The major rating agencies have been in the thick of credit market disaster. During the housing boom, they failed miserably in evaluating the risk associated with mortgage backed bonds and their derivatives. Their failure resulted in bonds with junk quality risk, getting investment grade, even pristine AAA ratings. This cost investors all over the world billions in losses, and precipitated the current crisis.
The rating agencies faced a conflict of interest; they were hired and paid by the same banks that were issuing the bonds and benefited from the investment grade ratings. The banks needed the imprimatur of two out of the three major rating agencies - S&P, Fitch & Moody's - and could pressurize the agencies to give better ratings to their bonds.
In the aftermath of the disaster, the credit-ratings are being very cautious about their behavior, especially when it comes to the financial sector. However, Moody's stands out in being egregiously aggressive, without any regard to the significance or the impact of their calls, especially in these tumultuous times.
Lehman Brothers
Lehman Brother's shares came under immense pressure on Tuesday, September 9, when the news that the talks with Korea Development Bank (KDB) for a capital infusion had broken down. The markets were in a jittery mood since the Federal take-over of Fannie Mae (FNM) and Freddie Mac (FRE) the previous weekend had caused significant losses to investment firms which held preferred shares of the GSEs.
In response, Lehman preannounced its results on Wednesday morning, along with plans to reorganize itself by splitting the firm up and selling some parts to raise new capital. Lehman's stock fell a bit more that morning, since Lehman had not announced an agreement, but just mentioned plans. However it had stabilized by noon and was gradually inching back up as the market settled down and waited in hope for Lehman's next move.
Later that day, Moody's announced that they would downgrade Lehman Brother's debt ratings unless it completed the transactions it had already announced earlier. Further, Moody's felt that Lehman's falling equity prices showed that it was fast losing the market's confidence and hence just raising capital would not be sufficient.
Morgan Stanley
With the world's financial markets under a spectacular collapse, Moody's announced that they are putting almost $200B of Morgan Stanley (MS) A-1 rated debt on review for a downgrade. The news resulted in panic selling of Morgan Stanley's stock sending it down almost 50% before it recovered to close down 22%; the financial sector (XLF) was up 10% on the same day.
Moody's attributed its review for a downgrade on the following:
It's expectation that an extended downturn in global capital market activity will reduce Morgan Stanley's revenue and profit. [The bank] will need to adapt the firm's business activities and balance sheet to operate in a bank holding company structure.
Credit Ratings and Their Role
Credit ratings are primarily used by professional bond traders to price bonds. Traders are typically ahead of the rating agencies when it comes to anticipating risk and price it into the bonds before the rating agencies. The ratings are also used to determine the collateral to be posted to back up financial contracts made between institutions. Equity analysts use ratings to determine cost to borrow capital and calculate estimates for financial firms.
Lehman's problems were well known for months, and any financial professional doing business with them was well aware. Any potential investor would do their own detailed analysis, with orders of magnitude greater rigor than what the rating agencies do.
In Lehman's case Moody's call triggered a sell-off in Lehman's share from which the firm never recovered, destroying the tenuous level of equilibrium they had reached after Wednesday morning's restructuring announcements. When a distressed firm is trying to raise capital in a bearish environment, it makes a huge difference whether its shares are priced at $8 or $4. Further, by declaring that just raising capital was not enough, and equity prices had to rise to prevent a downgrade, Moody's effectively ruled out equity sale as a means to raise capital.
Incidentally, other credit ratings though concerned about Lehman Brothers, did not come out with similar statements about how the drop in equity price will lead to a downgrade. Under normal circumstances, equity prices are a good proxy for market's confidence in the firm. However, under such extraordinary circumstances, where the market is far from stable, trying to find equilibrium equity prices can become very far detached from fundamental values.
In the case of Morgan Stanley, the change in charter from an Investment Bank to a Commercial Bank, the lower leverage, and slower business are all facts well known to the investment community. However, Moody's chose to put Morgan on a credit-watch just after the ban on short-selling of financial shares was lifted, and right before the $9B investment in Morgan Stanley from Mitsubishi UFG is about to close. The collapse in the price of Morgan Stanley's share from $18 on Wednesday to $10 on Friday has raised doubt about whether the investment from MUFG will close.
