What's Really on the Line Because of Credit Agency Debacles? And how is fashion affected?
By Joan R. Magee
Admittedly, we're going through a paradigm shift in this country. The separation of private enterprise and government, much like the separation of church and state, was something adhered to for the most part since our dawn days.
Until now.
Washington and the private sector have an increasingly symbiotic relationship, as the Feds are soliciting advice from and working closely with the private sector to tackle the a major problem: the big three credit rating agencies. S&P, Fitch and Moody's have been under the gun over the past months, and subject to relentless governmental scrutiny for what can be seen as questionable ratings practices.
Government agencies and quasi-governmental agencies are looking to those outside the old boy's club to figure out how to fix a major contributing problem in what is the worst financial crisis America has encountered in decades.
"The financial markets to make up their own minds as to who are trustworthy sources of information on the creditworthiness of bonds and bond issuers," Lawrence White, the head of the Economics Department at New York University's Stern School of Business. "This would be in contrast to current and past policies, stretching back to the 1930s, in which financial regulators have forced the financial markets to pay attention to a select few credit rating agencies. It should come as no big surprise that when the sellers in the market (in this case, the market for bond information) are few and are protected, they may grow a bit lazy and careless."
Subsequently, the major flaw with the ratings of senior tranches of subprime CDOs was that the instruments were fundamentally different in kind from corporate bonds and similar instruments to which such ratings have been applied for almost a century. For one thing, the probability of failure to make all payments of interest and principal on a timely basis was essentially tied to the degree of subordination for a tranche.
Since the underlying assets had a high mean default rate, such subordination was subject to constant expected erosion, according to David Rowe, VP of Risk Management at SunGard. This is quite in contrast to a corporate bond where many companies maintain stable ratings for years based on their continuing success in the marketplace, he added.
"This change of policy could still be consistent with the goals of financial regulation, which have been to require that regulated institutions (banks, insurance companies, pension funds, broker-dealers, money market mutual funds, etc.) have only safe bonds in their portfolios," White said.
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