Moody, what would happen to US credit ratings if suddenly it was not any longer the world’s mightiest military power?

Sir, Rochelle Toplensky and Eric Platt write that according to Moody, the four primary factors it considers when assessing a country’s creditworthiness are “very high degree of economic, institutional and government financial strength and its very low susceptibility to event risk”, “Moody’s warns next US president over debt” September 8.

In the case of the US they perhaps miss a very important factor. As I once argued in a letter that the Washington Post published, “Much more important than a triple-A for the United States is the fact that this country is, by far, the foremost military power in the world. Lose that supremacy and all hell breaks loose. Keep it and a BBB rating could do.”

And so perhaps you should ask Moody: How would it impact your credit rating of the US if the US was no longer, by far, the mightiest military power? And would the credit rating of any closing up mighty then automatically improve?

@PerKurowski ©

Bank credit: In tough times there are no benefits derived from making it harder for the tough to get going.

Sir, I refer to Kadhim Shubber’s and Gavin Jackson’s report on that “Moody’s warns on lending crackdown” August 4.

Clearly the “risky” part of the economy, like SMEs, entrepreneurs and “highly indebted companies” are, as a consequence of tightening bank capital requirements, having to struggle more than others to obtain access to credit, precisely at the exact moment when we most need them to have fair access to it.

And the tightening of bank capital requirements, which lead to bank credit austerity, are usually most called for by those who oppose government spending austerity. Just read through the articles of most of your columnists over the year and you will find requests for higher capital requirements for banks going hand in hand with similar pleads of less government austerity. The most plausible explanation for that… is that it is all the result of an unconscious or conscious pro-government political agenda.

I repeat what I have argued many times over the years. Before we raise capital requirements we need to get rid of the distortionary implications of the risk weights. Let’s reduce the capital requirements like to 5 percent on all assets and then build it up over a decade to around a more reasonable 10-15 percent.

In tough times there are no benefits derived from making it harder for the tough to get going.

Also I am absolutely convinced that if banks are not distorted, bankers, pursuing maximizing the returns on bank equity, are much more able to allocate credit efficiently than government bureaucrats.

But, if bank regulators absolutely must distort, in order to show us they earn their salaries, then at least let us ask them to distort in favor of something more productive than keeping banks from failing. 

For instance let them authorize slightly lower capital requirements based on job-creation and earth sustainability ratings… so that banks earn slightly higher risk adjusted returns on equity funding what we believe should be funded, and not like now, earning much higher risk adjusted returns on equity when funding what is ex ante perceived as safe… like AAA rated securities were… like Greece was.

@PerKurowski

And citizens could sue agencies for too good credit ratings of sovereigns, which caused governments to borrow too much.

Sir, I refer to Stephen Foley’s and Guy Dinmore’s “Italy eyes €234bn suit after ratings groups failed to value la dolce vita” February 5. It reminded me of an Op-Ed of September 2002 titled “The riskiness of country risk”.

In it I wrote: “What a nightmare it must be to be risk evaluator! Imagine trying to get some shuteye while lying awake in bed thinking that any moment one of those judges, those with the global reach that have a say in anything and everything, determinates that a country has become essentially bankrupt due to your mistake, and then drags you kicking and screaming before an International Court, accused of violating human rights.

What a difficult job to be a rater of sovereign creditworthiness! If they overdo it and underestimate the risk of a given country, the latter will most assuredly be inundated with fresh loans and will be leveraged to the hilt. The result will be a serious wave of adjustments sometime down the line. If on the contrary, they exaggerate the country’s risk level, it can only result in a reduction in the market value of the national debt, increasing interest expense and making access to international financial markets difficult. Any which way, either extreme will cause hunger and human misery.”

And so what’s more to say. If the Italian Government sues the credit rating agencies for having given Italy too bad ratings, an Italian citizen might equally sue these for having given Italy too good ratings

And after that, what about suing the regulator who with their risk-weighted capital requirements for banks multiplied immensely any signal emitted by the credit ratings?

More important than how accurate credit ratings are, is how these are used.

