Old joke about Analysts:

You do not need them in a Bull market, and you do not want them in a Bear market.

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I was thinking about that in light of the S&P’s mass EU downgrade threat.

As always, the Credit Rating Agencies are quite late to the party. And consider that the European Central Bank, whose balance sheets are festooned with bonds from all of these countries, is somehow still AAA.

My bottom line about the rating agencies is they are worthless to investors.

Consider how the market actually reacts to these outlook and ratings downgrades. As an example, think about the downgrade of US debt from AAA to AA+, as the chart below reveals:

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Spot the Down Grade!

click for larger graphic

Source: Stockcharts

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As a reminder, the S&P downgrade was August 5th; US Treasuries have actually rallied since, then, sending rates appreciably lower, and making US borrowing costs less expensive. (Thank you sir, may I have another?)

Equity markets wobbled for a few months, then resumed what they were doing previously (going sideways).  Last I checked, the Euro was practically flat year to date.

Given the various downgrades, they seem to make a lot more heat than light. They do not seem to matter as much as we think to the markets they are actually rating — namely, debt. Its somewhat ironic that a downgrade of debt seems to have more impact in the equity markets.

Which leads us to telling question: Do the ratings agencies matter anymore? Have investors figured out that they are corrupted, conflicted, unable to honestly discharge their duties?

Or is it simply that they suck at what they do? Recall the downgrades of Enron, Worldcom, Lehman, AIG, and many others. It seems the markets force them to act, that Traders are issuing the call long before the analysts at Moody’s or S&P actually  downgrade a corporate or sovereign ratings.

We may not need the judgment of honest analysts in a bull market, or want them in a bear market, but it seems the answer to our headline question: When it comes to the ratings agencies themselves, investors seem to have little if any use for them anytime.

Category: Analysts, Really, really bad calls

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.

28 Responses to “Do Ratings Agencies Still Matter?”

  1. Sechel says:

    MF Global defaulted on their investment grade bonds issued before distributing a coupon payment. On what information did they rate the debt? That said, there are countless retail investors who have no choice but to monitor their portfolios of tax free bonds using rating agency opinions. It sucks, but what better choice is there. At least with RMBS investors can obtain loan tapes and run default and severity assumptions.

    The rating agencies are a highly imperfect but value added way of monitoring bonds. So how do we make the process better? Treat them like auditors with all the risk and rewards associated with it. How can you rate debt or securities if you don’t audit the data?

  2. PDS says:

    BR….don’t you find it largely ironic, and somewhat hypocritical, that those who complained the loudest about the inept and late to the game ratings agencies during the financial crisis (and yes they did fail) are now, when finally they get it right with the big ratings downgrades that really matter re the US govt and Euro zone….isn’t it bizarre that many are now saying that they don”t matter any more???….in fact, in the case of the US, the spend spend spend govt has gone to the extent of having the FBI investigate them….so we critisize them for doing a lousy job with corporate America but when they finally get one correct we call out the authorities….only in America!

    ~~~

    BR: You think this downgrade is timely? Its 6 months, maybe even a year too late!

  3. Worthless to investors?
    They are worthless, period.

    Also dishonest, unethical, liars, cheats…

  4. amboycharlie says:

    Let them work for the buyers rather than the sellers, with some liability for a customer’s losses if if they are wrong.
    It might insure due diligence instead of the due indiligence we have today when the sell side pays.

    http://bonalibro.us

  5. Moss says:

    They matter in that some investors can’t hold securities that are rated below investment grade. In addition collateral calls are triggered in some cases when a downgrade is made.

    No doubt they are corrupted, conflicted and dishonest.

    They should be stripped of any governmental legitimacy, use the model where the investors pay, not the issuers. Their behavior is predictable given the compensation scheme.

  6. rpseawright says:

    One can agree with your main point (and I do) but still question the appropriateness of your primary example. The S&P downgrade of the U.S. was correct in my view, but the subsequent rally in Treasuries still makes sense in that the U.S. remains the best house in a bad neighborhood.

  7. you know, it’s funny, but, way back when, the ‘Stock Broker’ had sent my Mom a (general)Prospectus for a Unit Trust (filled with “Municipal” Obligations)–it laid out two Options..

    one was “AAA”-rated–though the Prospectus delineated the, then, ‘Credit Rating’ and then the name of the ‘Guarantee Issuer’

    the other was “A+”-rated, on average, with, primarily, similar Securities..

