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Buffett and the Rating Agencies


Vizi1

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I think buffett is right, it is tough for end users to pay, the only end users with $ to pay are probably institutions who have resources to do their own due diligence anyways.  There is a good created by allowing small issuers access to capital and small investors access to research.

 

Have you guys read Ackman's opinion on situation?  I think Ackman is awesome, usually has straightforward, logical ideas.  His idea is basically a rule that allows raters to be paid by issuer, but make it so the payment is somehow contingent on long-term accuracy of rating.  Also, must wait 60 days prior to issuing rating on new issues, so there is no pressure from underwriters for rating.  So essentially somehow measure the long-term accuracy of the rating, and make it so the fee is earned not all up front at issuance, but over the life of the bond.  See here http://cache.dealbreaker.com/uploads/2010/06/Wait-to-Rate.pdf

 

Not sure how this is done in practice, because outcomes of bonds are binary (default or no default); whereas ratings are analog in a sense.  He says set aside $ into pool that is distributed to all raters based on relative accuracy to each other.  Also, another good idea he has is to make it mandatory that the SEC revokes the NRSRO status of any rater than is consistently wrong.  This is good incentive not to fuck up. 

 

Another good idea he has is to rethink Reg FD.  Right now raters get inside info and are exempt under reg fd.  This is unfair, because the raters are not even doing their jobs.  That info would be better if in hands of investors.  He argues the prospectus requirements require any info that investors would reasonably require must be disclosed.  How can you say that there is exists info raters need to do their job, on the one hand, that on the other hand isn't reasonably necessary to investors?

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To use a world cup analogy;

How is this any different from the crowd booing the referee for making bad calls in the lead up to the premier game?

 

The refs are effectively controlled/work for a 'union' - the 'union' here is the US gov.

The refs are exposed to bribery & game fixing - same thing for a credit rater, its just done differently

The crowd has to assume impartial refs - same thing for the market using the ratings

 

When the corruption/intimidation gets out of hand the refs refuse to ref, there's no game, the bookmakers & fans go ballistic, & refs (& their families) receive visits from 'legbreakers' wielding baseball bats. The equivalent is a ratings moratorium (not a problem if no one is actually using them), & threatening lobbyists all over the raters/gov.

 

Hasn't happened yet because lobbyists are more effective than baseball bats?

 

SD 

 

 

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Franken, Ackman, or Roubini all have good solutions to this problem.

 

Roubini uses the analogy of paying teachers directly for the grade you get, with the option of 2 other teachers available for the course.

 

The status quo sucks and I dont agree with Buffett on this. 

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Ackman's idea is interesting but how would it be implemented? If you tie payments to bond performance, then how will the performance be measured? After all, ratings change according to changes in the business or in the capitalization, and those factors change simply due to time. If a manager sells his most profitable unit at a low price days after recieving a AAA, then it seems unacceptable to restrict payments to the rater.

 

Also, if the company is paying the rater, but it can also retain payments if their own default risk increases, then that seems to create a perverse incentive to default on payments.

 

In addition, Ackman's plan seems to bring the rating company's role a bit too close to that of a bond manager. Let's say Ackman's plan becomes the status quo... if the market overly weighted ratings under the current system, how blindly will it use ratings when the raters are accepting credit risk? We could actually see an increase in moral hazard!

 

My personal belief is that current discussion about ratings focuses too much on the raters, whom are simply the logical results of the current system. I don't see a solution that doesn't focus upon the why and the how of rating consumers.

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Ackman's idea is interesting but how would it be implemented? If you tie payments to bond performance, then how will the performance be measured? After all, ratings change according to changes in the business or in the capitalization, and those factors change simply due to time. If a manager sells his most profitable unit at a low price days after recieving a AAA, then it seems unacceptable to restrict payments to the rater.

 

Also, if the company is paying the rater, but it can also retain payments if their own default risk increases, then that seems to create a perverse incentive to default on payments.

 

In addition, Ackman's plan seems to bring the rating company's role a bit too close to that of a bond manager. Let's say Ackman's plan becomes the status quo... if the market overly weighted ratings under the current system, how blindly will it use ratings when the raters are accepting credit risk? We could actually see an increase in moral hazard!

 

My personal belief is that current discussion about ratings focuses too much on the raters, whom are simply the logical results of the current system. I don't see a solution that doesn't focus upon the why and the how of rating consumers.

 

Rabbit you bring up some good points. Payments over a period of time really only makes sense on structured products, but even then the raters shouldnt have to deal with the risks that the economy turns down and what not. I will have to throw his ideas out, but Roubini does have some great ideas concerning this in his new book.

 

I feel as though you need some sort of rating systems for pension funds, and insurance companies. Perhaps it shouldnt be as relied on as it is now though, but that could be just to a basis for what we have in place.

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