How highly should we rate the rating agencies?
BOTTOM LINE:SINCE LAST Thursday’s downgrading of 15 international banks by Moody’s, the financial press has been awash with the news that nobody cares anymore.
One of the “big two” credit rating agencies took action on some of the world’s largest financial institutions, and the market barely shuddered. In fact, many bank stocks rallied the following day.
As you may have read in these pages earlier this week, Bloomberg recently examined market reaction to 314 rating actions since 1974 and found that, almost half the time, government bond yields fell when a rating action suggested they should climb.
Perhaps the most pointed illustration of this came last year when Standard Poor’s downgraded the US government’s AAA sovereign credit rating. Since then, yields on US debt have hit historic lows – again, suggesting that investors have blithely dismissed the view of the agency.
It is worth noting that the top three credit rating agencies – Moody’s Investor Service, Standard Poor’s and Fitch Ratings – are simply publicly-traded companies, or subsidiaries of such. While their ratings are recognised in the US by the Securities and Exchange Commission for regulatory compliance purposes, they are not internationally-appointed bodies with a higher mandate. Some people have even taken to calling them “rating companies” to stress their private, unofficial status.
Issuers pay the agencies to rate their securities, and investors pay for access to their data. In other words, they offer a service and those who want it pay for it. And, in a few cases, if customers don’t agree with the rating given, they even fire the agency – as happened earlier this year when the Danish mortgage lender Nykredit said it had terminated its contract with Moody’s because of the agency’s “volatile view of the Danish mortgage industry in recent years”.
The country ratings issued by the agencies are just a little bonus on the side.
The one concrete knock-on effect of last week’s rating action by Moody’s is that it will affect the funding costs of many of these institutions – “all because of the opinion of a small group of New York-based credit analysts whom many criticise for missing the excesses that exacerbated the crisis”, as the Financial Times wrote after Thursday’s action. The insinuation here is that the agencies have an outsized influence that, given their recent track record, is unjustified.
Richard Robb, co-founder of the New York and London-based investment firm Christofferson, Robb and Co, says the FT’s description of the power wielded by the agencies with regard to funding costs is exaggerated.
“If we saw tiering of funding costs that closely corresponded to banks ratings, I think we would conclude that ratings companies – as I like to call them – have too much power. But we don’t,” he said.