Rating agencies are worthless

Mar 18, 2009

In this issue:
» Insider scoffs at credit rating agencies
» Dr. Doom is pessimistic, but buying stocks
» Realtors' mantra for survival
» Indian industry grapples with less closures
» ...and more!

Perhaps no other business has invited as widespread criticism for its role in the financial crisis as credit rating. Expert after expert has hauled the rating agencies for not being able to assess default risks properly. However as per New York Times, one expert who goes by the name of Warren Buffett has remained uncharacteristically silent on the role of ratings agencies. And his silence is all the more intriguing given the fact that he frequently takes pot shots at everything that is wrong with Wall Street and its methods.

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Furthermore, what gives Buffett's detractors enough fangs is his little over 20% stake in Moody's Corporation, parent of one of the three rating agencies that have almost all the market of rating firms and banks to themselves. So, is Warren Buffett's silence an indicator of his ruthlessly capitalistic streak or is it just another attempt to tarnish the man's reputation? And as is often the case, there have been arguments on both sides.

However, we would like to leave you with one that does its bit to absolve the Oracle of Omaha of what can be called his wrongly perceived sin. Moody's former managing director, Jerome Fons says that Mr. Buffett has long found his connection to Moody's a little awkward. Mr. Buffett never attended any board meetings, he says, and Berkshire has never bought any additional shares after it acquired its stake in 2000 as part of a deal with Dun & Bradstreet, then its parent company. Mr. Fons further adds, "I think he'd love to sell his stake in the company, but he can't. As soon as it was known that he was selling, the value of the company would plunge." Now that might silence a few of his critics.

While he may come to the defense of Buffett, Mr. Fons has nothing else but bucketful of harsh words to say for his former employer and others of its ilk. In an article published in Moneynews, he has called the rating agencies - Standard & Poor's and Moody's - as worthless, and worth ignoring. He is appalled that although one year has passed since the crisis unfolded, regulators and investors still continue to rely on ratings. The system is rife with conflicts of interest, Mr. Fons goes on to add, and the only tool that will work is the tool of judgement. We cannot agree more.

At this time, we remember a recent issue of the 5 Min. Wrapup where we had quoted some of the other employees of Moody's as saying that the company "sold our soul to the devil for revenue." They were crying foul about how the company issued fake ratings to junk securities just to make money on them. Do we need to say any more?

Coming to the global scare called 'unemployment', the same in much of the developed world is likely to be above 10% by the end of 2010, as per the Economist. In the developing world, around 53 m people will fall below the level of extreme poverty this year, as per the World Bank. The Great Depression highlighted the need for a government response to unemployment. So, what should they do this time around?

As per the Economist, in the short term they (the government) should subsidise companies to keep more people at work. For those who still lose their jobs, welfare schemes and unemployment benefits should be extended so that people don't plunge into destitution. In the long term, however, the government should do the exact opposite. It should keep labour markets flexible. Some old cushy jobs, such as the Wall Street trader, certainly are not coming back. Unless old jobs can be destroyed, new jobs can't be created. Hence, in the long run governments should focus more on training for new jobs rather than protecting old ones.

We believe this balance between the short term and long term is easier said than done. It demands too much agility from the policy makers.

Real estate companies in India are being compelled to completely rethink their strategies to bolster their already sagging sales. During the heydeys, property prices had reached astronomical levels and the focus was more on building luxury homes which meant higher revenues and profits. All that has completely changed!

The buzzword now is 'affordable housing'. For instance, as reported in the Wall Street Journal, real estate companies are changing the design of buildings to squeeze in more apartments and are also scaling back the details of individual units to save money. The focus has also shifted more towards one-bedroom and two-bedroom apartments. However, while prices have considerably corrected, consumers are still cautious and are of the opinion that there is headroom for prices to fall further. We second that thought!

Anyways, for Indian business and industry, while the year 2008 was marked by a whole range of negatives, there was one aspect that stood out as a positive. As per an Economic Times report, the January-November 2008 period was 'the most peaceful year for industrial relations in the last four decades'. That is because instances of industrial disputes such as labour strikes and management lockouts saw a drastic fall during the period; they were almost half of what they were during the same period in 2007.

While strikes were down by about 15%, lockouts were down 80%. Prima facie that may sound like great news, but it could also be seen as an indicator of the level of job insecurity felt by employees in general, leading to a benign attitude towards their employers.

While 'Dr. Doom', Nouriel Roubini remains utterly pessimistic about the state of the US and global economy, wonder how his funds are invested? As per the Financial Times, he is 100% in stocks! "In the long run, stocks do best and he is not yet close to retirement, so he keeps putting more money into index funds each month," reports the newspaper. We vouch for that.

The man who shares the 'Dr. Doom' epithet with Roubini - Marc Faber - also believes that tough times are here to stay, specifically for the US economy. "I think the US government bond market is a disaster waiting to happen for the simple reason that the requirements of the government to cover its fiscal deficit will be very, very high," said Faber in an interview with CNBC.

Companies making acquisitions are getting a greater bang for their buck given that the sellers are not in a bargaining position anymore. The case of the real estate major Unitech proves this point. The company has sold off around 67% stake in its telecom venture, Unitech Wireless, to the Norwegian telecom major Telenor about 11% cheaper than what was originally agreed upon. This is because Telenor gets this stake at the same price of Rs 61 bn that it had paid for a 60% stake in the company, not 67%! For Unitech, this is the price it has to pay for being starved for cash.

"Do as the Japanese do," is the advice of a US Senator to AIG's executives. As reported in international media, Charles Grassley, the Senator from Iowa, has said that AIG executives should follow the Japanese example by publicly apologising (for bringing such trouble to the company and then asking for bonuses) and do one of two things - resign or commit suicide!

Led by an unexpected strength in the housing market, the US markets saw another day of gains yesterday, as the Dow Jones Industrial Index closed 2.5% up. And the effect was clearly seen in the way stocks in Asia traded today.

While the Indian benchmark BSE-Sensex closed with around 1.3% gains, stocks in Hong Kong (up 1.9%), China (0.2%), and Singapore (1.1%) also ended in the positive. The Bank of Japan's announcement that it may provide loans to help banks replenish capital and restart lending also aided sentiment across Asia today.

As we remain intrigued by the languages bankers and investment bankers spoke to lure their clients to buy junk securities, there are some (actually many) languages the world speaks that are facing extinction. As per UNESCO, the UN's cultural body, out of the 6,700 identified languages the world speaks; around 2,500 are deemed at risk. Ironically, India leads the race with the most number of languages being at risk!

The 5 Minute WrapUp: Countries with most languages at risk.
Image Source: Economist

 Today's investing mantra
"I think you have to learn that there's a company behind every stock, and that there's only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies." - Peter Lynch

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