This Crunch is Not Yet Rated
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We’ve spent the past week anticipating the US and UK governments’ plans for financial regulatory reform. Some City players stand to gain from the changes, some will lose, but amid all the blaming and reforming, another blurry culprit - the rating agency - hasn’t been forgotten, and politicians are seeking to reduce investors’ reliance on them.
Credit rating agencies are some of the biggest culprits in this recessionary blame-game. Everyone now knows that Moody’s and Standard & Poor’s bungled their analyses of bonds backed by subprime home mortgages. But their most costly mistake lies in their area of alleged expertise: measuring corporate risk.
Given, most people are pretty terrible at risk assessment. They tend to overstate the risk of dramatic events (like a plane crash) at the expense of more common events (like food poisoning). But credit agencies were paid handsome amounts of cash to read in-between the lines assessing risk appropriately, and yet they didn’t manage to do this.
If politicians are able to marginalize them, what does this mean for the Square Mile’s credit-raters?
It’s not great. In the City, working at a rating agency confers much of the cache as working for a regulator - boring, unglamorous work - a place for failed investment bankers. Friends of mine at Moody’s are not only worried about redundancy, but also that they won’t be able to compete for jobs with the swarms of unemployed bankers.
On the other hand, I don’t feel too sorry for them. They didn’t exactly excel at their jobs. They should have warned investors of the dangers of buying toxic mortgage-backed bonds, for example, but most investors purchased them on the delusionary AAA rating they were assigned.
Why didn’t they check the information behind these bonds? The reason is pretty clear. There remains a fundamental conflict of interest between companies and the agencies that rate them - that is, agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of 'grade inflation'. The rating agencies, like the investment banks, believed in financial black magic - that F-rated toxic mortgages could be converted into products that were safe enough to be held by banks and pension funds. Unfortunately (for them), this magic has lost its hypnotic power.
To be fair, the City’s agencies have been getting tougher on rating big players recently - for example, downgrading UK government debt. Of course, now that governments are attempting to downplay the rating agencies, maybe they were previously right to operate on the mantra "Don’t bite the hand that feeds you".
Given, most people are pretty terrible at risk assessment. They tend to overstate the risk of dramatic events (like a plane crash) at the expense of more common events (like food poisoning). But credit agencies were paid handsome amounts of cash to read in-between the lines assessing risk appropriately, and yet they didn’t manage to do this.
If politicians are able to marginalize them, what does this mean for the Square Mile’s credit-raters?
It’s not great. In the City, working at a rating agency confers much of the cache as working for a regulator - boring, unglamorous work - a place for failed investment bankers. Friends of mine at Moody’s are not only worried about redundancy, but also that they won’t be able to compete for jobs with the swarms of unemployed bankers.
On the other hand, I don’t feel too sorry for them. They didn’t exactly excel at their jobs. They should have warned investors of the dangers of buying toxic mortgage-backed bonds, for example, but most investors purchased them on the delusionary AAA rating they were assigned.
Why didn’t they check the information behind these bonds? The reason is pretty clear. There remains a fundamental conflict of interest between companies and the agencies that rate them - that is, agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of 'grade inflation'. The rating agencies, like the investment banks, believed in financial black magic - that F-rated toxic mortgages could be converted into products that were safe enough to be held by banks and pension funds. Unfortunately (for them), this magic has lost its hypnotic power.
To be fair, the City’s agencies have been getting tougher on rating big players recently - for example, downgrading UK government debt. Of course, now that governments are attempting to downplay the rating agencies, maybe they were previously right to operate on the mantra "Don’t bite the hand that feeds you".
Here Is The Writer : Ceedy Girl
CeedyGirl is a saucy young investment banker, trading and dating in the heart of the Square Mile. She has worked in the City for the past four years, has a brutal Starbucks habit, and lives by the mantra 'carpe diem'.
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