Under fire for losing their objectivity when it comes to assessing the true credit worthiness of issued securities and sovereign governments, have credit rating agencies become too powerful for their own good?
By: Ringo Bones
For anyone watching the blow-by-blow account of the Financial Crisis Inquiry Commission (FCIC) hearing back in June 2, 2010, it seems like the preconceptions since harbored by everyone critical of credit rating agencies since the few preceding years before the start of the 2007 subprime mortgage crisis has been proven right yet again. Credit rating agencies had truly become too powerful for their own good for two main reasons. One, they are not exactly unbiased when it comes to assigning the true credit worthiness or credit rating of issued securities and sovereign governments under their purview and two, they don’t do their share of due diligence – as in legwork - to assess the true credit worthiness or credit rating of financial instruments issued by securities issuers and sovereign governments under their purview.
Financial Crisis Commission Chairman Phil Angelides had recently grilled the two prime “instigators” of the 2007 subprime mortgage crisis. Namely, the famed investment guru and Berkshire Hathaway CEO Warren Buffett and Moody’s CEO Raymond McDaniel over the loss of credibility of credit rating agencies in the June 2 FCIC hearing under full press fanfare. Also on the agenda is the credit rating agencies’ inability to warn institutional investors against the impending subprime mortgage crisis that started near the end of July 2007 that nearly brought our global financial system o the brink of collapse. And yet Buffett and McDaniel – in their defense – have reiterated yet again what every seasoned investor already knew about the preexisting systemic faults that plague credit rating agencies.
According to Moody’s CEO Raymond McDaniel, it is very difficult to avoid potential conflicts of interest inherent in a typical credit rating agencies’ assessment of the credit worthiness of a typical sovereign government and / or typical issued securities. Inevitable considering that a lion’s share of the salaries of credit rating agencies’ analysts came from the securities issuers and the sovereign governments under their purview. McDaniel’s reassurance that Moody’s are on top of valuations and possess enhanced analytical integrity seems sacrosanct to anyone who had experienced the global financial crisis first hand. But McDaniel managed to shift blame to the Bush administration era financial watchdogs for initiating a sudden tightening of credit in s softening housing market, which made hell to everyone wanting to restructure their mortgages.
While Warren Buffett’s “behavior” prior to the start to the subprime mortgage crisis does seem suspicious – i.e. he dumped his Fannie Mae and Freddie Mac shares from his investment portfolio just before the housing bubble burst citing its focus on enhanced earnings. Buffett also did the still trendy thing to do during the June 2, 2010 FCIC hearing – blame credit default swaps and related derivatives as the primary instigators of the subprime mortgage crisis. Buffett says that credit default swaps are the financial world’s equivalent of weapons of mass destruction because they provide so much unfair leverage, also citing that their improper use posed system-wide problems that led to the subprime mortgage crisis.
Securities issuers and sovereign governments – more often than not – usually resort to do what most unscrupulous restaurant owners do in order to drum up business – pay exorbitant sums to an A-List restaurant critic to make his or her restaurant appear better to potential diners and patrons than it actually is. Seasoned investors have caught on this “dirty trick” since the credit rating agencies has first set up shop, thus making them view credit rating agencies with suspicion and often take their assessments – in the form of credit worthiness reports – with a grain of salt. Maybe credit rating agencies had truly become too powerful for everyone’s good, especially when moral hazard concerns are often lost in the relentless pursuit of profits.