These behemoths, whose word is almost holy to bond investors, grossly overrated bundled mortgages (CMO’s) and other questionable products. They checked their integrity at the door in order to invite in more business, and they have never regained their prior creditability and reliance. That is, until now. Over the last few months, rating agencies have taken on the world in order to rebuild their creditability. First, S&P downgraded US Treasuries below AAA, an almost unthinkable action in years past. President Obama did everything possible to discourage this action, as did Secretary Geithner. Yet S&P took on “the man”, and did the downgrade. The ratings agencies also downgraded France below AAA, and downgraded a number of other European countries and banks. Many American banks have also been downgraded. In sum, downgrades have been about as common as high priced commercials in the Super Bowl. One security downgraded with impunity has been the bundled CMO’s. Some CMO’s rated AAA on 2008 are now rated CCC or lower. Various other securities have been equally harshly downgraded. Indeed, the ratings agencies seem to have drunk the cool aid. They have a new morality in trying to accurately rate fixed income investments. More importantly, this new morality will play a major role as the current Greek tragedy enters its final act.
Here’s where Greece’s private bondholders stand now: A deal is on the table where they would take a 70% haircut by exchanging their old bonds for new ones. If all bondholders agree to this deal, there will not be a “default” on Greek government bonds. However, if some bondholders do not agree to the deal, they will likely be forced into it by Greek legislative action or otherwise. This forced action could well be deemed a “default” on the bonds. As such, it would give effect to credit default swaps written on the Greek bonds. And once this occurs, nobody can accurately predict the interbank and other ramifications that could possibly threaten the world financial system. That’s why it is important for there NOT to be a default. Moreover, whether the ratings agencies call a certain event a default will largely determine whether a default has indeed occurred. That’s why the ratings agencies are incredibly crucial players in this Grecian drama. It will be very interesting to watch how the ratings agencies play the cards they have been dealt. Will they objectively call a default by its name. Or will they play financial shenanigans, like they did in 2008. Clearly, Prime Ministers, Finance Ministers, Presidents, and Central Bankers will come up with hundreds of complex reasons why there has been no default. But a Duck by any other name is still a Duck. In my opinion, the ratings agencies will conclude that there has been a Greek default. They will be objective and correct. They will not do so because of ethics or morals. They will do so in the best interest of their businesses. Ratings agencies deal in creditability. It is their stock in trade. Once gone, it is very tough to regain. Moreover, once gone completely, these companies have nothing left to sell to their customers. That is why S&P downgraded US Treasuries. They made one grand gesture to reclaim their creditability. In my opinion, they and the other agencies will continue down this road. They will not call a default a daisy or a bluebird or a polar bear with feathers. A default is a default and they will call one when they see one.
As indicated above, such an action could wreck havoc with credit default swaps, but Dr. Helicopter Bernanke and his fellow central bankers will know it is coming. They will do LTRO II or QE 3.789. They will allow the world economy to shake a bit, but not to freefall. They are far smarter than I am. They know a “default” is coming and they hopefully have a plan already in place to deal with it. All of which will hopefully lead to a brighter financial environment in the future. The world needs highly respected, creditable ratings agencies. We need ratings that fixed income investors can rely on. It is far better to live in a world where US Treasuries are AA+ (and this rating can be relied on), than in a world where private bankers and central bankers manipulate the ratings agencies, so that CCC CMO’s are rated AAA, and the ratings are about as useful as high heel shoes on an elephant. The world will survive the Greek crisis. And hopefully we will have involved creditable, reliable, honest rating agencies who will never repeat their mistakes of 2008.
By Floyd at KOTM follow me on Twitter @ USKOTM