“There is no other realistic way to get business done”, says The Aleph Blog in a rare defence of the ratings agencies. The agencies have been under fire from all sides since the credit squeeze began earlier this year.
But here are the realities, according to David Merkel:
- There is no way to get investors to pay full freight for the sum total of what the ratings agencies do.
- Regulators need the ratings agencies, or they would need to create an internal ratings agency themselves. The NAIC SVO is an example of the latter, and proves why the regulators need the ratings agencies.
- New securities are always being created, and someone has to try to put them on a level playing field for creditworthiness purposes.
- Somewhere in the financial system there has to be room for parties that offer opinions who don’t have to worry about being sued if their opinions are wrong.
- Ratings can be short-term, or long-term, but not both. The worst of all worlds is when the ratings agencies shift time horizons.
OK, so investors want advice, but they don’t want to pay the fees the issuers pay. The agencies offer opinions, and these opinions should not therefore take the place of common sense. Merkel says:The ratings agencies aren’t perfect, and good buy-side shops use them, but don’t rely on them.
Secondly, there has to be a way for the regulators to assess credit risk to size capital positions. The waters are only getting murkier, and the models more complex, so the options are that they use ratings agencies or they become ratings agencies.
Thirdly, new instruments are being developed all the time, and financial institutions will buy them. Anyone want to try assessing and ensuring proper capital levels without standardised ratings?
Fourthly, back to opinions.
If you were stupid enough to rely on the rating without further analysis, well, that was your fault.
If you don’t do the analysis or read the small print, then pay the price. If the agencies can then be sued for their opinions, the process of getting a rating is going to become a lot more expensive, suggests Merkel.
Lastly, ratings agency opinions are long-term by nature, rating over a full credit cycle. In the midst of a crisis people may wish those opinions were geared to the short-term. But in the interest of stability, says Merkel, keeping one time horizon is best, whether short- or long-term.
For those that don’t like it, Merkel suggests some alternatives:
- Regulators can ban asset classes until they are seasoned. Could be smart, but there will be complaints. “Regulators are slow, and they genuinely don’t understand investments.”
- Open the markets and “allow for more rating agencies.”
Ultimately, he suggests, has anyone out there actually got a better idea?