Moody's Mood Swings
Moody's action in the case of Lehman Brothers and Morgan Stanley was not based on new information nor on new analysis of existing information. It was primarily a reaction to market action. None of the other two major agencies followed Moody's.
Moody's might be coming down hard on banks during this period to restore some confidence in the value of their ratings. However, the timing of these actions was egregiously inappropriate, bordering on the point of being irresponsible. It is unlikely that they are scoring any points with regulators; and are more likely to be face greater wrath when the hunt for the scapegoats starts.
Related Articles
|
Hedge Fund Jobs
Job Seekers: Search jobs by category, get job alerts by email or live feed, apply online See full list of jobs »
Employers: See all recruitment options, get applications online or by email Post a job »
Trading Center
- Free E-Newsletters
- About Seeking Alpha
- About Us
- Contact Us
- What's New
- Readers Feedback
- Advertise With Us
- Contributors
- Contribute an Article
- Feature Your Book
- Our Contributors
- Anonymous Contributions
- Dispute an Article?
- Legal
- Terms of Use
- Privacy
- Copyright
This article has 12 comments:
- phat cat
- 24 Comments
Oct 12 05:34 AMWho's rating these rating agencies? Just like who's insuring hte insurance companies, or who's guaranteeing those who handing out those warranties you buy at electonic shops.
- Utide
- 267 Comments
Oct 12 05:54 AMNobody expects a Life Insurance Company to die before its client.
Looks like it may happen !!
- lucky larry
- 1 Comment
Oct 12 09:10 AM- ccbreaker
- 1 Comment
Oct 12 09:19 AM- who
- 82 Comments
Oct 12 03:07 PMjust close the agencies down and let the market decide on the risks hence the price they are willing to pay!
- zermux
- 11 Comments
My Website
Oct 12 04:07 PM- FDH
- 3 Comments
Oct 12 06:24 PM- Frozen Tundra
- 33 Comments
Oct 12 08:31 PMFitch & S&P have made similar announcements w/ similar effects on other companies.
Most ridiculous is the claim that MCO somehow is in league w/ someone (exactly whom, not clear from the conspiracy nuts) to put companies out of business, fatten some hedge fund's wallet, or take other nefarious action.
My experience w/ Moody's suggests they take their reputation, products and credit analysis seriously. That said, they, and the other agencies, messed up big time with regard to structured products, cdo's, subprime and cmbs. Criminal ? Not very likely.
While you dopes blame Moody's, nobody there makes the big bucks. The analysts don't get paid anything like the Wall St. bankers that put together and peddle the crap.
As much as I didn't want to see Bear or LEH or others go under, it is the BANKERS that created, marketed and sold the product; took the insane risks; sold crap to the mutual funds and banks; earned the big fees and the bonuses.
There, and with crooks like Chris Dodd and Barney Frank is where the fault really lies.
Where is your anger at Lehman ? At Fuld, who played a jack high hand into bankruptcy. At Jimmy Cayne, playing golf, bridge and getting high while his company blew up ?
C'mon people, get real.
- fii
- 3 Comments
Oct 12 08:42 PM- User 277960
- 1 Comment
Oct 13 02:50 AMIn these hard times, I think that one's has to be very careful, speak softly or even better keep his mouth shut. It is a real pity, that such a well known rating agency is following the insanities and the rumours that are thrown on the markets! Wake up please! Be responsible and don't play the "gossip agency"!
the real problem is that the rating agencies business suffer from the lack of competition.. break this monopole, the world will get better!
- phat cat
- 24 Comments
Oct 13 05:19 AMI don't deny that there are too much greed in Wall Street, but isn't what capitalism is based on? Without the fundamental drive to create wealth, we might as well all go back to farming and barter system. What we need is some check and balance to make sure greed doesn't go out of control. Dick Fuld is guilty of his arrogence, but the system created him. Don't think for a minute that the guy who's working at the rating agency didn't want to make the same amount of money as Fuld.
- Stockbuzz
- 2 Comments
Oct 13 10:42 AM