Rating the Rating Agencies

Last week Moody's Investors Service announced a review of many banks and securities firms with global capital markets operations for a possible downgrade, citing “fragile funding conditions, wider credit spreads, increased regulatory burdens and more difficult operating conditions” for these companies.

Financial stocks were the second best performing sector in the S&P 500 the next day, with banks on the review list like Citigroup (C - Analyst Report), Goldman Sachs (GS - Analyst Report), JPMorgan Chase (JPM - Analyst Report) and Bank of America (BAC - Analyst Report) ending the day up between 1% and 4%. Either the investors did not care about Moody’s warning or these factors were already known and priced in. Also, the investors focused on better macroeconomic data in the US and the positive news from Europe.

S&P had downgraded the credit rating of the United States on August 5, 2011. This was followed by a sustained rally in Treasuries.  Similarly many European countries that were downgraded recently saw their yields fall, as their problems were already known for quite some time and downgrades did not bring out any new information.  

Credit rating agencies are supposed to serve the purpose of assisting investors in evaluating the safety and soundness of their investments but their record for the past few years has not been impressive at all, to say the least. They completed failed to recognize the risk embedded in mortgage-backed securities and complex structured credit vehicles. Billions of dollar of paper rated triple A by these agencies proved to be worthless.

Both S&P and Moody’s failed to see the warnings signs in MF Global’s exposure to European sovereign debt and were very late in downgrading their credit rating on the brokerage.

As such, it appears that the investors have stopped trusting these agencies and their rating changes do not affect the markets the way they are supposed to.

If you were to rate these agencies, what would your rating be?

Read the full analyst report on BAC

Read the full analyst report on C

Read the full analyst report on GS

Read the full analyst report on JPM