Ratings agencies overstep the mark

2011-08-13 14:46

So let me get this straight.

Ratings agencies helped spark the financial meltdown of 2008 and 2009, when they deemed that steaming piles of mortgage junk were brimming with triple-A goodness. They were wrong – and epically so.

Now Standard & Poor’s (S&P) downgrades the debt of an entire country, further threatens to do so another notch, teams with fellow ratings agencies to bring Europe to its knees with each new appraisal and gets an assist for wiping trillions in wealth from investors’ portfolios in just a few days.

Anyone else think the ratings agencies need a time out?

“If you had asked me a couple of years ago if they could do anything more destructive than the mortgage debacle, I would have said never,” says Roger Kirby, an Of counsel for New York City law firm Kirby McInerney, who is involved in a class action against Moody’s on behalf of shareholders.

“But it seems they’re managing to do it again, right now. In order to restore their damaged reputations, they’re interjecting themselves unsolicited into sovereign markets.

“It’s not productive, it’s probably inaccurate, and they’re just going out there on their own with no real purpose to what they’re doing.

“When future historians are writing about this period, they will probably single out ratings agencies as the single most destructive collection of entities.”

It’s not just an academic exercise. The musings of the ratings agencies are having very real effects on people’s portfolio.

In the first day following S&P’s downgrade of US debt from triple-A, another trillion was erased. And as a result, some individual investors are starting to do a slow burn about how ratings agencies are stoking financial chaos.

“It’s definitely hit me personally,” says Andrew Schrage, MoneyCrashers.com editor, a personal-finance website based in Chicago, the US. “Anyone in stocks has been thoroughly wiped out. My personal accounts, and retirement savings like my Roth IRA: I was very aggressively in stocks, so I’m down about 15% in just the last few weeks.

“Now I’m not even sure if we are going to be able to dig our way out of this.”

What worries Schrage is not necessarily the underlying creditworthiness of the US debt – does anyone really think Treasuries won’t be honoured? – but that a vicious cycle of downgrades will hobble the stock market for the long
term and doom a highly fragile recovery.

After all, any currency, country or asset class is only as secure as investors’ confidence in it. Take that away, and all bets are off.

“There’s definitely a psychological aspect to it,” says Schrage, who’s re-evaluating his entire investment approach in response to the wild volatility.

“People just hear ‘downgrade’, and they get scared and sell off. Meanwhile other countries start charging us higher interest rates, even though the fundamentals haven’t really changed in the last few weeks.

“It’s having a very corrosive effect on the US economy.”

The brewing fury at ratings agencies is also making for some strange political bedfellows.

Said famed conservative columnist, George Will: “Standard & Poor’s would have forfeited its good reputation, if it had a good reputation to forfeit these days?.?.?. Their opinion isn’t entitled to any particular respect.”

From the liberal camp, New York Times columnist Paul Krugman, wrote: “S&P is just making stuff up – and after the mortgage debacle, they really don’t have that right.

“So this is an outrage … these people (ratings agencies) are in no position to pass judgment.”

Nonetheless, ratings agencies are firing off fresh rounds almost daily, and panicked investors are apparently listening closely.

For a preview of what’s in store, says Kirby, just cast a glance towards Europe. Enraged finance ministers have been vowing to take on the “oligopoly” of the ratings agencies, for so casually setting off financial contagion.

“Italy was stronger than most countries in the European Union, but as soon as the ratings agencies opened their mouths, yield spreads shot up and it was really in trouble,” says Kirby.

“Ratings agencies have no business at all sticking their noses into this arena. They’re doing real harm, because what they prophesy becomes self-fulfilling. They’re playing a very dangerous game.”

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