On Monday, Moody’s downgraded Greece’s government bond ratings to junk status of Ba1 from A3.

As legislators debate new regulation for the financial sector, this action yesterday serves as a reminder to the folks in DC that the current regime of ratings agencies has become an unmitigated disaster.

It also raises a simple question: What possible reason on God’s green earth do the ratings agencies currently serve?

Consider the following facts about Moody’s and S&P:

• They are not unbiased observer of credit issuers.
• They do not provide actionable intelligence for bond or equity investors.
• Their positive credit ratings are, as we learned during the collapse, mostly worthless.
• Downgrades and negative ratings are also mostly worthless — but downgrades do have the redeeming quality of providing comic relief, to wit, the astonishingly belated downgrades of Enron, Lehman Brothers, Bear Stearns, Citi, AIG and now Greece. (Good times!)
• Last, they seem to be incapable of providing any sort early warning about potential systemic credit issues with major economic ramifications.

Other than that, they are a terrific group of folks who have done a bang up job paying themselves huge bonuses for previously unimaginable levels of incompetence.

When the Nationally Recognized Statistical Rating Organization NRSROs were created in the 1975, there seemed to be this genteel belief that no management team would willingly risk their entire firm merely to enrich themselves via short term bonuses. And — Of course! — no firm would ever behave so recklessly as to put the entire economy at risk for profit motives. Indeed, market discipline would insure such was the case.

We now know that this idealistic belief system is completely false, and relying on the efficiencies of the market to enforce regulations is sheer folly.

Category: Credit, Really, really bad calls, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

26 Responses to “Moody’s Downgrades Greece (Also, Kennedy was shot)”

  1. beatstreet says:

    Everyone should pick up a copy of the aptly named Confidence Game – its about Bill Ackman’s battle with another insurer, MBIA.

  2. JustinTheSkeptic says:

    That is because market forces are no where to be found in the process.

  3. scepticus says:

    the point of the RAs, at a 10000 foot level seems to be that their existence and the existence of so called AAA ratings implies that there is indeed such a thing as a risk free rate.

    because if there isn’t, why then the entire foundation of capital markets is an illusion. While many people in the industry probably understand that, no-one is actually going to admit it that portfolio theory is a bunch of cobblers.

    So carry on moody’s and Fitch et al, at least as long as there is a AAA out there.

  4. Marcus says:

    Bravo

    “The King has no clothes.”

  5. cswake says:

    The market isn’t failing with NRSROs, since they are artificial creations to begin with. The Financial Times made an interesting observation during the 2007-2009 credit crisis that prior to the creation of NRSROs, investors tended to shop between ratings agencies for the most accurate credit rating. Additionally, the compensation overwhelmingly shifted to issuer-pay after the SEC began to license the rating agencies:

    http://www.ft.com/cms/s/0/eb4cb918-c241-11dc-8fba-0000779fd2ac.html

    They do argue that it isn’t plausible to return to the way it was before, since “some form of systematic third party, arm’s length, rating of risk, and the allocation of tranches of risk among appropriate parties, is inherently more efficient.” But, I can’t help think of the recent conversation with Taleb where he stated that efficiency and removal of redundancy has made our system unstable (@15 min):

    http://link.brightcove.com/services/player/bcpid1827871374?bctid=90038921001

  6. BarryNL says:

    I wonder just how long after the coming collapse of the UK economy the downgrade from the present Triple A rating for British sovereign debt will come.

  7. teraflop says:

    Answers to “What possible reason on God’s green earth do the ratings agencies currently serve?”

    1) reducing sell-side liability risk.

    2) providing employment for those who didn’t make it through the bulge-bracket hiring filters.

    Imagine if they worked for the government, oh the humanity!

  8. beatstreet says:

    Maybe someone can edit my original post. I didn’t mean to imply that MBIA and Moody’s were in the same business … MBIA is an insurer, Moody’s is a rater. The book deals w/the fact that Ackman recognized very early that there was no way MBIA could ever really insure all the paper they were insuring, but that Moody’s (and the other raters) turned a blind eye (despite overwhelming evidence) and continued to give MBIA a AAA rating until the entire planet knew they were junk.

  9. “When the Nationally Recognized Statistical Rating Organization NRSROs were created in the 1975…”

    Oligopolies and ‘self-regulation’ are mutually exclusive..

    as, JTS, above, puts it: “That is because market forces are no where to be found in the process.”

    cswake, above, points to some illumination on the matter..

    as does teraflop, albeit on a, slighty, different facet..

