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?

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.

Where can we sue bank regulators for having empowered Standard and Poor’s too much?

Sir I refer to the several writings in FT on Standard and Poor’s being sued by the US Department of Justice, February 6.

In a normal world one would name and shame the raters who got it so wrong, and their bosses. In this world the Department of Justice sues Standard and Poor’s which only means now that credit rating agencies will either stop giving ratings or that the cost of their opinions must increase, as a consequence of now having to carry insurance against the raters getting it so wrong again… something which we know will happen… sooner or later, they are only human.

In a normal world, our failed bank regulators would have been held accountable for what they did. Because much more interesting and relevant would be: Where can we sue bank regulators for recklessly having empowered the credit rating agencies too much?

Because what the regulators did was to empower the credit rating agencies to such an incredible extent that an AAA to AA rating issued by them, sufficed to allow banks to hold only 1.6 percent in capital and leverage their capital a mindboggling 62.5 times to 1.

And that created of course an insatiable demand for AAA to AA securities and the market, as a market normally does, if it runs out of good ratings, it delivers Potemkin ratings.

Sir, and do not start mentioning black swans or in any other ways try to excuse the regulators recklessness: They, by accepting to be bank regulators, should have known what was going to happen. Here are but 3 of my many warnings:

In the Financial Times, a letter I wrote in January 2003 states: “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”

In a formal written statement delivered in April 2003 as an Executive Director of the World Bank I held: “Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on a limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just the tip of an iceberg.”

In an Op-Ed of May 2003 I wrote “In a world that preaches the worth of the invisible hands of the market, with its millions of mini-regulators, we find it so strange that the Basel Committee delegate, without any protest, so much responsibility in the hand of so very few and so very fallible credit rating agencies” 

And please Sir, do not tell me that regulators had no inkling about weaknesses in many of the risk models being used to evaluate the credit worthiness of instruments. If even I who am not directly involved in financial risk manager, and again as an Executive Director of the World Bank, could in October 2004 formally warn that “much of the world’s financial markets are currently being dangerously overstretched, through an exaggerated reliance on intrinsically weak financial models, based on very short series of statistical evidence and very doubtful volatility assumptions” should not the regulators, paid for being regulators not have intervened.

Frankly to me the way regulators have managed to evade their responsibility to the extent of even being promoted, is the mother of all the lacks of accountability… and, for the time being, I am sorry to say that you Sir in FT are, knowingly or unwittingly, assisting them in the cover up.

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” 

We need to bring the credit ratings down to earth

Sir, John Authers´ “Easter parade of worries over Uncle Sam´s credit”, April 24, refers to the rating agencies wielding “real power”, but then describes that power only in terms of “affecting the rates at which companies or countries can borrow”; without making any reference to what has yielded the rating agencies the excessive power they posses, namely that the ratings also play a role when defining how much capital a banks needs to have.

It is that the credit ratings are given a double consideration, which has elevated their importance to the skies and brought us the current crisis. Let´s go back to Basel I days, or better yet Basel 0, set one single capital requirement for all bank lending; and then we have brought down the opinions of the rating agencies to something more in harmony with what they really are, a bunch of fallible humans who, had they been laboratories, would have long ago been sued out of the waters for their harmful mistaken opinions.

Though the outlook is for hurricanes you have not yet seen the roofs flying, just yet.

Sir Martin Wolf, as an economist, stubbornly refuses to even consider those financial regulations, or may I dare to say global capital controls, that directed the worlds capital flows so excessively towards creating excessive debts in areas that were officially perceived as not risky, like the US, UK, Greece and the triple-A rated securities in this world. “Faltering in a stormy sea of debt” April 20. Since what the regulators are currently doing is trying to correct for that mistake, instead of correcting the mistake, we should expect a serious case of regulatory overmedication to also strengthen the storms that await us.

Let me take the opportunity to comment on Standard & Poor’s recent grim outlook for the US debt. Given that the US can always by printing repay its debt in nominal terms that must mean that S&P is, I believe for the first time, considering the possibility of collecting on loans in real terms.

How long are regulators allowed to persist with their foolishness?

Sir I refer to so many news, about when a downgrading of credit ratings cause much havoc, like for instance Nicole Bullock´s report on April 19 “Muni bond risks grow after S&P’s DeKalb cut”.

It is high time to ask our regulators some basic questions like when they believe banks incur in the risk of lending, when they make a loan or when the borrower is down-rated. Of course, when they make the loan!

And so I ask how long should we allow the regulators to insist on a foolish system with retroactive corrections, based on credit ratings, and which makes the difficulties encountered with a client that turned out to be worse than he was originally rated even more difficult, and not a system of upfront capital requirements independent of ratings.

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

More stars for a more stable triple A?

Sir when the president of Standard & Poor’s, Deven Sharma writes that the credit “ratings should not be used for purposes for which they were never designed”, like “hardwiring” prudential regulations around them, we can only ask… why did he wait so long to say that? Investors require consistency when it comes to credit ratings” October 2.