Sir, Brooke Master’s reported “Regulators exposes big three rating agencies’ shortcomings”, March 19, referring to the European Securities Markets Authority’s (Esma) year-long examination of Moody’s, Standard and Poor’s and Fitch. Two comments:

First, when they hold that one agency was not giving the markets sufficient notice that it was reconsidering the ratings of a large group of banks, they should never forget that the credit ratings, when predicting the bettering or worsening of credit ratings, can also help to catalyze these.

In this respect I would suggest reading the US GAO Report in 2003, subtitled “Challenges Remain in IMF’s Ability to Anticipate, Prevent, and Resolve Financial Crises” It stated: “Internal assessment of the Fund’s EWS (Early Warning System) models shows that they are weak predictors of actual crisis. The models’ most significant limitation is that they have high false-alarm rates. In about 80 percent of the cases where a crisis was predicted over the next 24 months, no crisis occurred. Furthermore, in about 9 percent of the cases where no crisis was predicted, there was a crisis.”

From that report it is easy to understand that one of IMF’s problems is that what it opines, becomes a political and an economic risk too. And the same goes for the credit rating agencies.

And please, let us also never forget that it would be just as wrong of a credit rating agency to underrate the creditworthiness, of for instance a bank, than to overrate it.

Second, worse than a badly awarded credit rating, is a badly used credit rating. And of that bank regulators are guilty. Let me explain, again.

Banks normally cleared for perceived (ex-ante) risk, that which for instance is given by the credit ratings, by means of interest rate (risk-premiums), size of exposure and other term; let us call that “in the numerator”.

But our current bank regulators, those in the Basel Committee and the Financial Stability Board told the banks they needed also to clear, I would call it re-clear, for exactly the same perceived (ex-ante risk) risk, “in the denominator”, by means of different capital requirements, more risk more capital, less risk less capital.

That was, and is, loony, and only guarantees the banks did and will overdose on perceived (ex-ante) risks.

And that only guarantees that when bank crises will finally occur, as they always only result from excessive exposures to what is believed “absolutely safe” but that ex-post turned out risky, we will find the banks standing their naked with too little capital to cover up with.

And that only guarantees that those perceived as “risky”, and which could in fact be those our real economy most need to keep it moving forward, and create jobs for our young, will have their access to bank credit made more scarce and expensive than ordinary.

And so much more important than having Esma examining credit rating agencies would be having Esma, and all others too, examining first how the bank regulators use the credit ratings.

Please, never forget, that even the most accurate credit rating is made wrong, when excessively considered.

In January 2003 in a letter published by the Financial Times I had written: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”. Where was Esma then?

Does FT really want to impede banks to help out, so that we must rely on government? I pray it is not so.

Sir, “Moody’s grows nervous at Britain’s extension of austerity” reports Sarah O’Connor, February 25. 

But what Moody really should be nervous about is the fact that bank regulators allow banks to make so much higher expected risk-adjusted profits when lending to someone with a good rating than when lending to for instance someone unrated. That will of course dampen the risk-taking a nation needs to move forward. And, if Moody and the others don’t know that, then they should lose their credit rating quality ratings. 

And in “British credit fears” you hold Sir that “ratings decisions can sometimes have real effects because of the wrong-headed way investment mandates and capital rules are designed to rely on them”. And that leads me to ask you, if you believe it “wrong-headed”, why have you then been so silent about it? Might it be because you are too hard-headed? 

You write “As this newspaper has long argued, there is room to shift resources from inefficient subsidies to uses that can stimulate the economy [and] to unclog banking and tilt Britain away from over relying on finance”. But Sir, if there is a real clog that stops banks from helping us to efficiently allocate resources in our real economy that is precisely imposing different capital requirements for banks based on perceptions of risk. 

Sir, you sometimes leave me feeling very uneasy. Could it really be that you want to impede banks to help out, just so that we must rely more on government? I do pray I am wrong.

In June 2004, there was an unwitting but de facto terrorist act against the good corporate governance of the credit rating agencies.

Sir, of course we fully agree with John Gapper in that “Credit rating agencies must beware of the law” February 7. But!

Let us say you had a credit rating agency and which with some mistakes here, and some there, some worse than others, had been able to reasonably prosper over the years. And then suddenly, in June 2004, with Basel II, bank regulators decided that if a security was rated AAA or AA by your company, banks could hold these against only 1.6 percent in capital, meaning banks could leverage their capital with the expected risk-adjusted returns of that instrument an amazing 62.5 times to 1.