  10. parkj238 says:

    JustinTheSkeptic Says:
    June 15th, 2010 at 7:23 am
    That is because market forces are no where to be found in the process.

    ____________________

    What sort of illusory market forces are you referring to? Something the government has to set up and actively monitor? Market forces do not always lead to competition and good, there has to be able participants that can compete and deliver – most of the spectrum that capitalism provides does not deliver that.

  11. rktbrkr says:

    Looks like the Greek bailout could lead to changes in Germany, bye-bye euro!

    http://www.nytimes.com/2010/06/15/world/europe/15germany.html?emc=eta1

  12. The Curmudgeon says:

    The NRSRO’s have become pretty much an ink-blot test for what what one believes would help make a better market. Moody’s, S & P, etc, are creatures of government intrusions into the market. The only regulation that would fix the regulation that created the disaster of the ratings agencies would be to rescind the NRSRO law and make investors liable for their own investment decisions.

  13. darekkkk says:

    “We now know that this idealistic belief system is completely false, and relying on the efficiencies of the market to enforce regulations is sheer folly”
    What idealistic belief?
    For me what is false is a trust in regulations.
    May be what is wrong is a system relaying on rating agencies (sometimes that is enforeced by regulations).
    Why higly paid professionals should relay on rating agencies?
    For me they should be treated as a consultants which you may but not have to hire.
    Mess with rating agencies was created by regulations saying that one or other market participant should buy debt with rating no less that AAA …
    That’ s not a free market fault.

  14. ToNYC says:

    John Perkins told it all in “Confessions of an Economic Hitman”. You set up a corruptible leader, pay up to fix the democratic election (x$/vote) or whatever becomes necessary (note: the recalcitrant enemy=nationalist) always has a “strongman” in charge, then start the looting. In the US we use MoCs and revolving GS regulators to keep the pipes greased, await the eventual or provoked as necessary crisis and ramp up the game with latest tweaks. The fruit of financial engineering keeps us out of the Garden of Nature whose sustainability is the only real lunch we can afford to eat.

  15. Moody’s is part of an oligopoly, they are not part of the free market. We would be using the free market much more efficiently if there were no ratings agencies and each individual or institution did their own ratings of credit quality of an issuer. But I don’t think you can say the free market failed here. That’s like saying that the free market has failed in healthcare. If healthcare were subject to the free market (no federal/state mandates, interstate competition, individuals, not companies, paid there own bills), we would have much more price competition and much more affordable healthcare.

  16. beaufou says:

    darekkkk

    They were consultants.
    Previously on TBP: Bond issuers choose ratings agencies and pay for ratings, meaning raters’ revenues depend on the very firms whose bonds they are asked to judge.
    And as far as no-regulations-no-ratings, isn’t this jungle already dense enough as it is, why not get rid of the value of everything and let Goldman and co decide what is worth what.

    “Mess with rating agencies was created by regulations saying that one or other market participant should buy debt with rating no less that AAA …”
    again.
    “Bond issuers choose ratings agencies and pay for ratings, meaning raters’ revenues depend on the very firms whose bonds they are asked to judge.”
    Who profited most from these “drastic” regulations that greatly helped create the crisis, they couldn’t do it without each other.

  17. Rationale for existence:

    “they are a terrific group of folks who have done a bang up job paying themselves huge bonuses for previously unimaginable levels of incompetence.”

    Isn’t that good enough anymore?

