Tuesday 25 May 2010

A New Rating Agency from the Fearsome Kroll

The record of the 'traditional' rating agencies is deplorable. Go back 10 years and you will not find them having called time on Enron's 'asset-lite' business empire, nor on any of the dozen or so large Enron wannabees that had sprung up in emulation of that pioneering 'merchant energy' and which were all to go under in 2001-2002, basically for the same reason of gross under-capitalisation.

Cue for breast-beating, sack-cloth-n-ashes and, we were led to believe, soul-searching. Oh, how the agencies realised the error of their ways ! Oh, how they now saw the additional analysis that was required. Oh, how they would never let it happen again.

They told the energy market players that, unless they disclosed a great deal more, in particular about their proprietary trading and its inherent risks, they would be severely dealt with in the ratings department.
And indeed, for a brief but glorious period in 2002-2003, a window of transparency was established, through which to view the relevant details of the (remaining) energy merchants' activities. Disclosure was made on a scale never seen before.

Or, indeed, since: for guess what ? Gradually the window misted over, and the window-cleaners stayed away. Soon we were back to the minimalist disclosures of yore. And what's to be expected, when the agencies receive their fees from the firms whose debt they are rating ! Don't like a rating you've been given ? Then go rating-shopping.

So there was never much chance that the vastly bigger and more complex banking sector was going to get proper scrutiny. As late as 3 days before it collapsed, Bear Stearns was rated single-A by both Moody's and S&P ! Such failures can only have contributed to the crisis.

An interesting development then is the fearsome Jules Kroll's proposal to set up a new rating agency. One trusts his 'sceptical' approach is as rigorous - and successful - as his reputation from the world of corporate security would imply, and as the world of finance sorely needs. A new business-model required, since one can't see a great deal of traditional business migrating their way ? Yes: he plans to seek fees from investors - a form of outsourced due-diligence.

Good luck with that. It has to come.



mark said...

Rating agencies are worse than useless.

My favourite quote about rating agencies is attributed to John Heimann, former comptroller of the currency:

"the function of the ratings agency is to go on the battlefield after the battle is over and shoot the wounded."

Andrew B said...
This comment has been removed by the author.
Andrew B said...

Option 1:-
Lots of possibly unsavory people pay me to say how unsavory they are.
If I say they are more unsavory than they think they, they take their fees somewhere else.
I publish (for free) a big list, with a range from Salt&Vinegar to Brown Sugar Cinnamon Ritz Crackers (unsavory).
Once every 5 years or so I get it very wrong.

I can understand the business model, and why the ratings will not be too accurate.

Option 2:-
Lots of possibly people pay me to say how unsavory other people are.
If I say they are more unsavory than they think reasonable, they take their bonds somewhere else.
I publish (for a fee) a big list, with a range from Twiglets to Caramel coated popcorn (unsavory).
Once every 15 years or so I get it very wrong (this will happen).

I can understand why the ratings will be a bit more accurate, but not the business model.

CityUnslicker said...

I have seen Deloitte too are thinking of entering this market.

However, as pointed out by Nick Drew - as with auditors, until the piper stops paying the rats will follow.

A whole new way of institutional investors and shareholders payig directly ought to be installed. That in itself would be a good bulwark against a future financial crisis.

Pogo said...

One wonders whether the market could, in fact, survive a dose of the truth...

Nick Drew said...

that's one to file & use again, Mark - thanks!

(I also like annalists, not analysts)

Andrew - business model indeed needs proving: but at least under (2) there's little incentive to get it wrong, or indeed for all such companies to sing from the same hymn-sheet: hopefully contrarain voices would also be heard more often

CU - institutional investors and shareholders paying directly - excellent idea: something new & better has got to be devised, the need it so obvious

Pogo - indeed: when we see measures being taken like the suspension of publishing mark-to-market valuation, we know there's a lot of fear in the air

(Nietzsche had a lot to say about being too weak to bear the truth ... another day)

Anonymous said...

Aren't you assuming that investors actually care about this? The only reason these products existed was because investors WANTED to take the risk but needed a figleaf of a stamp of approval to invest.

Surely it makes more sense to:

a) Make asset managers have a strong, clear cut legal responsibility for fiduciary care of their clients money
b) Get rid of credit ratings all together. Subject to the above if you want to invest in "high-yield" instruments you take the consequences.