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McGraw Hill: S&P completely misunderstood

C. HUYGENS - Friday, August 17, 2012
Ratings are instrumental in fostering market liquidity because they provide investors with information that helps them assess credit risk. Now, Bloomberg reports (17 August, Detrixhe), S&P argues that after more than 100 years of use, investors appear to have a "misunderstanding" of credit rankings.

The companies that provide these rankings, beginning with Moody's in 1909, have received extraordinary regulatory attention after every market crisis. In 1975, following a crisis, financial instrument ratings became a quasi government-mandated monopoly, a regulatory license, when Moody’s, S&P and five others were identified as Nationally Recognized Statistical Rating Organization (NRSRO) by the U.S. Securities and Exchange Commission.

Dissatisfaction with quality of the ratings has reduced the stature of the various providers, and the need for credit issuers to buy products from Moody’s and its competitors – the bread and butter -- is being whittled down. In October 2010, the Financial Stability Board (FSB) created a set of "principles to reduce reliance" on credit rating agencies in the laws, regulations and market practices of G-20 member countries. Although the rating agencies were criticized for "technical failings and inadequate resources", the agencies' "need to repair their reputation was seen by the FSB as a powerful force" for change.

"“Ratings are really just a rank ordering of our opinion of relative credit worthiness based on our criteria,” Peter Rigby, a credit analyst at S&P, said in a telephone interview. “It’s neither an objective nor goal or intent to determine yields or prices. Obviously, investors do that using a whole host of information and different investors have their different valuation objectives.”

In other words, if S&P says the United States is less credit worthy, credit markets say it is more creditworthy, and investors are confused...it is proof that investors do not understand what rankings mean and why they are so important.

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