Rating Agency BubbleOmics: Time For the Regulators to Take Away Their Ball

By: Andrew_Butter

Writing in Barron’s under the title “The Credit Umpires Blew It, Too”, Randall W. Forsyth concluded:

…the leading ratings agencies aren't seen as venal, stupid or hopelessly conflicted by the way they're compensated. No, it's even worse. They're seen as irrelevant.

http://online.barrons.com/article/..

Forsyth remarks that nowadays bond investors look harder at the market for CDS and at the fundamentals. Yet:

Except…that many institutions have strictures about minimum ratings for their bond portfolios or limits as to how much unrated securities they may hold. So, the rating agencies call do count, if only because of those standards imposed years ago.

But that’s not the problem, the problem was, and is that the risk weighting of assets (read bond (securities) portfolios), plus the solvency of insurance companies and pension funds; is calculated from the ratings, as I pointed out a while back:

http://seekingalpha.com/..

That’s not changing, the US Financial Reform Bill says nothing about that, which is why the bill is in the cold-light of day, nothing more than a load of hot-air designed to make the administration feel good and create more layers of bureaucracy that can only be handled cost effectively by Big Banks…specifically Too Big To Fail Banks. 

The reason there was a credit crunch was that banks made foolish loans, they were allowed to make foolish loans by the regulators because the loans they made (and the securitized products that were distilled from those loans) were rated too high.

And in the event the amount of money that the previously highly rated assets could be sold for, was a pittance, compared to what the last sucker in the elaborate game of pass-the-bundle had paid.

The rating agencies will say (and said) that it is good the investors have started to do their own due diligence, and in fact, they advised them to do that all along. But that leaves the question, if all that a rating does is provide a government approved quality stamp; that no one believes, what useful economic function do they provide?

The answer to that question, based on past experience is not, “None”. It is less than none, because like it or not, if the government has (by proxy through the monopoly provider rating agencies), given that precious AAA stamp, that opens the door for devious and dishonest to exploit the system.

Yet the thought of regulators losing the “control” afforded by ratings, is so horrifying, that it has been firmly swept under the carpet.

Yet again, there are plenty of easy market-based solutions based on providing investors and counter-parties with the necessary information to make rational decisions independent of what this or that rating agency might say. The “buy” side in the securities market has been complaining for a long time about the inconsistency and lack of transparency in the goods that they are obliged (by the regulators) to buy. 

It’s time to move on, but until the regulators start to address this issue properly, the market for securitized debt, and indeed other types of debt (corporate bonds and sovereign debt), will be depressed.

And the consequence of that will be the rate of de-leveraging of the private sector will accelerate. The good news there is that the Treasury will be able to sell its AAA rated bonds at a great price (yields will stay down), the bad news is that economic activity will become increasingly dependent on government debt.

Right now, essentially, nothing has been done to address this issue. Until some coherent and decisive steps are taken, don’t expect long term Treasury yields to go up significantly; that’s good for housing and the stock market, but it’s bad news for anyone who holds cash because it’s highly likely that the “real” rate of inflation will exceed bond yields.

And that’s a receipt, for…you guessed it…bubbles.

By Andrew Butter

Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2010 Copyright Andrew Butter- All Rights Reserved
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