One of the great mysteries coming out of the 2008 financial collapse
centered on how the rating agencies, for all their culpability in
aiding and abetting the mindless risk-taking on the part of the big
banks, escaped legal responsibility.
After all, these were the companies that slapped all those faulty
triple-A ratings on toxic debt that the banks either sold to investors
or held on their own balance sheets. Yet not one of the senior
executives at the agencies went to jail, much less were any charged
with civil penalties by the Securities and Exchange Commission. And
all the rating companies are operating as if the events of 2008 never
happened, with their absurdly conflicted business model of collecting
fees from the entities they rate still in full gear.
As it turns out, you can't just shut down a company for simply
maintaining a business model that leads to corruption or else every
firm on Wall Street would have been indicted and put out of business a
long time ago. But companies do lose their significance and eventually
disappear for being stupid and that ultimately may be the downfall of
one rating agency in particular, Standard & Poor's.
As most people know, S&P has downgraded US government bonds -- regarded
as the safest in the world -- from their long-held triple-A status. The
company cited a few sound reasons for doing so, namely mounting levels
of debt, anemic economic growth, but most of all, the recent political
discord that failed produce a plan adequate enough to fix country's
Okay, points well taken, but not exactly stuff we haven't heard before.
Moreover, the ratings company somehow ignored (or was too dumb to
figure out) the one argument that would render those points moot and
make a downgrade absurd on so many levels: as bad as we are, the world
is in even worse shape. In failing to recognize that one salient
point, S&P told the financial world that France -- a country that is
teetering financially amid the Euro-zone mess -- is actually a safer bet
than the US. As I write this column, France maintains its triple-A
rating; in fact S&P affirmed the rating last week, while the US is
considered a credit on par with New Zealand and Belgium.
Investors have a pretty good record at blowing past the absurd and
coming to their own, generally accurate, conclusions. They ignored the
mindless executives at Bear Stearns, Lehman Brothers and the rest of
the banks who assured the world they were fine by selling short bank
stocks well before the financial collapse and bailouts of 2008. And
now they're ignoring S&P as well.
Prices of insurance contracts on French bonds -- also known as credit
default swaps -- rose sharply last week, meaning that traders believe the
French sovereign debt is too risky to hold without some protection.
Meanwhile, investors continue to flock to the now lower-rated US
government debt as the world's safe haven.
In the eyes of the smartest money men on the planet, it doesn't matter
that we have a president who loves to spend and has no idea how to
grow the economy -- the US is still the preeminent super power. S&P
says "the downgrade reflects our view that the effectiveness,
stability, and predictability of American policy making and political
institutions have weakened." Many investors I talk to say that if the
recent debate over raising the debt ceiling
proves anything, it's that we are finally waking to the fact that the
spending spree has to either end or be paid for. The outcome of the
2012 election will determine how much spending gets cut or how much
taxes get raised to finance the costs of government.
Of course the smartest money men in the world have gotten things wrong
in the past, but in what rational sense can France with its low birth
rate, second-rate military, and quasi-socialist economy be considered
a better bet than the US?
Which leads me to another question: how good of a bet do investors
consider S&P? You would think a move like downgrading the US and the
massive amounts of publicity it produced would be a positive for the
stock. In fact, the rating agency's parent company, McGraw-Hill Cos.,
has had a very good one-year run, with shares spiking around 66
percent. But that was before the downgrade. Shares of McGraw-Hill have
lost nearly 10% of their value since the announcement, and that's
after gaining a few points during last Friday's market rally.
And here's what investors in S&P have to look forward to:
Congressional hearings into how raters there view France as a better
credit than the US; a bond market that has all but ignored its dire
warnings about the US debt being equal to Belgium and New Zealand, and
most recently, an investigation into whether S&P leaked the downgrade
to Wall Street traders before it made its official announcement late
Friday night, on August 5.
The Fox Business Network was first to report the
possibility of an S&P leak last week. Following our report,
Congresswoman Maxine Waters wrote SEC chairwoman Mary Schapiro
demanding an inquiry into the matter, and by Friday that inquiry into
among other issues, possible insider trading had begun.
Based on what I know at least so far, whatever the commission uncovers
will sound less like a high-level white collar crime ala Ivan Boesky,
and more like something out of The Gang That Couldn't Shoot Straight;
executives at one major bank tell me that the day before the downgrade
was made official, they had met with S&P about how a US sovereign
downgrade might impact the bank's own rating. They heard other banks
had met as well.
S&P, of course, had been threatening for weeks that it would downgrade
the US bond if the budget deal didn't create substantial budget
savings in the neighborhood of $4 trillion, which it didn't. But the
tone of the latest meetings, I am told, was such that people at the
banks came to believe that something was coming and fast. This bank,
along with the rest of Wall Street, and just about every major money
management firm I know, began to hedge for the likelihood of an S&P
downgrade early Friday morning as rumors of the downgrade began to
S&P, for its part, won't comment to me about these meetings, but the
ratings agency won't deny they occurred either. Nor will it deny that
some bonehead executive slipped up and signaled to the Wall Street the
decision that would tank the markets more than 600 points the
following Monday, though you can be pretty sure the big banks
themselves were hedged enough that their losses were mitigated.
In the end, however, possibly spilling the beans about the biggest
event in its corporate history may ultimately turn out to be the least
of S&P's problems. It still has to explain to Congress and the
investing world why France is a better bet than the US.
Now you know why its stock is getting hammered.