Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Gold Prices Investors beat Central Banks and Jewelry, as having the most Impact - 18th Jun 21
Has the Dust Settled After Fed Day? Not Just Yet - 18th Jun 21
Gold Asks: Will the Economic Boom Continue? - 18th Jun 21
STABLE COINS PONZI Crypto SCAM WARNING! Iron Titan CRASH to ZERO! Exit USDT While You Can! - 18th Jun 21
FOMC Surprise Takeaways - 18th Jun 21
Youtube Upload Stuck at 0% QUICK FIXES Solutions Tutorial - 18th Jun 21
AI Stock Buying Levels, Ratings, Valuations Video - 18th Jun 21
AI Stock Buying Levels, Ratings, Valuations and Trend Analysis into Market Correction - 17th Jun 21
Stocks, Gold, Silver Markets Inflation Tipping Point - 17th Jun 21
Letting Yourself Relax with Activities That You Might Not Have Considered - 17th Jun 21
The Federal Reserve and Inflation - 16th Jun 21
Inflation Soars 5%! Will Gold Skyrocket? - 16th Jun 21
Stock Market Sentiment Speaks: Inflation Is For Fools - 16th Jun 21
Four News Events That Could Drive Gold Bullion Demand - 16th Jun 21
5 ways that crypto is changing the face of online casinos - 16th Jun 21
Transitory Inflation Debate - 15th Jun 21
USDX: The Cleanest Shirt Among the Dirty Laundry - 15th Jun 21
Inflation and Stock Market SPX Record Highs. PPI, FOMC Meeting in Focus - 15th Jun 21
Stock Market SPX 4310 Right Around the Corner! - 15th Jun 21
AI Stocks Strength vs Weakness - Why Selling Google or Facebook is a Big Mistake! - 14th Jun 21
The Bitcoin Crime Wave Hits - 14th Jun 21
Gold Time for Consolidation and Lower Volatility - 14th Jun 21
More Banks & Investors Are NOT Believing Fed Propaganda - 14th Jun 21
Market Inflation Bets – Squaring or Not - 14th Jun 21
Is Gold Really an Inflation Hedge? - 14th Jun 21
The FED Holds the Market. How Long Will It Last? - 14th Jun 21
Coinbase vs Binance for Bitcoin, Ethereum Crypto Trading & Investing During Bear Market 2021 - 11th Jun 21
Gold Price $4000 – Insurance, A Hedge, An Investment - 11th Jun 21
What Drives Gold Prices? (Don't Say "the Fed!") - 11th Jun 21
Why You Need to Buy and Hold Gold Now - 11th Jun 21
Big Pharma Is Back! Biotech Skyrockets On Biogen’s New Alzheimer Drug Approval - 11th Jun 21
Top 5 AI Tech Stocks Trend Analysis, Buying Levels, Ratings and Valuations - 10th Jun 21
Gold’s Inflation Utility - 10th Jun 21
The Fuel Of The Future That’s 9 Times More Efficient Than Lithium - 10th Jun 21
Challenges facing the law industry in 2021 - 10th Jun 21
SELL USDT Tether Before Ponzi Scheme Implodes Triggering 90% Bitcoin CRASH in Cryptos Lehman Bros - 9th Jun 21
Stock Market Sentiment Speaks: Prepare For Volatility - 9th Jun 21
Gold Mining Stocks: Which Door Will Investors Choose? - 9th Jun 21
Fed ‘Taper’ Talk Is Back: Will a Tantrum Follow? - 9th Jun 21
Scientists Discover New Renewable Fuel 3 Times More Powerful Than Gasoline - 9th Jun 21
How do I Choose an Online Trading Broker? - 9th Jun 21
Fed’s Tools are Broken - 8th Jun 21
Stock Market Approaching an Intermediate peak! - 8th Jun 21
Could This Household Chemical Become The Superfuel Of The Future? - 8th Jun 21
The Return of Inflation. Can Gold Withstand the Dark Side? - 7th Jun 21
Why "Trouble is Brewing" for the U.S. Housing Market - 7th Jun 21
Stock Market Volatility Crash Course (VIX vs VVIX) – Learn How to Profit From Volatility - 7th Jun 21
Computer Vision Is Like Investing in the Internet in the ‘90s - 7th Jun 21
MAPLINS - Sheffield Down Memory Lane, Before the Shop Closed its Doors for the Last Time - 7th Jun 21
Wire Brush vs Block Paving Driveway Weeds - How Much Work, Nest Way to Kill Weeds? - 7th Jun 21
When Markets Get Scared and Reverse - 7th Jun 21
Is A New Superfuel About To Take Over Energy Markets? - 7th Jun 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Rating Agencies Are Dead: Long Live The Rating Agencies.

