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Deika Morrison: Reasoning the Reasons

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Wednesday, October 22, 2008

Rating the Ratings Agencies

Yesterday, I called for immediate action with regard to CDSs.

Today, I believe the case has been more than made for immediate action with regard to ratings agencies. I have previously expressed my concerns about how ratings agencies function; and further how they should be allowed to function in a crisis, especially a man-made crisis of confidence in the global financial system in which they played no small role.

Yes, it takes a while to fix problems. But it's quite straightforward to stem losses and prevent further problems. Whether you have the 4+ hours to watch the hearings today on the Hill on the Ratings Agencies (see CSPAN. I think these hearings should be required viewing, personally), or you just want to read a few news articles (see example from MarketWatch here: Ratings agencies 'put system at risk,' CEO says), the analysis takes you to the same simple conclusions:
  • Rating agencies were not helping prior to the crisis
  • Rating agencies - by their own admission - were making the problems worse
  • Rating agencies are not helping now
If we accept that:
  • there is still a liquidity crunch (crisis averted by extreme government intervention),
  • there is a credit crisis (although thawing solely because of extreme government intervention),
  • from now on credit will be difficult to come by,
  • people are expected to remain risk averse for some time given the crisis of confidence,
  • the impact of the crisis has seriously impacted current and future expected earnings as we see reported
  • the world is facing "contraction", "recession" or "depression" or whatever term you are most comfortable with,
then, which instrument, entity, country is going to get a favourable rating? If you have 10 ratings issued by a day - on anything - how many positive ratings can one reasonably expect on anything? If you expect one, even one, then you are extremely optimistic.

I've said before, if ratings agencies were not helpful before, and if they were not even accurate before, why do people believe that somehow allowing rating agencies to continue to "rate" in this environment is somehow constructive? This just further accerelates a downward spiral of the financial system.
  • Do people have faith in the ratings? No. But if a rating is negative, it creates panic and in the case of countries, just makes it more difficult for countries to recover.
  • Do people have faith in the ratings agencies? No. But the agencies are still there, so people feel like maybe they should listen
  • Do the ratings agencies believe they were right? No. They have said they were wrong. They have said why they were wrong - and many of these are serious systemic problems that cannot be solved overnight.
So, can somebody please explain to me the value of any body - and this includes the former Investment Banks - rating any body or anything right now?

Respectfully, the only way to prevent a complete collapse of the financial architecture is to inject some common sense into the process.

In principle, ratings agencies are a critical part of a functional market. In my humble view, they are an indispensable part of a functional market. But they must be credible. And that only comes with reform. If you live in a glass house, you really just cannot throw stones.

Besides, if they continue like this, the ratings agencies are just putting themselves out of business since they would have accelerated the complete unraveling of the financial system. So what would they have to rate?

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Reasoning The Reasons by Deika Morrison is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.