ARE RATING AGENCIES ‘JUNK’ TOO?

Within 45 days, rating agencies downgraded IL&FS from an investment grade to junk!

And it ignored loud and blaring warning signals like the highly leveraged balance sheet which was in front of it for over a year, its inability to raise capital, struggling finances. How come all these signs were completely missed by the rating agencies and what it looked only at was the delay in interest payment?

Again, in a hurry to set its mistake of overlooking the earlier signs, the ‘junk’ rating was conferred on the company in complete urgency.

This brings to fore the question all over again – should we as investors ever rely on rating agencies?

Have we all forgotten the role played by the rating agencies in 2008 collapse? All over the world, people had questioned the integrity of these three and the big question which dogged all was – how could they have granted triple A ratings to mortgage based financial securities even when the housing markets had collapsed? It was crystal clear to all that these rating agencies had misrepresented the true credit risk, keeping their own selfish interests in mind. Otherwise how do these agencies explain the fact that all these “Triple A” rated issues were in default within a year of this rating? At that time itself, it was clear that these rating agencies were actually at the heart of this entire financial collapse. But over a period of time, people got busy trying to save their homes and jobs and this got buried deep. But the hurt and mistrust which these rating agencies had created just refused to go.

Rating agencies are like up there on a pedestal; no one dare touch them. And they have been taking umbrage in the fact that these ratings were “opinions” and it was all about freedom of expression and this defense for so many years could just not be pulled down. But the very logic of these rating agencies work comes into question. How do these rating agencies rate products designed by the very banks from which it gets get paid? Isn’t that a major conflict of interest? Even though the rating agencies vouched for “objectivity” it obviously looks like it lost its very objective.  It was but obviously working for banks which they helped give good ratings for bad products. Competition was so intense, if S&P did not do it, Moody’s would it or Fitch would do it. So the fear of losing business was so high that most agreed to do things which were totally against the very grain of their business. In fact the Department of Justice, while prosecuting S&P has quoted several emails showing how S&P fretted about losing business to Moody's.

And to think that we Indians and the Indian Govt is worried about what S&P and Moody’s or Fitch say?  But the good part here in India is that at least that fear of “international image” gets the Govt working. Yes, any analyst who signed off junk as AAA securities needs to be prosecuted unless he can prove that they took all reasonable steps to confirm their rating.

At the same time, it is equally important for SEBI to step in and punish companies which do not furnish information to rating agencies, keeping them in the dark most often.

Having said all this, the truth is that the safety of money is the primary responsibility of lender or investor. All other agencies are simply working for a fee be it rating agency, valuers, advocates, brokers, chartered accountants or advisors – all are simply intermediaries.