Credit Where Credit is Due

Who elected the credit rating agencies?

It turns out that the credit downgrade of MF Global is what sparked its death spiral. S&P downgraded the company on October 24th. On October 25th the company reported a $200 million loss. Moody’s and Fitch followed suite shortly thereafter. As a result of the downgrades, MF Global’s repo counterparties demanded more capital, and on October 31st MF Global filed for bankruptcy—one of the largest filings in US history. The company has listed some $40 billion in assets and liabilities.

We’ve seen it happen before: a ratings-agency downgrade sparks demand for more collateral. If the debtor can’t fulfill these requests the creditors reduce their exposure and the borrower fails for lack of liquidity. In many cases, it’s the credit agency reports that initiate the death-spiral. Their ability to destroy a company is powerful. Who gave it to them?

The short answer is the Federal Government. In the ‘30s regulators wanted to stop banks from buying junk bonds, so they restricted bank investments to highly-rated bonds. Congress went along, and credit ratings acquired the force of law. Over the years insurance companies, pensions, and other regulated entities were included. Now it’s almost impossibly to conceive of financial life without ratings agencies.

What’s to be done about them? First, we need to understand that tighter regulation will only raise the cost of credit. But given that, perhaps improving financial disclosure—requiring issuers to improve reporting of their risk factors and financial exposure—and requiring the agencies to focus on these publically available reports would be most effective.

This wouldn’t have prevented MF Global’s demise, but it would have made their $12 billion leveraged bet on European sovereign debt more visible. In a complex world, expert advice will always be needed. But in the world of credit, the best surprise is usually no surprise.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-11T09:23:11+00:00 November 30th, 2011|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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