Monday, May 10, 2010

The Credit Rating Agencies: Sometimes You Need To Build A Fire

The investment business, for whatever reason, has remained over the years an area of modern/contemporary life that the vast majority of people have not taken much of an interest. My own interest in cars does not go very deep either. I love to drive, and I love to drive my BMW on the highways, but do not ask me any questions about what is under the hood or how it operates. I know how to put gas in the tank (I even know how to put in an extra quart of oil when it needs some). I am happy with that, and if something goes wrong, I take it to my BMW dealer for maintenance and repairs. I almost never read an article about the latest in automotive engineering, and yet I love to look at new and classic cars.

The investment business is not that complex, but there are a lot of terms and jargon that one needs to know to understand the finer points of the business. Without a knowledge of this specialized vocabulary, the world of bonds is a world of mystery. I have over the last two plus years written a great deal about bond terms and the bond market. One area, the credit rating agencies has remained "under the hood" so to speak for the general public. People working with bonds and bond portfolio management know what that credit ratings agencies do and the importance their credit ratings are to the process of taking a new issue of bonds from the underwriting through to the sale of the public offering of the bond issue.

Last week, on May 2, 2010, The New York Times wrote an editorial about the fact that the three largest credit rating agencies, the same agencies that gave out their Triple-A credit rating to the billions of dollars of mortgage-backed bonds, were somehow not included in the financial reform legislation that is making its way through Congress. This does not surprise me because they, the credit rating agencies, have some very powerful players involved in their business as investors. As I have written many times, "money talks and bullshit walks." Mr. Warren Buffett is a big time player and he owns a nice size piece of Moody's parent company as well as a nice size piece of Goldman Sachs. It is no mistake that the politicians glossed over this finer point of corrective legislation.

But, let us give credit to The New York Times for bringing this point to the greater public's attention. Now all we need is for the talking heads on the network news and the cables news people to pick up on this and keep it in front of the public's eye. As I have written many times, economics is easy, politics is hard. Removing the low hanging fruit from the reach of powerful old men is no easy task. They and the politicians that they contribute to will not do the right thing just because it is the right thing to do. Sometimes you need to build a fire.

Stay tuned.


Julie Schuler said...

I think I'm feeling too misanthropic to consider old man legislators today. Today, I give them an imaginary kick in the nuts and go back to my business.

LceeL said...

There's something that bothers me, a little. If shares in a company (and shares in a company usually refers to publicly owned, or publicly held companies) confer some sort of ownership of the company, why is it that it's only profits in which the shareholders share? I wonder how the game would change if 'shareholding' meant participating in the loss as well as the profits.

And something else - it bothers me to some extent that the financial well being of the nation seems to be dependent on the whim and fancy of gamblers. Speculators. High volume traders. People whose only purpose in 'investing' is to line their pockets - not to build anything, grow anything or preserve anything.

moneythoughts said...

Lou, it does. Shares sell on what is referred to as a Price/Earnings ratio. Shares sell at a number, say 10, times the earnings per share (EPS), say $5.00. Then that corporation would sell at $5 x 10 = $50. If EPS falls to $1.00 and the ratio remains at 10, the price of a share would then sell for $10. The shareholder has now lost 80% of the value of his shares.

winslow said... Lceel......
What has happened over the last 20-30 years in corporate America?

Corporate chieftans have discovered they can take as much money out of the company as the shareholders will let other words, there is virtually no limit, especially with stock awards and options. In the news today, 3 CEO's were listed as making over $30-40 million this year. This is absurd! I believe this is creating a huge separation of classes in America and will lead to our inevitable demise.
Secondly, the stock market today is controlled by hedge funds making enormous daily trades. It has gotten very speculative.