Evidence from Warren Buffett to the US Financial Crisis Inquiry Commission (FCIC) earlier this week in which the great man was seen to defend the role of the credit rating agencies left a good many people gobsmacked until they realised that Buffett controls no less than 17% of the shares of Moody’s – one of the top three rating agencies in the world. Extraordinary though Buffets remarks may seem to some and that included a belief that the “rating agencies should not be blamed for making the same mistakes that everyone else made” plus that “they were caught by a decline in housing prices that few saw coming” I doubt that Mr. Buffett’s evidence will have made that much of a lasting impression on the FCIC. Even so, given that Mr. Buffett does not usually take prisoners the three big rating agencies can count themselves rather lucky that someone of this calibre is on their side. Others take a very different view blaming rating agencies, former FED chairman Alan Greenspan and even the Clinton administration for its part in weakening US regulatory rules on banks for much of the problem that we are still trying to sort out. On rating agencies though the bottom line is that until and if there is some kind of suitable replacement for the anachronism that rating agencies are now seen by some to be then nothing can change. Will that happen – will something else come along? I very much doubt that it will. To those that would replace the rating agencies in their existing form I would say do we really want new style rating agencies controlled and maybe even owned by governments? I think not. So the answer is that though the present system may need some tinkering, tightening and maybe in some cases, shaking up there is in fact nothing that one could design than is better than the current system of independently and hopefully impartially operated rating agencies.
While desire for change on all forms of regulatory control remains in the air when it comes to how debt is rated I doubt that the current system of independently operated rating agencies will do anything other than survive. The agencies will of course need to be strengthened and a degree of increased regulation will be no bad thing. Indeed, I very much doubt that when the FCIC finally reports that the behaviour of rating agencies through the expanding bubble years will come out that well. Whatever, in future we will need to ensure that rating agencies remains truly independent and impartial, that they operate within suitably agreed regulatory conditions albeit on a country to country basis and that that ensure that they keep a sharpened eye on the potential for risk. On that score it has been right to question the behaviour of rating agencies over the past dozen or so years but we must take care not to question their value to society unless and before we have something else to put in their place. Mind you, given Mr. Buffett’s very apparent ringing endorsement of rating agencies led me to wonder whether the so-called Sage of Omaha would have taken such a kindly view had one of his senior investment managers at Berkshire Hathaway failed to build in the potential for downside risk within stock portfolio additions!
Of course, no matter what Mr. Buffett may say the impression in public is that never again should the rating agency model fail investors and indeed, governments across the world as it did. The reality of the questioning isn’t that anyone is trying to push the blame for the crisis that followed the Greenspan bubble on the rating agencies alone but to find out why they were not better able and equipped to have warned about the possibility of an impending crisis four of five years ago. It is also to ensure that in future there will be no shortage of risk warnings. Meanwhile during evidence to the Inquiry this week it seems that FCIC chairman Phil Angelides took a far more hostile view against the rating agencies arguing that they did extremely well during the years the bubble was inflating. On Moody’s alone he noted that that the firms’ revenues had increased from just $600m in 2000 to $2.2bn in 2007. Nevertheless, whether the rating agencies may or may not have been compromised by the nature of how they operate on behalf of banks and corporates and whether or not they were the cause or indeed, as someone else suggested one of the victims of the crisis is for the FCIC to decide. If they are found to have been a big cause of the following crisis because they allowed too many players to move forward with over inflated ratings and ignored the potential for risk they will of course deserve all that can and will be thrown at them. But even if of necessity they have now learned much from the criticism and innuendo if they do happen to find themselves absolved and maybe found to have been nothing more than a tiny cog in a very large wheel it is arguable that what will inevitably follow in the form of increased regulation may not be deserved. Thus as the US FCIC Inquiry is crucial to how we will perceive rating agencies in the future I believe that we should await its outcome before we do anything else.
Meanwhile in the carving for increased regulations within the draft proposals for Senate financial services legislation there exists the idea that rating agencies should be chosen by an independent board of regulators. The idea behind this is that it would discourage rating agencies from providing overly generous ratings in order to please the banks and corporates that pay them. This is but one proposal in the US in a process that can be expected to take several more months to complete yet and even longer to pass through both houses. As is typical the EU is taking a far more vigorous stance in its proposals for regulating the rating agencies including I am shocked to see that banks would then be forced to disclose the full details of all financial transactions to the rating agencies. Such an idea is quite ridiculous in my view and of necessity would probably need to see the existing size of the rating agencies trebled. Indeed, EU Commissioner has proposed the formation of another giant body of bureaucrats in the form of what is being called the European Security Market Authority that would encompass the transfer of all existing national responsibility for rating agencies to a single presumably Brussels, Paris or Berlin based permanent body. This of course is typical of the type of control behaviour we are seeing more and more of from Michel Barnier. Worse is that he says proposals such as this are only the first step to changes on the rules governing credit rating agencies. These are hopefully early days in this particular debate and none of this will help solve the sovereign debt problems of Greece, Spain and others. The worst point about the current Barnier proposals though is that they will greatly increase the number of people and committees involved and that they will lack necessary flexibility. They also appear to attempt to pass the buck of responsibility further on to directors of banks and auditors. This is not the way forward in my view – strengthen regulation of the rating agencies and others by all means but allow it to be done on its merits by individual national governments. We want less people involved in regulation but more action and protection. But we also want to ensure that all those involved can operate with some degree of freedom and that in tightening the noose around all those involved or that stand accused of playing a part in the 2008 crisis does not choke off the will to compete.
