Tag Archives: rating agencies

By James Kwak

A lot of the theory of securities markets revolves around information: securities prices respond to changes in available information, you want to provide incentives for people to produce information, some kinds of information should be equally available to everyone, other kinds of information you should be able to trade on, etc. In the conventional model, rating agencies are information providers: they produce information that is useful to market participants, and thereby improve the functioning of the markets.

Well, forget all that. Nate Silver has the best article I’ve seen yet on S&P’s sovereign debt ratings, and the summary is that it isn’t pretty. Some of the things Silver finds, using some publicly available data and Stata, are:

• Debt-to-GDP ratio alone is a better predictor of default risk than an S&P rating (meaning that the rating subtracts information provided by the debt-to-GDP ratio).
• S&P ratings have almost no correlation with future default risk.
• S&P rates European countries higher than other countries, all other things being equal—and look where that got us.
• S&P ratings are serially correlated, which means they incorporate new information especially slowly.

I would have thought that the credit rating agencies would be at least one group that everyone could agree to throw under the bus. We know that the powerful chieftains of Wall Street are trying to pin the credit crisis on rating agencies – see page 3 of JPMorgan’s blame-shifting attempt, for example. Yet the new Financial Regulatory Reform plan has almost nothing on the subject. Apparently the rating agencies, too, are Too Big to Fail.

Reuters catalogs the provisions relating to the rating agencies. Here’s the summary:

The plan urges Moody’s Corp’s Moody’s Investors Service, McGraw-Hill Cos Inc’ Standard & Poor’s and Fimalac SA’s Fitch Ratings and others to bolster the integrity of their ratings, especially in structured finance.

It also calls for reduced conflicts of interest and for regulators worldwide to tighten oversight.

But the blueprint does nothing to address what critics call the industry’s key shortcoming: That the biggest agencies are paid by issuers whose securities they rate, creating an incentive to win more business by assigning high ratings. . . .

“The overall impact of existing and proposed regulatory changes on rating agencies is extraordinarily easy to summarize: They reward abject failure,” said Jonathan Macey, deputy dean of Yale Law School.

Also see the Huffington Post, which has this understated but damning criticism: “Today, the agencies welcome the government proposals, saying that they favored improved ratings quality and transparency.”

Perhaps this is one area where Congress can improve on the administration’s plan.

Update: Krugman:

The plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.

By James Kwak

Calculated Risk reports that Citigroup is livid that S&P would have the audacity to downgrade the senior tranches of commercial mortgage-backed securities. 

Citigroup commented that the changes were “a complete surprise”, “flawed”, lacked “justification” and the “S&P methodology changes do not seem rational or predictable”. Ouch. 

It’s nice to see that the banks – who spent the last decade shopping for favorable ratings from the rating agencies, and overwhelming them with thousands of complicated offerings backed with sophisticated models – and the rating agencies – who spent the last decade giving AAA ratings to the banks’ models and are now claiming that it was all the banks’ fault – are getting along so nicely. Some marriages truly are forever.

By James Kwak

I’m drafting a post for The Hearing on credit rating agencies (the ones who gave AAA ratings to all those CDOs). The CEO of Fitch is giving this prepared testimony tomorrow. Here’s the question: Can anyone find anything in there that constitutes a constructive suggestion for how regulation of rating agencies could be improved? Or is it all just self-serving insistence that there is no problem? 

(My favorite part is on pages 6-7 where he says, effectively, “Don’t regulate us – regulate the issuers and underwriters instead!”

By James Kwak