Randomly Noted

When the major credit ratings agencies found themselves on the hot seat some years ago after the accounting scandals at Enron and Worldcom, their defenses were reasonable.

If those fraud-ridden companies were essentially handing out inaccurate financials, it meant the ratings agencies were being duped like everyone else. After all, you couldn’t expect Standard & Poor’s and Moody’s Corp. to act as auditors. So, their ratings of the companies were too high when the companies’ real and troubling situations tumbled into public view.

Around the same time, the business models of the major ratings agencies were called into question – they are paid by the issuers whose securities they rate. The ratings agencies said they knew how to handle the apparent conflicts and because they were employed by so many issuers, the potential conflict was diminished as no one company represented a large percentage of the raters’ revenues.

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In Berlin to try to secure Germany’s assent for a Greece bailout deal, IMF boss Dominique Strauss-Kahn said earlier today that we “shouldn’t believe too much in what rating agencies say.”

One has to agree – on a number of levels. Over the past decade, Moody’s, Standard & Poor’s and Fitch have proved time and again they can be fallible – and late – in identifying all manner of credit vulnerabilities.

Moreover, during the Greek crisis, the rating agencies have become prime actors rather than arbiters – issuing downgrades and decisions that principally shape markets’ direction (in a fairly brutal way) rather than enlighten and inform.

DSK may in fact hold rating agency industry in contempt. But today what he’s really trying to do is calm markets. The rating agency downgrades – of Greece, Portugal and Spain – over the past two days have pushed the euro down significantly and spurred stock market selloffs around the world.

His name was Jim Murphy and he penned the popular “Mark to Market” column for us.  Jim had a special connection with his readers, as you can see from the many heart-felt comments below.

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The U.S. stock market swoon last week – caused in part by Obama administration’s announced plans to limit the size of banks and restrict their proprietary trading – shows the dangers of populism and the mixed economic nature of most Americans.

Even banker-hating working people, the presumed natural constituency for populist rhetoric emanating from the White House and Congress, probably have some real stake in the heaalth of the financial markets, where values could be hurt by some of these plans.

Now that 401ks are a dominant retirement vehicle, even people who don’t make individual stock investments or buy mutual funds have something to lose. And defined benefit pension recipients are typically part of pools that are making big stock investments.

So most Americans are employees and investors, not either or.

There’s a new player in the corporate ratings game who is introducing a business model very different from the one used by more established agencies. Morningstar announced today that its research team that analyzes companies from an equity investment perspective will apply some additional metrics to come up with corporate credit ratings. It released a list of the first 100 companies it has rated. Click here to see the ratings. An interesting twist is how Morningstar will make money on this new service. Firms like Standard & Poor’s, Moody’s and Fitch charge issuers of debt securities to analyze them and come up with ratings. And that model has led to criticism about how impartial the ratings agencies actually are when they are being paid by an issuer for a rating. That criticism really heated up following the subprime mortgage disaster. Mortgage-backed securities were issued a few years ago with AAA ratings, many of which eventually blew up because the subprime mortgages that backed the securities were no good. So, Morningstar will give away its ratings for free but will charge institutional investors for a service that compares comparably rated bonds and their secondary market prices to determine whether they are overvalued or undervalued. Obviously, you get pricing distortions in illiquid markets, which is what many corporate bonds become once they are seasoned. But that said, it is good to see someone taking a stab at a new ratings model.

If it ain’t broke, don’t fix it. That’s as useful a bromide as any. After all, there are plenty of things in real need of fixing.

Still, in a bromide-resistant move earlier this week, the House Financial Services Committee approved an amendment that would not let the  presidents of regional Federal Reserve banks have any regulatory authority if and when the Fed is given broader powers over systemically important financial institutions.

Troubling and unnecessary as that is, the bigger problem is still down the road, and in the sights of a powerful member of the House of Representatives.

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If you had any doubt there was (and may still be) a problem with U.S. government regulation of credit-rating agencies, this will convince you: An in-house watchdog for the Securities and Exchange Commission says the regulator approved some unfit rating firms. As DJN colleague Sarah Lynch reports, at least one rating outfit had inadequate managerial resources and may have provided inaccurate information in its application for SEC approval, among other things. What this means is some investors received assessments of credits from wobbly rating agencies which bore the SEC’s approval imprimatur. It’s not a shock but it is another disappointment in the financial system. The report from SEC Inspector General H. David Kotz doesn’t name the firm or firms he feels shouldn’t have received the SEC’s okay. Sarah notes there are only 10 nationally recognized credit-rating agencies.