Anyone who does not understand what a de facto tsunami sized terrorist act against good corporate governance that meant, does not know what he is talking about, or is just out selling himself on a holier than thou basis.

Let the credit rating agencies rate, and us learn, again, just to take the credit ratings for what they are.

Sir with respect to your “Holding the rating agencies to account” November 6, there are only two alternatives: 

One is the caveat emptor route of taking the credit ratings for what they are, always subject to the possibility of human fallibility, of one or any sort, and always subject to some uncertainness which is very hard or even impossible to measure, and all for which the ratings should be handled with care. In this case, the best regulators can do, is to append a label stating: “Warning: excessive reliance on credit ratings can be extremely dangerous to the health of your portfolio.” And, the worst thing what regulators can do, is precisely to give the ratings the credibility and importance these were given in Basel II. 

The other route is that of “we must make them work” no matter what. Yes, if a credit rater had just gone out of his office for one single day to see how the mortgages that formed part of the securities he was rating, these would not have been AAA rated, and that I swear. But, since the rater preferred the comfort of his office to the subprime suburbs¸ just as you and I do, he did not go there. And so should he now be sued? Perhaps, but if you hope to get something remotely substantial out of him, you must hope he is able o enlist the support of Bernanke and Draghi. 

And here is the “sophisticated” Financial Times going for the second option and writing “Things will only change once ratings are regulated more rigorously and paid for by investors rather than issuers”. I am amazed that FT has descended into such primitive naiveté… just for starter what would a credit rating cost if the raters needed to insure themselves against any sort of malpractice. 

Really, if anyone should be held accountable in this case that should be the bank regulators, they must have known the risks. In a letter that you yourself published in FT in January 2003 I told them that “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds” 

No! Let the credit rating agencies rate, and us learn, again, just to take the credit ratings for what they are.

PS. The current S&P and Kroll duet “Anything you can rate, I can rate better I can rate anything better than you No, you can’t Yes, I can” 

Plain stupid or shameless… have a pick

Sir on your front page in “Moody’s admits to failings over crisis”, April 24, Stephanie Kirchgaessner and Kevin Seiff report that “The chief executive of Moody’s admitted to a Senate panel yesterday that the US credit rating agencies failed to anticipate the severe deterioration in the US housing market that led to the financial crisis”.

If Raymond McDaniel does not know what role the AAA ratings had in creating the worst part of the bubble in the US housing market and which had to explode, then he is plain stupid, but, if he is not that stupid, then he is just shameless… Have a pick!

Greece would be nothing compared to the big AAA-bomb already dropped!

Sir, of course Goldman Sachs´ Erik Nielsen is correct saying that “ECB must re-examine its dependence on rating agencies”, March 25, since “no country would hand the controls of a nuclear device to a third party”.

But this has really very little to do with Greece as that would be just a minor tactical puff! The real big AAA-bomb already exploded in the subprime heart of the Empire, causing a couple of trillions of dollars in damages and radiating many harmful after-effects that we are just beginning to tally and comprehend.

The AAA-bomb

It must hurt GE so much

Sir I have nothing whatsoever to do with GE but when Francesco Guerrera reports “Moody´s strips GE of triple A rating it has held for 42 years”, March 24, I truly commiserate with them. It must hurt so much being stripped of your AAA rating by one of those primarily responsible for your current problems.

Hey, you missed the story!

Sir, "Moody's error gave top ratings to debt products" May 21, is presented as a "human bites a dog" story even though it really is a "dog bytes a human" event. We all know that Moody and all the others are bound to commit errors, it is only human and must be forgivable, just as then try to cover up those errors is also human though not as forgivable.

The real story is how these agencies could have been regarded as infallible by the regulators who empowered them, and thereby forcefully or suggestively induced the market to blindly follow their ratings.

The article states "Credit ratings are hugely important within the financial system because many investors – such as pension funds, insurance companies and banks – use them as a yardstick to restrict the kinds of products they buy, or to decide how much capital they need to hold against them" and this gives the impression that the use or not of the credit ratings is a voluntary issue, which is clearly wrong. The investors mentioned, use the credit ratings because they have been strictly ordered to do so by their respective regulators.