Politics / Credit Crisis 2010 May 16, 2010 - 03:52 AM GMT

By: Andrew_Butter


Best Financial Markets Analysis ArticleOnce upon a time rating agencies were independent research companies advising end-buyers and traders on the fundamental value of securities. They sold opinions of value, i.e. they did valuations – they gave an opinion on how likely it was that projected cash flows would materialise in the future; and once you got a fix on that, working out present value is just arithmetic.

The trouble started when regulators decided to hitch a free ride on the backs of the rating agencies; they mandated that capital adequacy was assessed based on ratings provided by approved agencies.

Fair-enough,, that’s sounds “innocent”, and sensible; if a bank has a lot of high quality assets then the capital cover that they should be obliged to hold, can reasonably be less than a banks that has a load of low quality assets.

And who better to work out the quality of the assets than rating agencies, who were in that business, in the private sector, making money providing opinions to industry experts?

So the rating agencies just kept on “giving opinions”, except that there was a conflict of interest because their client base switched from being (mainly) buyers of securities, to the sellers.

And there is always more money to be made sitting on the seller’s side of the table than on the buyer’s side…much more money. If you get “X” percent of a deal that goes through, that is always more than the lump-sum you get paid for advising against a deal, and you never get paid for the deals that don’t happen.

Imagine sending someone an invoice, “in respect of the $1 billion deal that I persuaded you not to get into, that tanked, here is my fee for 1%”. That’s just ludicrous.

But turn that around, “with regard to the $1 billion deal that you did thanks to my wonderful explanation of how I reached my opinion about what a good deal it was that all the investors lapped up, here is my fee for 1%. Now that’s fair enough…everyone made money right?

The huff and puff of the SEC et al, going after the rating agencies is a red-herring. It was the regulators who depended on the rating agencies, and ultimately it was they, via this sleight of hand, who created the credit crunch.

Forget about President Clinton pushing for home ownership, Bin Laden frightening Alan Greenspan into dropping the base-rate after 9/11 and keeping it down too long, Liar Loans, naked credit default swaps, dodgy collateralised debt obligations or  greedy bankers.

Didn’t you know, all bankers are greedy…and mean, its part of the selection-process; you have to prove that you loved torturing small animals as a child before they let you into the “association” and their Patron Saint is Shylock from The Merchant of Venice.

 But that’s not new, what happened is new.

The reason there was a credit crunch was because there was a housing bust.

If there had not been a bust there would not have been a crunch. If there had not been a bust then all those AAA rated RMBS would be performing perfectly, Hank Paulson would have “saved the world” by his “confidence-building” pronouncement “The US Banking System is a Safe and Sound one”, Lehman would still be alive, ACA would be billionaires and John Paulson would be running a pop-corn concession in Detroit.

The reason there was a housing bust was because there was a bubble.

Logic my dear Watson, if there hadn’t been a bubble then there would not have been a bust. The reason there was a bubble was because too much borrowed (and easy) money was chasing too few homes.

And the reason there was too much easy-money-chasing-too-few-homes, was because Moody’s & Co stamped AAA on residential mortgage backed securities tied to the easy money.

And the reason they did that was because in the SEC handed out TEN concessions to TEN rating agencies.

