laughter.

Indeed, it is hard not to see the lighter side of the rating agencies' activities (with apologies to the multitudes who lost their shirts in 2008, some of whom have complained in court).

David Goodman and Mark Deen drolly began their Bloomberg report on Sept 16 thus: "By almost any measure France is a more creditworthy borrower eight months after Standard & Poor's said it no longer merits an AAA rating."

(S&P downgraded nine European countries on Jan 13.)

The rating agencies counter that they judge risk differently from and perhaps more narrowly than, say, equity analysts.

 They might even be overcompensating for 2008, in the unravelling of which they were not the only participants to have misread the signs. But industry insiders know that even when they get it right, they get it late.

"The agencies are responding to information that is already in the marketplace," Craig Veysey, head of fixed income at Principal Investment Management Ltd in London, told Goodman and Deen.

If the markets have wised up and are finally rid of their bugbears over debt, then that would signal a turning point from the long and choppy wake of the 2008 crisis.

QE3, and similar moves by the European Central Bank (ECB) and Bank of Japan, may well be contentious. But when the history books are written about this unprecedented series of cash injections into depressed economies, they might also conclude that the effect was mostly psychological.

Approval for the ECB to purchase bonds from distressed member countries removed the biggest fear factor in international markets: a break-up of the eurozone. In the US and Japan, central banks have shown themselves willing to step in while governments dither endlessly between stimulus and austerity.

The anniversary of the 2008 crisis will for the first time be worth noting if it marked a switch in the world's focus from debt and deficits to economic growth.

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