Tuesday, April 21, 2009

Credit Agencies Roundtable

The SEC held its roundtable last week, in four panels, "To Examine Oversight of Credit Rating Agencies."

If you missed it, you might be wondering, what did the much maligned "big three" agencies: Moody's, S&P, and Fitch, have to say for themselves? Was it just, "yes, we gave AAA ratings to securities that might have been structured by cows, but it was all first amendment protected, nyah nyah"?

Well ... not quite. (Though you can get your fill of the first amendment issue in a page C1 story of the Wall Street Journal this morning.)

Here, I'll try to give you the money quote from the statement of each of the Big Three's reps at this roundtable.

From Fitch came Stephen W. Joynt, who said: "Finding the right balance in assigning ratings of major global financial institutions during the current global financial crisis has proved challenging." He then made the point that Fitch built into its ratings the assumption that the US government wouldn't let the largest of these institutions fail. When it did let Lehman Brothers fail, all bets were off.

Or, in Joynt's words: "we have generally assumed that government support would be
forthcoming for financial institutions in peril, and it has been. Lehman Brothers was a notable exception; like most market participants we expected a ‘government engineered’ solution that did not materialize."

Raymond McDaniel, the CEO of Moody's Investors Service, defended the issuer-pays model that each of the Big Three uses. For the most part, he says, issuer-pays works better than the preceding regime of investor-pays did (or, by implication, than the later would if instituted again).

And from S&P there was Deven Sharma, who said in essence that people shouyld stop second-guessing them with hindsight. They're doing an essential job and doing it well, by gum.

Well, okay, he was a bit more eloquent: "Accountability standards that allowed for second-guessing of judgments made in good faith could have the unintended consequences of compromising the independence of those judgments (to prevent against fear of later criticism) and hindering analytical innovation, both of which would be harmful to the markets as a whole. Accordingly, we strongly believe that any accountability measures should focus on an [the agency's] adherence to its policies and procedures, not on second-guessing ratings judgments through regulatory action or private litigation."

Actually, the most coherent defense of the big three at the roundtable came from a representative of the AFL-CIO sitting in on the "competition" panel. He asked his listeners first to consider why the agencies are valuable.

The “cost of investing in fixed income markets” would go up significantly, especially for small investors, if the raters should vanish, and a money market manager’s role would become much like that of a hedge fund manager; his services would no longer be “a commodity” and become much more “high value added.” That would be good for the money market managers, but bad news for retail investors.

“Given all that,” he said, he is not an enthusiast of competition in the credit rating field, because should “full competition” be encouraged “the equivalents of Madoff’s accountant …will step in.” Here he was making a reference Friehling & Horowitz, CPAs, P.C., the small auditing shop that is alleged to have participated in Bernard Madoff’s Ponzi scheme by only purporting to conduct the appropriate audits.

Intriguing point, which also ties into network effects, economies of scale, etc.