It was not that many years ago that a slew of investigations almost ruined the big players in the accounting industry. Arthur Andersen disappeared under the weight of a Justice Department investigation.
The process of reviewing whether ratings agencies Moody’s (MCO), Standard & Poor’s, and Fitch did what they should not have done has begun. The SEC and the states attorneys general in NY and Ohio have begun to make the rounds. It will not end there.
The smoking gun is that, as The Wall Street Journal writes, that "from 2003 to 2006, the growth in the mortgage market helped Moody’s stock price triple, while its profit climbed 27% a year on average" The volume of coverage at the companies drives revenue and profits.If a company gives one of the agencies more revenue, do it favor that company with better ratings?
Greed being part of human nature as it is and with subpoenaed documents heading to legal enforcement officials in the government, the Vegas odds have to be that something turns up.
The sub-prime debacle needs a scape goat or two. Billions of dollars are likely to be lost, Investors want to know why there were no storm flags up until it was too late. How could Moody’s and its competitors have gotten it so wrong?
Moody’s began rating railroad debt over 100 years ago, but it is not a big company. It has less than $400 million in cash which is offset by $410 million in borrowing under a revolving credit facility.
It is not impossible to imagine that there will be liability suits against the ratings agencies. It could badly damage a small industry with only three real players.
So, the question becomes what if one or more of the companies fails? Who rates that bonds then? What happens to credit markets if outside advice on risk is lost?
Creating new credit rating firms overnight would be nearly impossible.
The problem is potentially a very big one, and it has no ready solution.
Douglas A. McIntyre