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Plenty of blame to go around for credit crisis

Plenty of blame to go around for credit crisis

It is too easy to blame the current credit crisis on just the mortgage brokers, the banks and the borrowers. But it is not that simple. A disaster of this magnitude has many guilty parties.
First on the hit parade are Alan Greenspan, Ben Bernanke, and the entire Federal Reserve Bank. Some of the fault lies with the easy money policy of the Greenspan years. The system is now choking on all that easy credit.
Under his watch, Alan Greenspan allowed the unsupervised proliferation of obtuse and opaque mortgage products. The Federal Reserve has the power in its charter to supervise the creation of new products and they chose not to exercise it.
The largest blame for this crisis falls on the rating agencies, Standard and Poor's and Moody's. When is an AAA rating not really AAA? Almost always. The craziest thing about this crisis is that most of the bonds that are now worthless were rated AAA. Investors mistakenly thought that they were buying bonds with the equivalent rating of U.S. Treasury bonds.
Without a default by the issuer, a bond that was worth US$100 four months ago is now worthless or, more accurately, cannot be valued. That is scary to me.
The system for rating agencies and the use of ratings is so broken that many think it needs to be thrown out in its entirety and a new system designed. Indeed, the European Commission has started an investigation into the rating agencies. They are investing whether they adequately alerted investors to the risks of mortgage-backed securities. The investigation will be lead by the internal markets commissioner, Charles McCreevy.
The rating agencies appeared to be asleep at the wheel. Even though the problems were bubbling to the surface much earlier, the rating agencies were slow to issue credit downgrades.
The current system is rife with conflicts. The rating agencies are paid by the very people that they are supposed to be overseeing, the issuers of bonds. The European Commission would like to abolish these payments. They would like the rating agencies to be paid by the users of the rating agency research. The European Commission plan might too radical to implement right away. They may have to settle for a revision of the code of conduct.
In my opinion, the biggest mistake of the rating agencies is their use of letters instead of numbers. Just like there are all kinds of blondes, there are many kinds of AAAs. It is impossible for a casual investor to differentiate between the platinum and ash blonde.
A number system would be easier to use. 100 would be US treasuries; 99 might be the appropriate rating for government agencies, Freddie Mac and Fannie Mae. Not all government agencies are direct obligations of the US treasury. Some only have the ability to draw on Government credit lines. The current letter system cannot differentiate those subtleties for the investor.
Corporations, no matter how creditworthy, should never be given the same rating as the United States government. As most of us know, the government has an unfettered ability to raise taxes. Corporations do not have that luxury.
Since 2002, at least three corporations have lost their AAA rating - Merck, AIG insurance, and Bristol Myers. In my numerical system, AAA-rated corporations would never receive a rating higher than 98.
The research of the credit agencies omits several vital elements. The rating does not encompass the liquidity of the issuer. It only measures the creditworthiness of the issuer. But that is only half the story for the purchaser of the bond. If a purchaser of a bond cannot sell the bond in the secondary market for the same price as a U.S. treasury or equivalents, I question the validity of the AAA rating. All AAAs are not created equal. There needs to be a two-part rating system that alerts the investor to the lack of liquidity in a bond.
The rating agencies rarely differentiate by maturity. Is it really feasible to give a AAA rating to a bond that has a 40-year maturity? It is unlikely that the rating agencies have a good enough crystal ball to predict that far into the future.
Berkshire Hathaway's CEO, Warren Buffett, is 77 years old. I am not sure it makes sense to continue rate their bonds AAA when the CEO is so close to retirement and has not named a successor yet.
Bond investors appear to be drinking from the same pitcher of cool aid as the followers of Jim Jones. They blindly follow the rating agencies without asking any questions. They need to be doing more independent due diligence.
There is plenty of blame to go around. We need to stop the recriminations and get serious about fixing the problems with the rating agencies. The European Union has started the investigation. It remains to be seen if the United States will cooperate or continue to protect the rating agencies.
Laura Goldman worked on Wall Street for more than 20 years for such firms as Merrill Lynch and UBS Warburg. She now runs her own investment advisory, LSG Capital, from Tel Aviv, Israel.


Updated : 2021-07-28 22:24 GMT+08:00