Thursday, October 23, 2008

FFIRA: Federal Fixed-Income Rating Administration

Yesterday while I was listening and watching the House of Representatives' hearing on the bond market meltdown, I heard a phrase I had not heard in quite a while, "shopping a bond rating." What is shopping a bond rating? Simply put, shopping a bond rating is when an investment banker goes from one rating agency (company) to another looking to see who will give their bond issue, which they are underwriting, a higher rating than the other rating companies.

Why is the bond rating so important? Well, if you could have heard the men from the rating companies talk to members of Congress yesterday, you would have been led to believe that the rating companies give only an "opinion". Yes, an "opinion" is what the investment bankers pay the rating companies for, just an "opinion". Unfortunately, that "opinion" put this country, in part, in the financial crisis that we now find ourselves.

I love it when a professional backs off the importance of what they do. In this case, the rating companies are only giving an opinion. An opinion that results in millions of dollars being invested in a particular bond issue. Add up all the mortgage-backed bond issues that have been rated by the rating companies and you have several billions of dollars of investment securities, being traded around the world, being placed into public and private pension funds, and the rating companies are only selling an "opinion".

What if you could buy a mile of road construction for your state? You might go to three or four construction companies that building roads and say to them, " how many feet are in your mile of road?" The company that would give you the best price per mile and have the longest mile would get the business. Or, when you go to buy some meat you find a butcher that gives 20 ounces and calls it a pound of meat. We all know 16 ounces equals a pound, but what the hell, if one butcher wants to give 20 ounces to the pound and charge the same as those selling 16 ounces to the pound, who are we to argue.

Am I crazy? No, I am not crazy. I just think that investment bankers should not be able to "shop" a bond rating any more than a drug company should be able to "shop" for the approval of their new drugs by going from one Food & Drug Administration to another FDA. There is only one FDA, and I believe there should be only one rating agency and that rating agency should be run by the Federal Government. If Wall Street brings a bond to be rated to the Federal Agency for Fixed-Income Ratings, then they take the rating they get and they don't "shop" the rating with the other rating companies. A mile is a mile, and a pound is a pound. Let's stop the BS!!!

I know that nothing is perfect whether it is done by the private sector or the government, but I do know that taking the rating of billions of dollars of bonds, and taking it out of the for profit side of the business would go a long way to improving the whole bond rating process. The amount of financing done by asset-backed bonds has changed the landscape of Wall Street tremendously over the last 30 years. With the creation of the whole asset-backed sector of the fixed-income market, the number of bond issues underwritten by investment bankers has exploded. The rating of billions of dollars of asset-backed bond issues requires that the government step in and take over the rating process. If the rating of bonds remains in the hands of the private for profit sector, it is just a matter of time before we visit the same financial crisis again.

Stay tuned.

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