Now if they managed to get you to spin a story about a once in a lifetime crazy mistake event that is never ever to happen again, then let me assure you that someone is shamelessly using you.

Clarity about what?

Sir Michael Mackenzie and Stacy Marie Ishmael report that “Moody’s offers to change debt rating system” basically substituting a number up to 21 for their current letters, presumably to increase clarity. Clarity about what? Risks? In that case the more confusing the reporting system perhaps the less prone it is to transmit the sense of clarity and exactness that does not exist. In this the current system is more adequately confusing.

Development rating agencies?

Sir Saskia Scholtes and Chrystia Freeland report that “Moody’s to revise ratings by end of year” and that it is now contemplating something to be marketed as “fundamental value”. Now, if that rating is only to be based on risk considerations then it does not really seem to be of such fundamental value to me. 

Of course a bank should be able to repay his deposits and that is why bank regulators in Basle are using risk to establish the minimum capital requirements. But a bank’s function is not only to be able to return the deposits but also to help promote growth and development and to assist the society in the distribution of opportunities. Otherwise a mattress would suffice. 

In this respect, besides the credit rating agencies, we perhaps should also be thinking of incorporating the criteria of development rating agencies and opportunity distribution rating agencies into the capital requirements of a bank. Only then would we be able to start talking about really fundamental values. 

It is very sad when a developed nation decides making risk-adverseness the primary goal of their banking system and places itself voluntarily on a downward slope but it is a real tragedy when developing countries copycats it and falls into the trap of calling it quits.

PD. Are the Basel Committees’ bank regulations good for development?

Regulators, please make the financial flows free to flow again

Sir, when Saskia Scholtes reports that “Moody’s alters its subprime rating model” September 25, we get a glimpse on what is the inherent weakness of any rating system that does its rating from the desk. It is not that the borrowers were subprime that caused the current difficulties since there clearly are many prime mortgages to subprime borrowers, it was that some of those shady operators that always exist in any market exploited the Achilles heel opportunity provided by the credit agencies themselves when they assigned prime ratings to very sub-primely awarded mortgage loans. Anyone should have been able to tell those mortgages were lose-lose propositions if only they have left their desk for just a second to go and have a look.

The above describes perfectly the systemic risks or even the moral hazard that can and will arise from empowering any agent in the market too much and there is no way on earth you can really correct that, and much less so if you insist on doing the ratings by monitoring real life from afar.

I do appreciate the credit ratings efforts and that we should be able to benefit much from their services, but this can only occur if the market is also totally free from not having to use them. Regulators please make the financial flows free again.

Stop them from digging!

Sir, Paul Davies and Gillian Tett in “Moody’s talks of rating reform”, September 18 quote Brian Clarkson, the President and chief operating officer of Moody’s saying “One of the issues we are talking to regulators about is the possibility of creating tools to address liquidity and market issues”. 

And we can just pray for that the regulators understand the real meaning of “when in a hole, stop digging”.

Once again, I do not have anything against the credit rating agencies refining and improving their mostly already very good products. What I oppose though is that the regulators press the market to use these products, since such a bias will only guarantee the introduction of even more severe systemic risks than those that we have been discovering lately with the sub-primely awarded mortgages to subprime borrowers.

If there’s ever been a confession there you have it.

Sir Brian Clarkson, the President and chief operating officer of Moody’s Investors Service in “Transparency and trust must keep on driving rating agencies” September 18, makes a confession that illustrates exactly the risks of securitization, meaning the packaging the selling and the forgetting of an investment by putting it on someone else’s book, and of the real danger of an excessive systemic reliance in the credit rating agencies criteria. He says” There have been allegations of lax underwriting and misrepresentations in subprime mortgage originations. There is no sure way for a rating analyst who is not involved in the loan origination process to detect such shortcomings.” With such a confession do we need more? Of course if a credit rating agency is to award an AAA rating based on the accumulation of a thousand individual mortgage loans, the least one could expect is a closer examination of some of them through a sampling process.

Nonetheless the real value of the confession lies in showing us how fail prone a system is when we are forced to trust someone, as is much the case with the credit rating agencies