If there is one thing that scares a banker more than a subpoena from the Senate banking committee, it is a downgrade in the bank's credit rating.The Big Three ratings agencies are like the Horsemen of the Apocalypse for investors, municipalities, financial institutions, insurance companies, banks, even national governments.
They make the ebola virus seem like a chocolate sundae. When you see them coming, hide the children and family valuables in the root cellar. Any downgrade from super terrific triple A, and Bay Street gets a violent attack of the vapours.
This past week, Moody's Investors Service downgraded, ever so slightly, the ratings of Canada's largest banks. The stated reason was concern over volatility in the housing market and a lot of blather that the banks are, "more vulnerable to unpredictable downside risks facing the economy than in the past."
The Big Three -- Moody's, Standard and Poor's and Fitch -- control something like 90 per cent of the ratings market. Their ratings are the single most important element in determining the value of a bond or a company or a portfolio. Investors cling to their findings like lint on Velcro. But leave us not forget that the credit raters got just about everything wrong leading up to the 2008 economic collapse.
For example, the thousands of residential mortgages rated triple and double A by Standard and Poor's, more than 70 per cent were near or in default by the end of that year. And Moody's kept pumping out good news about Enron and didn't downgrade its value until the day before the company collapsed.
Incidentally, Matt Taibbi, the much feared and much respected financial writer for Rolling Stone, calls Moody's, " the most whorishly corrupt ratings company in modern history."
Since the 2008 meltdown, politicians and others have voiced concern about the immense power of the companies. In fact, the June 2010 G-20 meetings in Toronto ended with a communiqué committing governments to reducing reliance on, "external ratings in rules and regulations." That resolve lasted about eight seconds.
Who are these companies that can make governments tremble? They are unelected, anonymous oligarchs with more power than many financial and political institutions.
It all started in 1909 when a man named John Moody began selling subscriptions to his reports on the financial worthiness of bonds being sold to finance the building of railways. He later expanded it to include electrical companies, and ultimately, heavy industry.
Companies employ a ratings agency to look at the books and give them a rating. For this, they pay a hefty fee. The rating is an opinion, not a fact, and the companies themselves seem to realize it's all a bunch of flapdoodle. For example, S and P warns at the end of every rating that the recipient, "should not rely on any credit rating or other opinion contained herein in making any investment decision."
Governments are starting to fight back, ever so tentatively. In the middle of January, the European Parliament adopted a resolution which will in fact restrict the operations of credit rating agencies. For countries like Portugal, this is a god-send, because thanks to a lousy credit rating, the government can't borrow and if it can't borrow it can't pay its bills.
The U.S. Financial Crisis Inquiry Commission, a ten-member panel set up to determine the cause of the 2008 implosion, found the credit rating agencies were complicit. Said the Commission's report, "This crisis could not have happened without the rating agencies. Their ratings helped the market soar and their downgrades through 2007 and 2008 wreaked havoc across markets and firms."
That's the indictment. What's the penalty?