The great anticipation about what the Federal Reserve would say about the state of the economy and the status of its non-traditional policy operations was met, essentially, with steady as she goes.

A phrase was coined. “Leveling out” is the way the U.S. central bank today described economic activity. That’s synonymous with bottoming out, one presumes, and the taken together the two words leveling out imply a process still ongoing rather than one completed.

It’s a flexible phrase, as well. Leveling out means there still could be more dips, the technical bottom in economic activity hasn’t necessarily been reached, but a new, sharp downturn is not at all anctipated.

In these weeks of maximum bullish interpretations being applied to at most relatively good news about the economy (a decline of a quarter-million jobs in a month is positive because it’s less than half the pace of losses in earlier months of 2009) we’ll take leveling out.

Leveling out also means it is still too early to talk seriously about “exit” strategies or even warm the financial markets up for an exit strategy. The Fed is still, and should still be concentrated solely on functioning financial markets and a recovering economy.

A couple months back some of the Fed’s non-traditional policies aimed at buying up various types of securities incited an inflation fear wave that palyed havoc with teh long end of the tReasurys markets and threatened to kick mortgage rates too high to help the ailing sector.

That seems to have passed. Maybe it was Fed Chairman Ben Bernanke’s Wall Street Journal “op-ed” in each he said, in effect, here;s the outline of our “exit” strategy when we need to implement it. Doesn’t it make sense?

Today, the Fed repeated that inflation is not the issue. It noted some increase in energy and other commodity prices. But added the Federal Open Market Committee was confident “that inflation will remain subdued for some time” because there’s still “substantial resource slack.”

There was speculation about what the Fed would do about its controversial $300 billion kitty to buy Treasury securities.  It is supposed to end Sept. 1. Would the Fed increase the dollar amount? Would it let the program expire as planned? The Fed essentially split teh difference. No new funds, but a new buying deadline, the end of October.

This seems prudent. If the Fed needs a bit more interventionist ammunition it keeps some powder for a couple more months. If it wants remaining purchases to have little impact on a deep market it can do so by spreading them out.

Today, media company Hearst Corp. agreed to increase its stake in debt rating agency Fitch Group. This comes just a couple days after Warren Buffett cut his stake in rival Moody’s Corp. What’s it all about? We know, from a recent Buffett statement, that he thinks the credit crunch weakened rating agencies by exposing their failure to accurately and presciently rate toxic debt. Hence, his decision to trim his Moody’s stake to nearly 17% from just over 20% was interesting but not surprising. Moreover, at least one analyst has said Buffett may have simply adjusted his Moody’s holding for fairly mundane reasons, such as to raise a bit of cash or eliminate a 20% ownership regulatory trigger point. Hearst’s move gives us more to chew on. Granted, the publisher already owned 20% of Fitch, but to increase its exposure by another 20% suggests it has something on its mind. A colleague says Hearst may see an opportunity to build up Fitch – long the No. 3 credit ratings player after Moody’s and Standard & Poor’s – since the latter two have taken the brunt of the public beating during the economic crisis. Owning more Fitch could enhance Hearst’s efforts to diversify away from traditional ad-based revenue souces (newspapers, magazines, TV) and position it to compete more directly against McGraw-Hill Cos., S&P’s owner. Then again, Fitch Ratings’ revenue fell more than 10% in the nine months to June 30. compared with the year-earlier period. It’s worth noting that Hearst bought the additional 20% from France’s Fimalac SA, whose Fitch stake now falls to 60%. Fimalac says it envisions selling another 10% to Hearst down the road, adding that the two companies always envisioned a 50-50 Fitch ownership.

Sallie Krawcheck writes an interesting op-ed piece in today’s Financial Times that takes a close look at what worked and didn’t as part of the big overhaul in equity research departments a number of years ago. And she applies those lessons to the discussion of how credit ratings agencies business model needs to be changed in order to catch disasters, like the one called the credit crisis, before they happen.

One lesson – the pendulum often swings too far in one direction in reaction to a problem unnecessarily.

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