Investors Beware Don’t Rely On the Rating Agencies!
I meant to post this article yesterday, but given our numerous posts decided to save it for today. The article is from the Financial Times and talks about the failure of rating agencies in exposing hidden financial risks. Although, intelligent investing requires one to have a firm grasp of a companies risk the reality is that many investors look towards rating agencies such as S&P, Moodys, and Fitch to understand a company’s risk. Unfortunately, due to collusion or just blind spots the agencies which are essentially government recognized failed to provide investors with accurate information. (Click here to skip the intro and read about the rating agencies)
Article Introduction (From Financial Times)
“In searching for clues to the financial disaster, attention has focused on predatory practices in originating mortgages and on investment banks’ “cosy” relationship with the agencies entrusted to rate their structured assets. But there is another cause: failure to acknowledge that market participants – including financial institutions – and regulators alike have only imperfect knowledge about the forces and mechanisms driving asset values and the broader economy. This point is where reform must start.”
Article Excerpts (From the Financial Times)
“The ratings agencies used statistical models that projected historical default patterns to continue. These patterns showed very low loss rates, thanks to ever rising prices since 1997. With such low loss rates, triple A ratings appeared to be justified.”
“Brave new models tempted the industry to abandon proven prudential procedures, which combined their own judgment and more formal criteria… But these stresses are hidden in ratings reports and, as recent events have painfully demonstrated, are woefully inadequate.”
“Had the agencies been required to make explicit how their ratings would have changed under the alternative assumption that house prices would fall back to benchmark levels, the markets would have feared greater loss rates, lowering the demand for mortgage-backed securities. “
“Requiring the agencies to rate securities under one or more pessimistic scenarios as well as the optimistic one would make it harder for the agencies to deliver rosy ratings in return for business from the investment banks.”
Click Here to read about the Failures of the Rating Agencies
