Bank creditworthiness: we don’ wanna know
If someone offered you free additional information that might be relevant to a critical financial decision, wouldn’t you want it?
You don’t want to know what I’m thinking
Say you were a global institutional investor planning to buy securities issued by a major bank in a foreign country. Similarly, if you were thinking of investing in a country, you might want to know how sound its credit system was, and whether the central bank or monetary policy could stabilize a period of market jitters. Either way, it would be relevant to you to know how the bank stands vis-a-vis its government, and whether the government might be predisposed to assisting the bank through a liquidity patch.
Might you want to know, in addition to the bank’s own inherent risk, whether it stood any chance of being aided by its central bank?
Which financial firms might end up in the government’s lap, were the worst to happen? Moody’s, a rating agency, has started to ponder this question in earnest. It is rolling out a new way of rating big banks, the backbone of any economy, that takes into account their chances of being bailed out by the state if push ever came to shove.
Yet when Moody’s announced its new joint-default analysis (JDA; free registration required), it was greeted not with applause but with catcalls.
I think they didn’t like it
As the Economist noted with its characteristic dryness:
Many European banks can count on the state’s graces, Moody’s reckons.
Reaction to Moody’s innovation has been scathing. CreditSights, a research outfit, called its report “Moody’s Makes Aaas of Itself”.
Triple-aaaaaaaass!
That CreditSights competes with Moody’s in providing information to this marketplace has nothing to do with its view on this matter … does it?
The ratings “add no value,” says Simon Adamson, the report’s author, because investors already factor in the chances of a bail-out.
Adamson cannot believe how little value the ratings add
Mr. Adamson cannot possibly be correct. Unless it is pure random noise, additional information always has a value, for several reasons:
The more we know, the more we want to play too
· If ‘investors already know,’ that means some investors already know. Those who do not can get in on the game, strengthening markets.
· Making an evaluation algorithmic creates an ‘expert system’ structural approach. Because human beings are fallible, expert systems are better predictors, less likely to let their emotions sway their perceptions.
A better methodological criticism, if it proves valid, is offered by another doubter:
Tom Jenkins of Royal Bank of Scotland thinks Moody’s has “completely missed the point” of bank debt ratings. Investors use them not only to measure the likelihood of a bank’s collapse, which might prompt a government rescue, but also to gauge the risk of milder discomfort, such as late payment on a bank’s debts.
A rating that is misinterpreted, or compiled using metrics irrelevant to the risk it is measuring, is liable to misuse.
Moody’s retorts that the new ratings are meant to complement its traditional measures, not to replace them. But judging by the response of money managers, two metrics may be one too many.
Finally, there’s a pragmatic objection to the ratings: they produce nonsense results and after the ratings came out, as noted by Bloomberg, several major institutions blew loud raspberries at Moody’s for its ratings of three apparently rickety Icelandic banks:
Here’s what I think of the Icelandic bank ratings
Moody’s came under fire after it raised the grades of the three biggest Icelandic banks to the highest Aaa rating, the same as the U.S. Treasury. Merrill analyst Richard Thomas called the ratings “perverse.’
That’s for your ratings
Royal Bank of
“The market will be stupefied,’ Tom Jenkins, an analyst at Royal Bank of Scotland in London, said in an interview after publishing a note titled “Moody’s Lose The Plot Completely’ earlier today. “Creating Aaa rated banks across the board essentially means that there is no risk in investing in financials, and that buying a senior Kaupthing bond, for example, is effectively risk-free. It isn’t.’
It’s not risk free? Dang!
This is, in technical terms, a major oopsie. As Groucho Marx put it, “Who are you going to believe, me or your own eyes?“
With eyebrows like these, I must be trustworthy
The top Aaa scores Moody’s assigned Kaupthing Bank hf, Glitnir Banki hf and Landsbanki Islands hf, Iceland’s three biggest banks, are at odds with the judgment of bondholders, who demand five times higher yield premiums to lend to them than to ABN Amro Bank NV, which has a lower Aa1 ranking.
Markets are imperfect, but they can’t be that wrong. Moody’s has a lot of egg on its face.
I thought we were prepared for this
“The pause is designed to pull back some of the more egregious of the outcomes,’ said Thomas at Merrill in
That’s material as well — if one is introducing a new and improved tool, you must either be right or transparent. If you’re both opaque and wrong, you look a pompous fool. When that happens, a climbdown is in order:
This will take a while
In the way in which Moody’s initially applied its new methodology, “some rating outcomes were heavily dependent on high external support assumptions,’ Chris Mahoney, chairman of Moody’s credit policy committee, said in today’s [
Here’s the point the critics missed: you can’t beat something with nothing. Moody’s ventured into an undefined space and gave it some definition. Its first shot was wide off the mark, but the howls of protest enable it to triangulate toward the azimuth.
Zut, alors! I sink we meesed!
Data, once published, only gets better. Even if Moody’s has taken a knock, it will shake off the boo-boo, and in the process the market will gain knowledge advantage:
We’ll be better for this experience
Moody’s plans to release “adjustments’ to ratings for the banks it has reviewed under the new criteria by April 10.
“They’re going back to where they started,’ said John Raymond, a London-based analyst at CreditSights Inc.
Mr. Raymond is entitled to his sense of vindication, for his opening salvo was loud, unequivocal, and right.
“They’re buying time. They look better doing this than if they’d come out with all the answers now.’
Expanding transparency will improve the metric’s utility. So will fixing the bugs:
Maybe we should use more experienced analysts
Moody’s Investors Service may reverse credit-rating upgrades it gave banks less than a month ago following criticism from Merrill Lynch & Co., JPMorgan Chase & Co. and Royal Bank of Scotland Group Plc.
Our credibility heading that way too