And when Sharma mentions the investment institutions want “credit ratings to be relatively stable” and that he intends to satisfy such demand by an “initial lower rating” of any security “more prone to a sharp downgrade in periods of economic stress”, we can only think of a chef developing some ratings a la carte, in order to earn more stars on some Michelin guide.

Doing a little sleeping with the enemy, aren’t we?

Though it is clear that the faulty ratings issued by the credit rating generated more real losses than what 50 Madoffs could have done it is amazing to see FT giving so much voice to the President of Standard & Poor’s to defend his business model “Re-evaluating and rebuilding a more useful rating system”, March 12, while silencing so much of the fundamental criticism against the creation of an oligopoly in the market of risk information, namely the systemic risks that this in itself generates. Doing a little sleeping with the enemy aren’t we?

The credit rating agencies were not just innocent bystanders

Sir, Vickie Tillman, Executive Vice-President of Standard & Poor Ratings Services, in “Rating firms do not capture risk in one measure”, March 2, writes, “credit ratings are opinions about future default risk and do not address the many other risks that have affected debt securities in recent months and accounted for the bulk of losses reported by financial institutions … policymakers should review regulations that may inadvertently encourage undue reliance on ratings. If rating opinions are used as benchmarks of creditworthiness – which, incidentally we have never encouraged – other benchmarks and factors should be considered as well.”

Does this mean that I have wrongfully been accusing these poor credit rating agencies, that they are only innocent bystanders and that they have nothing to do with this crisis that is going to result in so much misery for the world? Of course not!

Granted, the primary responsibility lies with the regulators who enabled the regulatory framework that incited this crisis and then with those investment bankers who took advantage of the system failures but in no way should we allow the credit rating agencies to go free of any historic guilt; as we should neither allow those financial newspapers that still have the gall calling the credit rating agencies “indispensable” something that even the credit rating agencies would not dare to do, to wash their hands.

It is not a question of quality control or knowledge… it is solely about wise prudence

Sir Mr Blaise Ganguin from Standard and Poor’s Ratings Services is in his right to defend his company like he does in “Analysis of S&P’s ‘quality control’ is freely available” December 22. But, even accepting that all he writes is 100% the truth that does not diminish the fact that no matter how good the credit rating agencies are at what they do, it is still plain madness to empower so few with so much power over the market.

In January 2003 in a letter published by FT I wrote “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

Well here we are years later facing an enormous financial crisis that will have tragic consequences for hundreds of million people around the world, and where the credit rating agencies triple-As can be identified as having directly provoked 50 Bernard Maddof' losses or more. We are now long overdue returning the rating agencies to where they were before the financial regulators in the Basel Committee super-empowered them.

And no one called Mr Sharma’s bluff!

Sir, in View from The Top March 14 you have Devin Sharma, the president of Standard & Poor’s saying “Ratings play an important role in the capital markets by providing opinions on creditworthiness” and nobody called his bluff. Had it been true then we would most likely not be in our current mess, though perhaps in another one.

The truth is that the credit rating agencies give much more than opinions since empowered by the financial regulators they do in fact give orders to many of the actors in the financial market of where these can or not go, and to the banks with respect of how much capital they have to set aside for each credit.

Striping the credit rating agencies of these really crazy powers is one of the most important things to do if we are to avoid future financial disasters that could prove if possible even more lethal than the current one; and so that they then can go back to just providing opinions.

Does FT have a conflict of interest?

In your editorial “Subprime chains” February 13, when writing about the wrong incentives that led to the current crisis; even asking for “regulation that increases the average size and stability of brokers”, as if size of a brokerage firm has anything to do with the accumulated stability of a market (if anything the contrary), you do not even mention the fact that had it not been for the good ratings given to the subprime mortgages backed securities by the credit rating agencies neither banks or brokers would have had neither the tools or the incentives to create any subprime mortgage mess.

I know that McGraw-Hill owns Standard & Poor’s. Does FT have a similar conflict of interest that could cloud its “Without fear and without doubt” with relation to the credit rating agencies?

There should be limits on how much you can make your opinions heard.

Sir in “Fitch eager to make headlines” September 17, Adam Jones quotes Mr de Lacharriére the owner of Fitch Ratings saying with respect to the possibility of buying Les Echos “that a ratings agency and a financial news provider are complementary since both strive to deliver impeccable information: ‘There is no conflict of interest, we have truly the same objective” May I ask has he ever heard about the reason for separation of powers in any government even though their different branches have the same objectives. On the contrary if I was a bank regulator of those who have empowered the credit rating agency to dictate so much within the financial markets one rule I would make sure of is that these credit rating agencies should have no access to other additional means of imposing what they consider to be their First Amendment protected opinions.

Is the coverage in Business Week influenced by the fact that its parent company, McGraw-Hill, also owns Standard & Poors?

Most probably not but given the real power that has been given to the credit rating agencies that should not even have to be a question we consumers would have to ask ourselves since the regulators should know that it is in their best interest to keep incest as far away as it can?

Is there anything else with sufficient power to stand up to the credit rating agencies going crazy than a free media with the voice to criticize it? Will the criticism be the same if they have the same father? I do not think so and so I would gladly suggest that McGraw-Hill makes up its mind about which part of the business it wants to keep.