Moody's List of Riskiest Companies Forgets to Include Moody's

This post first appeared on Minyanville.

Make-up calls belong in basketball, not finance.

In an attempt to render itself useful, Moody’s Investors Services (MCO) is issuing a list dubbed “The Bottom Rung,” cataloguing the riskiest 15% of all companies it tracks. The effort, which the company claims is an attempt to get ahead of the looming mountain of corporate defaults, has already ruffled a few feathers.

According to the Wall Street Journal, Eastman Kodak (EK), which appeared on the list, issued a harsh rebuttal last night, saying “Any speculation, however informed, suggesting that Kodak is less than financially sound is irresponsible.”

Among the list of allegedly shaky companies: Familiar names like Ford (F), General Motors (GM) and Chrysler made the cut, along with airlines AMR Corp (AMR) and US Airways (LCC). Retailers, restaurants and even a few energy firms also appeared in this corporate hall of shame, in addition to chipmaker Advanced Micro Devices (AMD) and chemical manufacturer Georgia Gulf Corp (GGC).

Moody’s, along with fellow ratings agencies Standard and Poor’s (MHP) and Fitch Ratings Services, played a major role in the recent financial market meltdown. Conflicts of interest with debt issuers, faulty models and lax internal controls all led to credit ratings that were unreliable at best, deceptive at worst.

Unfortunately for Moody’s, gone are the days when investors valued haphazard assessments of credit risk. The Bottom Rung, while generating ample work for Moody’s customer-complaints department, isn’t likely to reclaim any of the company’s lost glory.

When a firm that specializes in assessing whether borrowers will repay their debts fails to see the biggest wave of defaults in a generation, it’s safe to say that company isn’t very good at its job.

Minyanville's Jeff Macke said it best last week:

In an environment in which DC is creating and changing the laws of corporate governance on a daily basis, it’s simply lunacy to allow 3 groups complicit in the creation of the underlying problem to go on their merry ways while members of the House endlessly lambast bankers for being bankers. Take the gun away from the 5 year old; suspend the ratings authority of Moody’s, S&P and Fitch.

Calpers Gambles, Loses - Again

This post first appeared on Minyanville.

Americans should be wary of letting the government invest $700 billion of taxpayer money on highly illiquid, difficult-to-price assets. To say that we're virtually guaranteed to turn a profit is offensive and insulting to anyone with a sense of how convoluted, risky and opaque these securities really are.

Indeed, it appears even politicians are no longer sure this is a such good idea.

For evidence of just how well government-run bureaucracies manage vast pools of money, one need look no further than the nation’s largest pension fund, the California Public Employees’ Retirement System, or Calpers.

This June, a joint venture between the fund and a California developer filed for bankruptcy. Calpers had dumped almost $1 billion into raw land outside Los Angeles at the height of the real estate boom, which turned out to be kind of a bad idea: Calpers could lose its entire investment.

In late 2006, the fund made another equally ill-timed bet on highly speculative real estate.

Together with developer Tishman Spears, Calpers plunked down $500 million to buy the 80-acre swath of housing developments that make up Peter Cooper Village and Stuyvesant Town on Manhattan’s east side. After much debate in New York about the fate of the developments -- whose thousands of units were formerly reserved for low-income renters -- MetLife sold the 56-building complex for $5.4 billion.

With the New York economy beginning to slow and property values showing cracks up and down Manhattan, Calpers may have yet again bought at the top.

According to the Wall Street Journal, the deal was financed with $4.4 billion in debt from Wachovia (WB) and Merrill Lynch (MER). Now, Standard and Poor’s (MHP) has downgraded a portion of that debt connected with a $3 billion mortgage used to fund the project.

S&P is concerned not only about the 10% drop in the property’s value, but also about whether rental cash flow and money generated from selling off individual units will be able to cover the debt service. Tishman, for its part, says cash flow is improving, and that credit markets have prematurely written an unhappy ending for the investment.

The continued inability of government-run investment funds to make good decisions is deeply unnerving, given the fact that bureaucrats could soon have their grubby little paws on a slush fund of unparalleled size.

Rating Agency Overhaul Falls Short

This post first appeared on Minyanville.

So much for accountability.

The Wall Street Journal reported yesterday of the striking of a preliminary deal between New York Attorney General Andrew Cuomo and Standard & Poor's (MHP), Moody's Investment Corporation (MCO) and Fitch Ratings.

Under the proposed settlement, the three major debt rating firms will change the way they're paid for evaluating non-prime mortgage-backed securities. No fines will be imposed for their role in the collapse in value of bonds they once rated as investment grade. Despite the billions of dollars lost as a result of their shoddy reviews, the agencies will not admit (nor be forced to admit) any wrongdoing.

Cuomo hopes the new plan allows rating companies to be tough on issuers, while still generating income. Simply, agencies will charge issuers for reviewing potential securities and, if selected to rate the deal, earn an additional service fee. Additionally, agencies must disclose on a quarterly basis which deals they've reviewed. It's expected the increased transparency will help investors better evaluate the relationship between issuer and rater.

While the new fee structure is a step in the right direction, it fails to address the root of the issue. As I noted earlier this year:

The problem is one of incentives. As long as rating agencies are paid by the issuers of securities rather than investors, they'll be financially motivated to hand out generous ratings. In the for-profit business of rating debt, business is awarded to the firm that provides the best ratings.

Any marginal benefit from increased transparency will be wiped out by the impact of higher borrowing costs. The new fee structure is likely to increases ratings-related expenses, which will no doubt be passed on to investors. Investment banks like Lehman Brothers (LEH), Goldman Sachs (GS) and Merrill Lynch (MER) -- already under intense pressure to sustain profit margins -- aren't about to shoulder the extra burden alone.

The rating agencies were an integral part of Wall Street's debt experiment gone wrong. Regulators had the opportunity to make a bold statement: That those responsible for the implosion of the credit markets would be held accountable. Instead, the lack of material change in the relationship between issuer and rating agency demonstrates the ongoing unwillingness of regulators to police the very markets they're charged with monitoring.

Professor Macke's take on Moody's and S&P is perhaps blunt, but not unreasonable: "[The rating agencies] don't have to justify the myriad 'one off' mistakes they've made over the years, but rather their very existence."