Monday, 16 January 2012

Remember when Ratings Were About Films?

SlovenĨina: mince English: coins
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So a company in America called Standard and Poor's has pronounced on the performance of Europe's economies and governments and downgraded them. This has been taken seriously rather than laughed out of court. I'm sure I'm not alone in being totally bewildered as to how this is the case.

I first came across a rating agency, and the concept of 'ratings' in 2001, when I was working on launching a mobile network. My client's competitor had been rated (It was being primped for a sale) by one of the 'big three' rating agencies with many As and pluses. I was interested to see how the competitor could rate so highly in someone's eyes and obtained a copy of the rating report. The report cited a total lack of competition and an excellent infrastructure. At the time, (if memory serves me correctly) we had just noisily launched a competitive network with the backing of a major international telco brand. The competitor's infrastructure was also, as was obvious to anyone who had spent any time on the ground, woeful. Even their masts looked like rickety water pumps on a hick Ohio farm.

The chap from the rating agency told me they didn't just rate companies - they rated municipalities in the States, too - cities. I remember being awed at the idea that some company would actually have the power to rate a city and effectively change its ability to raise money.

It's an experience that's been very much in my mind over recent weeks as we hear this or that agency threatening to downgrade this or that government. Firstly that these three companies hold that power (and don't tell me for one second these decisions aren't politically or commercially influenced over cosy little lunches in Washington) and secondly that my one experience of them showed that the rating was based on what was presumably some pretty sloppy research and didn't reflect the actual market conditions prevailing.

I wonder why everyone's putting up with it?
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Keefieboy said...

Glad I'm not the only one who thinks rating agencies a dodgy concept - especially for countries.

nzm said...

Count me in.

It's all a scam.

Political and international manipulation.

Big Dave said...

Spot on! Read Michael Lewis's "The Big Short" on how the ratings agencies kept classifying the dodgiest packages of sub-prime mortgages (which they patently didn't understand)as AAA right up to the time they collapsed.

Alex said...

Welcome to one of the many major issues in global finance. The problem lies in the business model of ratings agencies. Firstly, these guys are clearly short-staffed and don't have the human capital to pore over the necessary information in great enough detail to rate it properly in all cases. Secondly, the human capital they *do* have is largely comprised of people who couldn't make it into an investment bank. This is because ratings agencies pay a fraction of what banks pay and it isn't exactly a higher calling that would draw one on ethical grounds. Finally and most importantly, the business relies on being paid by the very same entities you're supposed to objectively rate. The inherent conflict of interest is palpable.

The problem is many investors do not have the capacity to do their own due diligence and our bound by compliance regulations that are intended to mitigate risk. One stupid trader could lose a billion dollars in a pension fund on a bad investment. That is supposed to be mitigated if his pension fund only approves trades rated AAA by an independent and objective agent like a ratings agency. The problem is of course, they are not always independent and objective.

There is evidence that, since their massive screwup during the financial crisis, markets are beginning to disregard the pronouncements of ratings agencies in some cases. After S&P downgraded the United States there was a rally in treasury bonds. This is because investors knew that regardless of an S&P pronouncement, the US sovereign is still one of the safest in the world if not the safest.

But in order for this to change in a big way, truly independent, competent and objective agencies need to exist to rate securities that investors can actually rely on. Either that, or regulation on disclosure is ramped up massively to make it easier for investors to make an informed choice (which still doesn't solve the risk management problem). Neither of these two things is likely to happen soon, sadly.

Luke said...

Oh come on, the rating agencies are just the latest scapegoat for politicians who sanctioned the accumulation of too much debt and are too concerned with re-election to really sort the problem out.

In 2008 the agencies were criticised for being behind the curve, and now they are being criticised for being ahead of it. I'd say they have been pretty spot-on this time around. Or do you think they should have continued to give Greece a single A, given the developments since 2008.

Yes, they are open to political manipulation, but i doubt that there is anything better. As long as you are aware of this, it doesn't matter anyway. Better the devil you know....

In any case, it isn't rating agencies that drive markets it is the flow of capital. Whether you listen to the agencies and make your investment decisions based on their ratings, is up to you. If you can't be bothered to do your own risk analysis then it is nobody's fault but your own. So don't go blaming someone else for having an opinion, right or wrong. At least they had one!

The fact is that there is too much debt and the southern countries in Europe are too uncompetitive to be able to pay the debt back. Rating agencies are reacting to this and the unintended consequence of the EU politicians trying to avoid a Greek default at all costs. The problem will continue to grow as they stumble from one "final solution" to the next, none of which will address the competitiveness of the southern nations and none of which have anything to do with rating agencies.

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