Wednesday, January 30, 2008 6 comments ++[ CLICK TO COMMENT ]++

Do the Rating Agencies Know what They are Doing?

CLARIFICATION: DougM points out that Tom Brown says he or his affiliates have a position in MCO. I assumed it was a long position but this may not necessarily mean a long position.

Seriously. Do the rating agencies know what they are doing? I'm not even talking about their past ratings of structured products (that was a disaster but let's ignore that for now). I'm talking about the present. Here is Tom Brown commenting on how ridiculous it is for rating agencies to use "market sentiment" (thanks to seekingalpha.com for the original mention).

In theory, the agencies are supposed to be the disinterested players with the data and sophisticated models, who keep their heads when the markets are going crazy around them. No longer. Now Moody’s says it is taking “market sentiment” into account when it sets ratings on the monoline bond insurers. What’s market sentiment got to do with it? Either the insurers have the ability to pay claims in a worst-case scenario, or they don’t. By relying on sentiment as an input, the agencies create the upheaval and uncertainty that their ratings are designed to prevent.


This is a powerful comment from someone who is supposedly long Moody's. As I have discussed before (I think it was in the comments and not in an actual post), the rating agencies are under great pressure from Bill Ackman (and others) to use "market information" such as sentiment, current prices (on believe it or not, illiquid indices) and so forth. In fact, Ackman's letter to the rating agencies a few weeks ago was almost solely based on his push to get rating agencies to use market information.

I am not well versed in rating agency methodoloy or their history, but I don't think they have ever used market sentiment in any of their ratings. The main thing the rating agencies are supposed to do is to evaluate something from a credit point of view. By incorporating market information, which fluctuates wildly during stressful periods, they are not providing much of a value added service. If a bond credit rating, for example, simply follows the market price, what's the point of their rating anyway? Unfortunately that's the path the rating agencies are following.

I am starting to think that run-off is perhaps the best route for the monolines. All these wild rumours, not to mention the ridiculous propositions (eg. takes $200 billion to save the monolines), pretty much makes it impossible to raise capital. Either the monolines go into run-off or stay downgraded and somehow minimize costs and wait for one year. I think we will know the ultimate outcome of this subprime crisis by the end of the year.

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6 Response to Do the Rating Agencies Know what They are Doing?

cak
January 30, 2008 at 9:40 PM

Siv-

I agree with you entirely.

This is why trying to stay level headed and fair is almost impossible. Where you, I, and others try to see both sides of a story people like Ackman only see their side., and they will go to any length, take any action to see that they succeed. Letters to the SEC, to Moody's, S&P, the NY Dept of Insurance, Wilbur Ross, etc, a full frontal assault on anybody that may actually try and do something to save or make money by investing in these companies.

And now the ratings agencies are caving in to the rhetoric, and without realizing it may be creating another credit crisis. Perhaps catastrophic. Do they understand the fallout?

Warburg Pincus closed the 500$ mill investment with MBI tonight. This is a reputable firm who is getting trashed because they stood up and took a risk. 95% of the so called experts are calling Warburg full fledged idiots. And it may all be for nothing, as S+P caves in to the media feeding frenzy.


Marty Whitman, unlike Ackman, more like you, quietly writes 6 short, cohesive paragraphs explaining his investment in MBI. There is little fanfare, minimum publicity and he's made a lot of money for a lot of people for a lot of years. He has gained a loyal following from people who respect him as a brilliant analyst and savvy investor. I bet he's been quoted less in the last 30 years than Ackman has in the last 30 days. With all the quick buck artists and super egos lining Wall St for miles on end, Whitman keeps to himself doing at 85 what he did at 25. Not many of us can say that.

I should write Marty and ask him what he thinks about all this trash talk.

Other positive folks are Jonathan Laing of Barron's who called the monoline top in June and is now bullish on MBI; Joe Mysak, who ebbs and flows but did write yesterday how ridiculous the loss estimates have risen ("bazillions" LOL), and Tom Brown. But they are lone voices in the wilderness.

The vehemence and outright hatred for these stocks is frightening as it is disturbing. Back in the day it used to be called yellow journalism, the constant piling on in order to make truth out of uncertainty. As Charles Foster Kane said to one of his editors "you supply the pictures I'll supply the war".


Ironically, the closer the ratings agencies and the shorts push these companies to zero the closer we get to some kind of bailout.

MBI posts earnings, or lack there of tmw morning. The stock will probably get killed but it is a very important release. The conference call is at 11.

I tried to explain my ABK investment the other day but the 'Blogger' site was down. I'll do it again when my heart rate slows ;)

cak
January 30, 2008 at 10:05 PM

Warburg picked up 2 board seats. That's good news for MBI shareholders. These guys will be all over risk like flies on poo.

