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TMFAleph1 (95.09)

Mr. Moody's Goes to Washington

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September 27, 2007 – Comments (2)

10:22 AM

Yesterday, the credit ratings agencies made the hike to the Hill to get a scolding by lawmakers over the subprime debacle. Congressmen waved their fingers and acted indignant – a skill they have perfected into an art form.

The truth is, one of the main parties at fault in this mess is… lawmakers. Indeed, they are the ones that sanctioned credit rating agencies or Nationally Recognized Statistical Ratings Organizations (NRSROs) in official parlance. Rating bonds isn’t exactly a competitive business – currently, there are only 7 NRSROs even after Congress passed a bill last year that was meant to open the business up. This is one of the reasons Moody’s (NYSE: MCO) have margins that are on par or greater than Microsoft’s. (Nasdaq: MSFT). Perhaps if anyone could enter the business, it would keep the big three, Moody’s, Standard & Poor’s and Fitch Ratings sharper. In fairness, there are other problems with the current model, including an inherent conflict of interest that stems from the fact that it is bond issuers, not bond buyers that pay for ratings. Furthermore, I think the agencies do a pretty creditable job, on the whole (there must be academic papers that look at the ratings as predictors of default probability).

The other thing that is lamentable in the spectacle of the Congressional hearings is that it demonstrates the fact that lawmakers don’t understand the difference between credit risk, on the one hand and market or liquidity risk, on the other. A AAA-rating doesn’t indicate that a bond can’t or won’t lose value, only that the rating agency expects the bond issuer to meet its obligations under the terms of the bond.

 

Total: 275 words

Time: 10.5 minutes

*** The above text was written (and spell-checked) in ten minutes. As a result, some of it may not stand up to rational scrutiny. I apologize preemptively for any errors, omissions and misrepresentations. ***

2 Comments – Post Your Own

#1) On September 27, 2007 at 11:31 AM, ikkyu2 (99.22) wrote:

A different perspective from the always-spot-on Jim Grant:

 

http://www.grantspub.com/articles/sellmoodys/ 

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#2) On September 27, 2007 at 12:24 PM, TMFAleph1 (95.09) wrote:

ikkyu2,

Thanks for your comment. I haven't read Grant's much, but he seems to be well respected. The call on Moody's in March 2007 appears prescient -- this chart shows Moody's performance against the S&P 500 since the article was published.

On a different note, have you studied Japanese? I lived in Japan several years ago and it's by far my favorite place in the world.

AD

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