    LSS: I was asking the ‘Broker’ about the ‘Credit Enhancement(s)/Insurance’

    His response? ~”The Issuer pays to ‘Rent the Balance Sheet’ of Guarantee Issuer” … “Some People “sleep better at Night” w/ the “AAA”-rating” …

    Well, with that, and being an early Student of Milken’s ‘Fallen Angel’-Insight, and taking a peek into the *Wonderful world of “Monoline Insurers”…I had, then, and forever afterward, wholly discounted, both, ‘Credit Enhancement’, in specific, and ‘Credit Ratings’, in general..

    On the Flip-Side, any ____________ that gets Paid to Exercise any semblance of Fiduciary Responsibility, and does Nothing more than check the “Credit Rating”, should be Called-Out and Strung-Up..
    ~~~

    though, BR, w/this..”…When it comes to the ratings agencies themselves, investors seem to have little if any use for them anytime…”

    There are ‘Buckets’ of Assets, and their Investors, that are, indeed, Delimited by them, Yes?

    http://legal-dictionary.thefreedictionary.com/delimit

  8. theexpertisin says:

    Yes, the rating agencies matter.

    But not so much, given the glut of instant news and analysis in our world from other sources.

    In times past, I waited anxiously for my weekly supplement to The Value Line Investment Survey via snail mail- to receive the “latest, up to the minute” dope on stocks. Today information is literally split second.

  9. MayorQuimby says:

    No…there just aren’t any better buys right now than insolvent us treasuries!

    Bulls should pay heed not get cocky.

  10. rktbrkr says:

    The best ratings money can buy!

    Ratings are turning out to be counter indicators

  11. Bill Wilson says:

    I don’t know who’s quote this is:

    “The job of the ratings agencies is to enter the field after the battle and shoot the wounded.”

    ~~~

    BR: John Heimann, a former U.S. Comptroller of the Currency and later vice chairman of Merrill Lynch and chairman of the Financial Stability Forum

    And thats our QOTD

  12. rd says:

    My guess is that they fulfilled an important role at some point.

    Unfortunately, becoming codified in law and accounting standards has meant that they can replace thinking and research for many buyers. As a result, they have proven to be dangerous to investors, not worthless.

    They should be stripped of their artificial legitimacy provided by government and accounting board requirements and returned to a simple role of the Consumer Reports of the bond industry.

  13. NoKidding says:

    “Do Ratings Agencies Still Matter?”

    Concensus is NO. I agree. Next question:

    Did ratings agencies ever matter? If so, what changed?

  14. Maybe. But the thing about the sovereign ratings is that they rate out of the kindness of their heart. There’s no one signing a check for them to do sovereign ratings–governments would probably rather pay them to *refrain* from issuing opinions.

    This particular move is most useful, I think. Markets have gotten way ahead of themselves in pre-summit EU-phoria, conveniently forgetting that Merkozy’s austerity pact does not a “fiscal compact” make. Markets’ willingness to be lulled into a false sense of security only means that the inevitable disappointment will be that much greater.

    http://financeaddict.com/2011/12/sp-plays-spoiler-in-the-europe-crisis/

  15. Expat says:

    Q: How many ratings agencies does it take to change a light bulb?

    A: Two. One to put in a 40 watt bulb and the other to say it’s 60 watts.

    I also like, in the same vein:
    Q: How many economists does it take to change a light bulb?
    A: None. The market will change the bulb if it makes economic sense.

    Q: How many GS traders does it take to change a light bulb?
    A: “You don’t want a light bulb. You want a Collateralized Light and Energy Amortizing Inverse Yield Bond”

  16. RW says:

    Many years ago I examined the difference between highly rated and insured muni GO’s and other muni GO’s and concluded an investor would do much better in terms of yield, call features and default risk by doing their own homework w/ an emphasis on uninsured muni’s.

    Ratings agencies were overrated even when they were (presumably) more honest but the models they use for corporate debt are fairly sophisticated and can probably add some info to those evaluating a large issue …but that isn’t me.

    The models they use on sovereign debt are primitive by comparison and not worth paying attention to. Breathless news reports about rating agencies threatening to lower the rating on a country’s debt are strictly for the rubes.

  17. Jim67545 says:

    Ratings are an attempt by the ratings agency to predict the future. When things are not volatile and either moving smoothly up or down, predicting the future is comparatively easy. At other times, like now, not so easy.
    Having been a commercial loan underwriter let me say that any such prediction becomes questionable 2 or certainly 3 quarters out. So any rating should be reviewed at least twice a year. Of course, since we all are so highly accurate in predicting the future, we should expect the same of them. (Pardon the sarcasm.)

    On the other hand, I do not understand why the “pay to rate” situation in which pools of obviously sub-prime mortgages got a AAA is not leading to indictments for fraud. The term “fraud” is used rather loosely here as the equivalent to “lying” but in this case I believe it meets the tests required under the law for fraud.

