Shares of ratings agency Moody's (MCO) are off about 8% today (they were down more but have rebounded), due to a few sentences in the 10q they filed late last week:
On March 18, 2010, MIS received a “Wells Notice” from the Staff of the SEC stating that the Staff is considering recommending that the Commission institute administrative and cease-and-desist proceedings against MIS in connection with MIS’s initial June 2007 application on SEC Form NRSRO to register as a nationally recognized statistical rating organization under the Credit Rating Agency Reform Act of 2006. That application, which is publicly available on the Regulatory Affairs page of http://www.moodys.com, included a description of MIS’s procedures and principles for determining credit ratings. The Staff has informed Moody’s that the recommendation it is considering is based on the theory that MIS’s description of its procedures and principles were rendered false and misleading as of the time the application was filed with the SEC in light of the Company’s finding that a rating committee policy had been violated. MIS disagrees with the Staff that the violation of a company policy by a company employee renders the policy itself false and misleading and has submitted a response to the Wells Notice explaining why its initial application was accurate and why it believes an enforcement action is unwarranted.I've long been of the opinion that Moody's should become obsolete not for legal reasons (I think in a world of adults, people that rely on a cursory glance at a "rating" before buying $100million in bonds deserve to lose money), but for common sense reasons. Need proof? Today Moody's is out with a warning that they might consider cutting Greece's credit rating to junk in the weeks ahead...can you say LATE TO THE PARTY?
Along with Moody's, Standard & Poor's and Fitch are beyond useless - they're harmful. Whether it is S&P officials texting each other that they would rate products structured by cows, or Fitch admitting that their housing ratings model would "break down completely if house prices were to decline."
Back in 2007, Robert Rodriguez of First Pacific Advisors nailed it:
We were on the March 22 call with Fitch regarding the sub-prime securitization market’s difficulties. In their talk, they were highly confident regarding their models and their ratings. My associate asked several questions. “What are the key drivers of your rating model?” They responded, FICO scores and home price appreciation (HPA) of low single digit (LSD) or mid single digit (MSD), as HPA has been for the past 50 years. My associate then asked, “What if HPA was flat for an extended period of time?” They responded that their model would start to break down. He then asked, “What if HPA were to decline 1% to 2% for an extended period of time?” They responded that their models would break down completely. He then asked, “With 2% depreciation, how far up the rating’s scale would it harm?” They responded that it might go as high as the AA or AAA tranches.NO ONE (well, no one worth investing with) in the equity markets buys $100million in stocks after five minutes of due diligence or peeking at a ValueLine or IBD stock ranking - it would be a breach of fiduciary duty to be so irresponsible. But this is commonplace among the dumb money (some pensions, endowments, insurance companies, etc.) when looking at fixed income.
In his May commentary, Bill Gross of bond giant PIMCO (by the way, when considering the outlook for bonds over the long term, one should not that PIMCO is massively expanding it's talent and offerings in the equity space....) issues a scorching assessment (not his first) of the utility of the ratings agencies to smart investors - mainly that there is none...
(in his piece, "CQ" means "common sense quotient - it's worth reading in full)
Second grade intelligence and a high CQ are a rare combination for an individual rating agency or an investment management firm as well. Still, the rating agencies in recent years have displayed little of either. In addition, they have brazenly sold their reputations for unbiased judgment to the very companies they were standing in judgment upon. Don’t bury them however; like vampires in the dead of the night they will outlast us all. Those looking to profit at their expense, however, will dismiss them. They no longer serve a valid purpose for investment companies free of regulatory mandates that can think with a teaspoon of IQ and a tablespoon of CQ.
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