They wanted a quality control on securities, but they didn’t want to pay. Can you imagine if BOA presents a list of “assets” and the regulator hires Moody’s to tell them how good they are, and what risk weighting should be applied; and pays them for doing that job?

That’s never going to happen, not in a million years.

Much easier to write Rule 436(g).

A good account of how that works was written by Shahein Nasiripour in the Huffington Post.
In return for the rating agencies doing the regulator’s job, for free; they gave them a concession, it was called Rule 436(g). What that meant was that in return for providing ratings that the regulators could rely on (for free), the agencies were awarded a monopoly and immunity from prosecution (civil and criminal), if they made a mistake.

See if you recognise where this came from…from Wikipedia.

Harley (The Lord Treasurer) needed to provide a mechanism for funding government debt incurred in the course of that war. However, he could not establish a bank, because the charter of the Bank of England made it the only joint stock bank. He therefore established what, on its face, was a trading company, though its main activity was in fact the funding of government debt.

In return for its exclusive trading rights the government saw an opportunity for a profitable trade-off. The government and the company convinced the holders of around £10 million of short-term government debt to exchange it with a new issue of stock in the company. In exchange, the government granted the company a perpetual annuity from the government paying £576,534 annually on the company's books, or a perpetual loan of £10 million paying 6 percent. This guaranteed the new equity owners a steady stream of earnings to this new venture. The government thought it was in a win-win situation because it would fund the interest payment by placing a tariff on the goods brought from South America.

Are you starting to get the picture, “perpetual loans…win-win…monopoly…off-balance sheet…shadow banks”?

That was the foundation of the South Sea Bubble.

The initial driver of the “concession” that led to the housing bubble was the fact that the State Governments in USA needed financing, but they were not (and are still not) allowed to run a budget deficit.

Yet they needed to build sewage treatment plants, and other essentials, and the way to finance that was by issuing securities. And having the rating agencies “on board” was a big help.

And then there was housing. OK the government didn’t benefit directly, but they didn’t mind if Average Joe and May Lou used their house as an ATM, because that helped the world go round, and that made the politicians look good. Of course they only allowed that so long as the “independent” rating agencies blessed the deals.

So on one hand the regulators mandated that securities should be rated by an approved agency, and on the other hand the approved agencies were simply “giving opinions”….except on behalf of the sellers.

So put them in sacks full of snakes and dump them in the oily waters of Louisiana?

That’s an idea, that’s what was contemplated after the South Sea Bubble burst by the British Parliament, find someone to blame, punish them, and you s=feel better.

Except you can’t blame “The Government” because yesterday’s pork is today’s pig-manure, and past governments have absolute immunity. So blame the rating agencies, they gave their opinion, they were wrong, except they were not paid (initially) by the people who (eventually) suffered from their mistakes, and they had no duty of care outside of “trying harder”.

Look at the huff and puff of the SEC throwing fluff at the rating agencies. Moody’s have admitted filling out some forms wrong…WOW…that may of course be a bureaucrat’s wet-dream to have discovered the discrepancy, but so what? Timothy Geithner filled out a few forms wrong in his time.

Notice how the SEC action against Goldman Sachs on the famous Paulson CDO, did not name the rating agency that stamped AAA on that, and the reason is clear, the rating agency has immunity.

Going Forwards

Regulators need someone to provide quality assurance on securities, without that the system breaks down, particularly when like now, no one believes in the quality assurance stamps.

But quality assurance requires a “bad-guy” who is truly independent. The move to force issuers and holders of securities to use an agency that is determined by the regulator (whoever pays him), is a step in the right direction.

But it won’t work, the rating agencies who decide the rating of a bond, needs to be employed by the regulator, AND answerable to him, AND liable for mistakes (PI insurance would help).

That doesn’t mean there won’t be work for the rating agencies providing “opinions” to the sellers and the buyers, but they will be buying just that, opinions, just like in the old days.

There are two jobs, the “good-guy” job, and the “bad guy” job, what just happened was that “someone” tried to kill two birds with one stone.

By Andrew Butter

Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2010 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Andrew Butter Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in