Three articles over the past week regarding S&P and Moody’s have caught my attention:
- Justice Department To Probe Moody’s Over Rosy Credit Rating
- S&P paying $1.4B over crisis-era ratings
- Standard & Poor’s Settlement Shows Futility Of Fighting Government Policy
All three reflect something I have been saying for years to my finance classes: don’t trust ratings companies, especially when they are paid by the firm receiving the rating. When discussing bond ratings in class I pose the question: “Did Moody’s acquire KMV to improve the accuracy and timeliness of their ratings or to shut KMV up?”
Lets look at a little history. Moody’s acquired KMV in 2002 after the Enron scandal. KMV’s analytics could inform investors of upcoming implosions (increased default probability). That was 2002. Now fast forward to 2008. KMV is now part of Moody’s. Where is the warning of the upcoming mortgage implosion? Buried in the company that assigned misleading ratings to soon-to-implode toxic mortgage backed securities.
The three articles referenced above point out that the chickens have come home to roost. They also point out that one must do their own research. KMV’s approach of computing bond default probabilities based on option and stock prices is published in academic textbooks, including my own. (how’s that for a plug?)
Be mindful my friends.