Views on improving the integrity of global capital markets
29 December 2010

Credit Rating Agencies: Call the Amnesia Hotline

Is it just me, or have credit rating agencies (CRAs) lapsed right back into their old habits? Once upon a time — 4,000 Dow points ago — we at CFA Institute and various governments around the globe lambasted the ratings firms for negligence particularly in how they assigned and monitored ratings to asset-backed debt. AAA ratings were awarded with a “wink and nod,” as it turns out.

Two short years later, we have seen a return of the wink-and-nod agreement in the municipal bond and sovereign debt space. Is it possible for these ratings firms to successfully navigate the politics of putting whole countries, or various states within the U.S., on credit watch? How about a credit downgrade of the U.S. itself?

The impact of such credit actions on the market for existing debt securities — much less the new issues needed to refund and roll over debt to ensure continued solvency for all these parties — can be quite significant. If the raters fear such impact and avoid or defer the hard decisions, we all know the ratings themselves mean little in terms of actual credit quality.

As an example, Moody’s says only that it may lower ratings for Portugal, perhaps as much as two “notches.” Meanwhile, the whole euro zone remains under close scrutiny for similar ratings adjustments. Not much Yuletide cheer there. Clearly they are aware of how “more candid” reflections of credit can erode investor confidence.

In these shaky, economic times, the same governments who complained about the miserable failure of the ratings process back in the day are now a bit more, shall we say, “tolerant.” Tolerance, in fact, may be the least of it — they’re begging for restraint in any downgrades. In that spirit, we reserve the right to revise our own ratings of CRAs either lower, or higher, depending on whether they choose to show some spine in this environment. So surprise us CRAs!

Happy holidays to our readers, and here’s hoping for a couple “notches higher” for all of us in 2011.

About the Author(s)
Kurt Schacht, JD, CFA

Kurt Schacht, JD, CFA, is managing director of the Standards and Financial Market Integrity division at CFA Institute, where he oversees all advocacy efforts and the development, maintenance, and promotion of the highest ethical standards of practice for the global investment management industry.

3 thoughts on “Credit Rating Agencies: Call the Amnesia Hotline”

  1. Bob Dannhauser, CFA says:

    Indeed, an interesting paper that sets a historical context for CRA use in federal policy, and a historical context for inherent conflicts of interest. My favorite quote from the paper (so far!): “Prudential writing requires unusual care in reading.” I.e. where you stand often depends on where you sit…. Thanks for the recommendation Gregg.

  2. Gregg Barrett says:

    Bob, glad that you could make the time to read it. It is certainly good material. Josh Rosner has also got some great work that is worth reading on the subject.

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