Europe Shoots the Messenger
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  • WigWag

    “The real scandal hasn’t been malicious and destructive downgrades by credit agencies; it was their failure to blow the whistle early on. Ratings agencies were asleep at the switch when it came to US subprime mortgages and European subprime countries. If anything, serious reform of the ratings agencies would make them tougher and meaner.” (Walter Russell Mead)

    I wonder whether sophisticated investors bother to pay any attention to the ratings agencies; the uselessness of their ratings is hard to overstate.

    Not only did they completely miss the impending disasters facing American financial companies like Lehman, Bear Sterns and AIG, but in a feeble attempt to make up for its stupidity, one of the major ratings agencies, S&P, downgraded U.S. sovereign debt.

    Downgrading U.S. debt was as astoundingly dumb as failing to downgrade Lehman. In a sign that investors are wising up to the stupidity of the ratings agencies, the market has responded to the S&P downgrade not only by ignoring it, but by purchasing U.S. debt with more gusto and enthusiasm than ever. In fact, since the S&P downgrade, the purchase of treasuries has taken on almost panic status driving U.S. interest rates so low that they are barely in positive territory.

    I don’t like how the Europeans are handling the ratings agencies either; Mead is right-they are trying to shoot the messenger. But the ratings agencies do need to be punished; not for revealing bad news but for their sheer incompetence.

    In the United States, the best way to do that is by making the agencies explicitly subject to the Securities acts of 1933 and 1934. If the ratings agencies were subject to being sued by investors injured by their failure to adequately rate Lehman or AIG or others, perhaps they would take their responsibility more seriously.

    What makes suing the ratings agencies under American Securities law more difficult is that the agencies claim that they are really just news organization and thus their rating assignments are protected by the First Amendment.

    Obviously this is hogwash. If Lehman investors who lost everything could sue the ratings agencies for fraud or negligence, you can be certain that the quality of the ratings would improve in the future.

  • Kenny

    “I wonder whether sophisticated investors bother to pay any attention to the ratings agencies; the uselessness of their ratings is hard to overstate.”

    Sophisticate investors don’t — at least seldom with their own money.

    As for their institutional investing, the favorable credit ratings give the institutions cover for their herd-like recklessness. It’s a type of moral hazard, just like FDIC insurnace tends to help weak banks because the savers don’t research the stability & financial strength of the banks before giving them their money.

  • Douglas Levene

    The ratings agencies are irrelevant and shutting them down won’t make any difference.

    Sophisticated analysts rely on prices on credit default swaps for sovereign credits. CDS prices are much more accurate than credit ratings – they reflect new information much more rapidly and without any political influence. The European bureaucrats are truly dinosaurs if they don’t understand this.

  • Eric Roche

    Prof Mead – I thought it was even more venal than you do…that it was an attempted end run around the ECB’s dug in position of not allowing defaulted bonds as collateral. Easy – just make sure the ratings agencies aren’t allowed to rate a country as in default.

  • Otiose

    The ratings agencies perform a valuable function expressing their professional opinion as to credit quality.

    It is a sword with two edges.

    Their opinions allow overall a higher level of stability and efficiency in conducting business in the credit markets. Most of the time their opinions while never perfect are correct enough to be on the whole a positive.

    They also have had an negative impact in that reliance on their opinions has allowed / caused the credit assessment skills of many credit professionals to atrophy.

    It’s common for their ratings to be incorporated into quant models as if they represented some objective reality.

    However, I know from personal experience when I’ve had access to information not generally available regarding a company’s health that their opinions often lag reality greatly.

    They did not cause the financial meltdown. Their mistakes – their views on the credibility of collateralized mortgage obligations for example – were widely held by the financial establishment in the years leading up to the meltdown. That establishment included most leading politicians, most of the leading economists – particularly those devoted to Keynesian outlook, Most of the managers of the top banks – corporate and investment, and last but not the least the heads of central banks – such as Greenspan and our current head Bernanke.

    Anyone taking a contrary point of view prior to the meltdown was dismissed as a fool.

    So most of the time the rating agencies perform their function reasonably well. That function is needed and allowing them to be sued when they make mistakes would deprive us of their services, which on the whole provide considerable value.

    Will they make mistakes in the future? No doubt, but I’ve no doubt they’ve learned some lessons that will improve their performance going forward.

    Scapegoating the rating agencies is foolish. If I were to list who should have known better and taken steps to avert the disaster they wouldn’t be on the list at all.

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