Monday, April 6, 2009

What caused the crash, who should go to prison and how to fix this mess

This article could have so many titles:


Whose to Blame?


Why are the wrong people being blames?


The one reform the market desperately requires?


Where was the free market watchdog? No not the SEC......


Why are the rating agencies not owning responsibility for their mess?


Should AIG and Madoffs investors be allowed to sue the Rating Agencies?


Who owns the Rating Agencies and is keeping them out of the press???


The Rating Agencies have held themselves out as our guiding lights in investment they have built a huge business in the niche of advising us what is safe and what isn't and then hung us out to dry. They do the hard work and the heavy lifting providing us with the due diligence we require to make educated and astute investment decisions. As an savy investor you wouldn't dream of loading your pension fund with NR (unrated) or "D" grade bonds months before retirement. It is their commitment to you that your "AAA" investment will be the "best grade, reliable and stable" yet how are they held accountable when these investments prove to be anything but.

In any self regulating system there are checks and balances, many of which relate to the manner in which the market carries out due diligence and how it assesses risk. The more risk one takes the higher the return, which mitigates losses when there is some kind of implosion. The investor normally is philosophical and says, hey I took a risk and had I wont the return would have been worth it. It is the very true for anyone investing in speculative oil exploration drilling the returns will be huge and you will only invest a small portion of your portfolio. A less speculative investor will wait until oil has been hit and invest in the secondary wells drilled to tap the known reserve, you would naturally be willing to invest more in this than in the exploration. The risk averse investor will invest in the pipeline from the known field to the known refinery, this is where the majority of investors have the majority of their money, including; pension funds, insurance companies, charitable foundations, banks. The financial implosion we are currently witnessing is the result of the self regulating bodies that held themselves up as our due diligence experts telling us that we were buying a pipeline to an existing oil field from a refinery. This was the coveted "AAA" rating or even slightly lesser rating such as "A" and "AA." They failed us and if anyone should be imprisoned, punished or found fault with it is the heads of these companies who held themselves up as independent and then earned their very revenues from the companies and assets they were supposed to independently rate. This is why the market has no trust now, what was seemingly secure and therefore had such a large proportion of wealth in it is now clearly seen to be unsecure, investor confidence is shaken to the core.


This confidence must be restored and there is truly only one way to achieve this. The checks and balances need to be trustworthy and more than any other thing the current Government needs to do is make the organizations' that decide who we should believe in be honest again. Would I be mistaken in thinking that these agencies are avoiding the limelight due to their owners (McGraw Hill owns Standard and Poor's)  and the vast profits (often 50% or more) this company makes for them. They are the most culpable entities in the current society. Whilst Madoff is vilified and the SEC is chastised, the rating agencies (Stand & Poor's, Fitch, Moody's) should have been the natural whistleblowers, they have skated by with barely even a mention.


I couldn't believe it when one of my potential investors asked me recently what my bonds "credit rating" was. The worthless piece of paper it would have been written on would have cost me nearly $500,000 to obtain and would have been almost entirely dependent on the information I provided carefully formatted by one of the ex-credit rating agency employees who charge $100,000 or more to guarantee you obtain certain ratings. The system is corrupted, "power corrupts and absolute power corrupts absolutely." These companies have absolute power over which investments flourish and which never make it, yet what is their process, ability and knowledge in handing out these ratings. Need I point out that Enron, Lehman, WorldCom, Texaco, Conseco, Global Crossing, United Airlines, GM, GMAC, Countrywide,  KMART, Fruit of the Loom, Continental Airlines, Citibank all held high ratings and the consumers found out before the rating agencies that these were wrong.


I propose that the very first thing the government does before any more bailout money is handed to banks etc is that this system is ripped apart, either nationalize these companies or imprison anyone who gets ratings wrong due to personal gain. Make these entities culpable, why should AIG loose so much money and its investors too when they entrusted their risk quite logically to the rating agencies. People should still to what they are good at and be able to have the confidence to trust other companies in their fields of expertise. I was able to work out that Countrywide's Chairman/ CEO Angelo Mozzilo was selling his stock as fast as he humanly possibly could, it was public information, why couldn't they have raised a red flag 6-9 months earlier when I did..... its basic due diligence...... When Harry Marcopoulos  raised the red flags why didn't they investigate it, it is not the SEC we turn too, to tell us if something is a good risk or a bad, it isn't the SEC that "RATES" something as "LOW RISK".


It is wonderful that these organizations create huge barriers to entry making only mega deals viable and pushing fund manager towards the limits of efficiency where returns will be compromised due to the sheer scale of the investment fund requiring investment. Warren Buffett has underperformed in recent years due to the sheer scale of his fund and that fact that opportunities are not as bountiful, he cant even look at smaller deals as the economies of scale no longer make sense. Whilst he will now make a killing because of his heavily cash weighted position he is proof that   


My call is out to the people is we should punish those who should be punished even if the media wont focus on it as they own them. The people who told us to trust in garbage are not people we can trust this sector of the system is utterly corrupt and needs a complete overhaul or else we will be right back here again before you can say next generation.


Long-term credit ratings

Fitch Rating' long-term credit ratings are set up along a scale from 'AAA' to 'D', first introduced in 1924 and later adopted and licensed by S&P. Moody's also uses a similar scale, but names the categories differently. Like S&P, Fitch also uses intermediate modifiers for each category between AA and CCC (i.e., AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB- etc.).

Investment grade

§                     AAA  : the best quality companies, reliable and stable

§                     AA  : quality companies, a bit higher risk than AAA

§                     A  : economic situation can affect finance

§                     BBB  : medium class companies, which are satisfactory at the moment

Non-investment grade (also known as junk bonds)

§                     BB  : more prone to changes in the economy

§                     B  : financial situation varies noticeably

§                     CCC  : currently vulnerable and dependent on favorable economic conditions to meet its commitments

§                     CC  : highly vulnerable, very speculative bonds

§                     C  : highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations

§                     D  : has defaulted on obligations and Fitch believes that it will generally default on most or all obligations

§                     NR  : not publicly rated

Short-term credit ratings

Fitch's short-term ratings indicate the potential level of default within a 12-month period.

§                     F1+  : best quality grade, indicating exceptionally strong capacity of obligor to meet its financial commitment

§                     F1  : best quality grade, indicating strong capacity of obligor to meet its financial commitment

§                     F2  : good quality grade with satisfactory capacity of obligor to meet its financial commitment

§                     F3  : fair quality grade with adequate capacity of obligor to meet its financial commitment but near term adverse conditions could impact the obligor's commitments

§                     B  : of speculative nature and obligor has minimal capacity to meet its commitment and vulnerability to short term adverse changes in financial and economic conditions

§                     C  : possibility of default is high and the financial commitment of the obligor are dependent upon sustained, favorable business and economic conditions

§                     D  : the obligor is in default as it has failed on its financial commitments.


Copyright Jonathan Rose 2009 - Creative Commons License

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