  18. jaymaster says:

    IMO, they serve two purposes these days:

    As a marketing crutch for ethically challenged debt dealers.

    As a CYA tool in the bizarro legal world.

    Note which parties accrue those benefits…..

  19. JimmyDean says:

    Raters are basically useless and at best are lagging indicators. My question is: how many pension funds and other big institutions are still mandated to use them? Having an idea of how much sell order flow is mandate driven would be helpful if you’re trying to time entry points.

  20. Lee Gibson says:

    I’d say the agencies matter only in that the inept media continue to report these downgrades as though they do.

  21. streeteye says:

    Another S&P cockup – initially only the FT had the story and everyone else was rehashing it, seems like someone spoke out of turn.

    Another reason Eurobonds and lender of last resort would be a good thing. The bonds would be in high demand and a relatively riskless reference asset would help oil the machinery.

  22. ljoseph says:

    “Do the ratings agencies matter anymore?”

    While evidence from the subprime mortgage mass delusion supports the case that the cooperation of the rating agencies can be bought when the price is high enough , it seems to me that this specific question, to some degree, confuses symptom and cause.

    The premise that rating agencies don’t matter because the markets rise on bad news instead of falling points to the larger issue of a different cause, namely, that the markets has been conditioned to rise on bad news based on the expectation that liquidity will be increased, first from the fed through the greenspan / bernake puts, and now from some new eu/imf liquidity facility.

  23. BigSpooky says:

    I think its possible there is a timeframe mismatch between the agencies and the replies on this board. If euro banking implodes in 2012, will people say the agency was too early and thus useless? These guys are trying to gauge where panamax-sized economies are going to land, I don’t think the 6 month timeframe really factors in.

    Honestly, I think S&P is doing a somewhat noble thing here – they are bucking quite a bit of political pressure and trying to honestly get back to their core business of independent risk analysis. It’s a risky business, no doubt.

  24. zozie says:

    The downgrade of USA’s credit worthiness in August didn’t affect bonds (The fact that investors saw US Treasuries as a safe haven in turbulent times makes it clear that they were not rating the bonds or T-bills.), but I think it had a dampening effect on the economy. It’s almost as if the people @ S&P want to see failure for the US. These generalized warnings and downgrades do not help bond buyers with future investing decisions. Everyone knows there’s a potential problem with Eurozone debt. If they don’t, they don’t deserve help. So this action by S&P is gratuitous and can only be damaging. As Finance Addict points out no one is even paying S&P – but someone seems to have their ear.

    I see the actions of S&P as largely politically motivated, and as such they are a toxic element – unelected and unaccountable.

    They should stick to the facts, stick to the areas of their expertise (corporate and governmental debt instruments), and stop looking into the crystal ball on world affairs.

  25. AHodge says:

    cant do much securitizing w/o rating agencies
    its really the big three that are a do over
    less necessary they are still blessed by the SEC as “recognised”
    and SEC forces some investments to have a recogmised rating rating

    Egan jones and some little guys are ok,
    and in theory if buyer paid its economic

  26. PDS says:

    I never said anything about timing BR…..even a broken clock is eventually correct….the issue is hypocrisy…..when they’re wrong…they’re wrong…..when they’re right? We sic the FBI on them….re timing? Yes they are late…..too bad they didn’t listen to euro sceptics like myself years ago who called the euro experiment doomed to fail….on your favorite biz network no less…..cnbc…..the Cramer National Biz Corp

  27. Sigi says:

    BR,

    funny that your two examples are the US (can print money) and the ECB (can print money). It makes no sense whatsoever to give credit ratings to entities who issue the currency in which their IOUs are denominated.

    That also explains perfectly well how TLT perfomance and S&Ps downgrade of the US are telling opposite stories.

  28. DAVID JOLLY says:

    European Shares Shrug Off Latest S.&P. Warning

    Stocks rose modestly Thursday in Europe, as officials gathered in Brussels for negotiations on resolving the euro crisis and the European Central Bank’s policy committee was deciding on its own next step.

    Investors ignored the latest dire warning from Standard & Poor’s, which said late Wednesday that it was putting the credit ratings of the entire 27-nation European Union on watch for a possible cut from its top AAA rating, citing “concerns about the potential impact on these member states of what we view as deepening political, financial, and monetary problems within the euro zone.”

    The action, largely technical in nature since the bloc has only minor debt issuance, came after the agency on Monday put 15 of the 17 euro member nations on watch for downgrade, meaning all of the euro-zone countries face ratings cuts — and potentially higher borrowing costs — if the crisis meetings fail.