ARMONK, N.Y.--(BUSINESS WIRE)--MBIA Inc. today announced the closing and funding of the sale of 16.1 million shares of its Common Stock at a price of $31 per share for the aggregate amount of $500 million pursuant to its Investment Agreement with Warburg Pincus. The stock sale is part of Warburg’s previously announced commitment to invest up to $1 billion in MBIA. In connection with its investment, Warburg has received 16.1 million warrants, as previously described.

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MBIA also said that David A. Coulter, a Warburg Pincus managing director who leads the firm's Financial Services investment activities, and Kewsong Lee, a Warburg Pincus managing director and member of the firm's Executive Management Group, have been appointed to the MBIA board of directors.

Commenting on the closing of the Warburg investment commitment, Gary C. Dunton, MBIA Chairman and CEO, stated, ”We have now strengthened our capital position by $1.5 billion, including the recently completed $1 billion surplus notes offering, and we intend to raise additional capital in the coming weeks. Our comprehensive capital plan, which improves our position by over $2 billion, has been recognized by Fitch Ratings, which affirmed our Triple-A ratings with a stable outlook, and by Standard and Poor’s Ratings Services, which affirmed our Triple-A ratings with a negative outlook. We will continue to work with Moody’s Investor Services, which has placed our ratings on review for possible downgrade, as our capital strengthening plan progresses. Our accomplishments send a strong message to those who doubted our determination to act quickly and decisively to defend our balance sheet. We remain firmly committed to enhancing our position as a leading provider of bond insurance.”

Mr. Dunton added, “Warburg Pincus has demonstrated that it keeps its commitments and has a long-term view of value creation. We are honored to have them as a significant shareholder. Further, I am very pleased to welcome David Coulter and Kewsong Lee to our board of directors. Both men bring a wealth of financial services experience and wisdom to the table, which will prove invaluable as we move forward with our strategic plan to return MBIA to a top competitive position with robust financial results.”

cak
January 30, 2008 at 10:09 PM

Also, Wilbur Ross is playing Catch-22

He wants to invest a billion dollars in mortgage insurers or fg's...but only if they are AAA, depsite the real possibility not one will be left with a AAA (except AGO and Berkshire who don't need the money) and that it will take his money to keep them AAA. Duh!

John Thain of Merrill thinks cash infusions are forthcoming for "some of the fg'S"

cak
January 31, 2008 at 8:13 AM

Ackman's analysis

Ackman

DougM
January 31, 2008 at 9:09 AM

Tom Brown said that he had a POSITION in MCO. That doesn't necessarily mean a long position...

cak
January 31, 2008 at 9:30 AM

A quick revisit to Marty-


It is possible that ... rating agencies will start to place great
weight on soft, qualitative considerations.
privileges).

In the case of MBIA and Radian, it is crucial
if they are to remain going concerns, that the national
rating agencies continue to assign AAA and AA ratings,
respectively, to each company’s bond insurance
subsidiaries. As an aside, given current prices, TAVF
would probably not lose money if Radian or MBIA
were to go into run-off rather than remain going
concerns. Run-off, i.e., liquidation, simply is not a likely
outcome, however.

It would appear as if capital infusions would not become
necessary if the rating agencies were to rely on only hard,

quantitative data. However, this month, Moody’s
announced that in reviewing ratings it would also
consider soft qualitative data, much as Moody’s views as
to what “investor perceptions” are. Consideration of such
qualitative factors as investor perceptions seems to
increase the probabilities that Radian might seek a capital
infusion as was the case for MBIA.


Marks to market are the most appropriate, and helpful,
tool in the appraisal of publicly-traded common stocks
held in trading portfolios. Marks to market are an
inappropriate, and unhelpful, tool in the appraisal of
credit instruments held in portfolios where the intent is
to hold the credit instruments to maturity. MBIA and
Radian intend to hold their credit instruments to
maturity.

MBIA’s fourth quarter 2007
reported losses will be
staggering. In addition to
mark to market losses, the
preliminary indications are
that case reserves will be
increased by $500 million to
$800 million pre-tax. The
Company, however, will
remain with a quite strong
capital position.
When I first trained as an
analyst – some 50 plus years ago – the primary role of GAAP
was to meet the needs of creditors who held credit
instruments to maturity. That’s all changed now. The
primary role of GAAP seems to have become to fulfill the
perceived needs of equity holders who are vitally affected
by day to day changes in common stock prices. As I’ve
pointed out in previous letters – What a waste! GAAP can’t
really be very useful to stock market speculators, but it can
hurt issuers like MBIA and Radian. In any event, TAVF, as
a “safe and cheap” investor, will continue to place primary
weight on “what the numbers mean” rather than on “what
the numbers are”.
Though I feel very good

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