  18. Fred C Dobbs says:

    I think the rating agency problem resembles the real estate appraiser problem. It wasn’t until the early ’60s when a California Savings and Loan Commissioner (a Berkeley Professor) required real estate appraisals to support the making of a mortgage loan that real estate appraisals were common. Lenders could, but were not required to get appraisals before making the decision to lend. As institutional lenders had been in the business of lending for centuries without always getting appraisals first, many considered this requirement needlessly intrusive, redundant, and more or less silly, for no one but a fool could believe that anyone can predict the worth of an ill-liquid asset tomorrow, let alone 15 or 30 years in the future, when they can’t predict the value of a liquid asset tomorrow. Nevertheless, lenders went along, most by hiring independent appraisers, a very few by putting them on their pay-roll. Lenders who went to outside appraisers gained a competitive advantage, for fee appraisers were cheaper and kept the cost of making a loan down. Lenders who relied on their own employed appraisers tended to suffer lower loan losses, however, for their appraisers could be fired if they made a questionable appraisal. Lenders who went outside, experienced higher rates of loan loss, for self-evident reasons. Borrowers who bought before cyclical declines in property values sometimes blamed the appraiser for their decision to borrow. This led to outside appraisers sometimes being sued by lenders and borrowers alike. And, as malpractice insurance was either unavailable or impossibly expensive, the outside fee appraisers ‘self-insured’ and, at the same time, rendered themselves more or less asset-less so that, if sued, the plaintiff had to assume that even if the appraiser lost the suit, the plaintiff would not collect very much, if anything at all. So, informed, knowledgeable lenders have always known real estate appraisals by outside fee appraisers lack integrity, are not to be relied upon, and are a waste of time and money. The same analysis is true with the ‘rating’ agencies. When sovereign governments lie to everyone about the state and condition of their finances, such as Greece has, does anyone have the relevant and material facts to begin an appraisal of a Greek bond? Assuming a sovereign discloses the facts, which is foolish to believe one could or would, who can possibly ‘appraise’ the ability and willingness of some future sovereign government to pay their debt in full? Assuming the sovereign pays on time and in full, who can possibly tell us in advance what the repaid debt will buy in the future? A domestic Greek bond holder might find inflation has robbed him of half of the purchasing power of the money he lent his government. A foreign holder might find the purchasing power of the Greek currency (drachma or euro) in Greece or at his home considerably reduced also. The test of a rating should be whether the purchaser of the service can obtain a future judgment against the rating agency and collect. Otherwise, the rating is worthless. Seneca was right to ask his son if he knew “… with how little wisdom the world is governed?

  19. TomL says:

    Could Harrah’s Sports Book do any worse than Moody’s, S&P or Fitch’s?
    They might actually do better.

  20. Mannwich says:

    But, hey, Sir Warren himself says that Moody’s a “great company”. Who am I to argue?

  21. Mannwich says:

    But they DO provide convenient cover for those who are in on the scam.

  22. d4winds says:

    Agreed; but big bonus payouts that are justified ex post as for productivity but which are ex ante for pure economic rent and/or power, the latter sometimes with legislated help, seem to have become the rule rather than the exception for many industries, the credit rating industry being merely one among many & hardly the most egregious.

  23. H. Rider Haggard says:

    “We now know that this idealistic belief system is completely false, and relying on the efficiencies of the market to enforce regulations is sheer folly.”

    Barry, you may have just launched a new meme. Painting the proponents self-regulating markets as starry-eyed idealists rather than cynical exploiters is a new one to me.

    But it may be a very effective meme.

  24. Its_Science says:

    “When the Nationally Recognized Statistical Rating Organization NRSROs were created in the 1975, there seemed to be this genteel belief that no management team would willingly risk their entire firm merely to enrich themselves via short term bonuses. And — Of course! — no firm would ever behave so recklessly as to put the entire economy at risk for profit motives. Indeed, market discipline would insure such was the case.

    We now know that this idealistic belief system is completely false, and relying on the efficiencies of the market to enforce regulations is sheer folly.”

    BR, either this statement is absurd, or subtly important. This is why it’s absurd:

    Capital requirement regulations are based on agency ratings. That is regulation, not free markets. And that is what drives the demand for more highly rated debt.

    This is why it might be subtly (and probably accidentally) important:
    If you are going to rely on market discipline, don’t create regulations that distort market incentives! This is a common problem in the most regulated industries in the US: health care and finance. Many bemoan the results of free market capitalism in both, but they don’t consider the distortions caused by policies and regulations.*

    This does not prove that total deregulation is the best policy, but it’s frustrating to hear people point to heavily distorted markets and then blame free markets for their results. You are capable of deeper and more complex thought than this.

  25. Simon says:

    Kennedy was shot??. OMG how terrible! When did it happen?

  26. Ole Drippy says:

    Only when you can do a terrible job and stay in business does the free market not work. The only way that can happen in the long run is when government is involved to “make it all better”. Moodys and S&P should be part of the creative destruction process, better companies emerge, wash rinse and repeat.

    That being said, there is a part where the government can intervene if there was collusion or fraud. Investors should have legal recourse in those cases.