Research Roundup: Moody’s Structured Finance Proposals
Reaction to Moody’s proposals to revamp its ratings criteria for structured finance has been skeptical, to say the least.
One of Moody’s proposals for consideration – putting special risk warnings on these instruments – was compared by Paul Kedrosky of Infectious Greed to the warnings on cigarette packs, while Doug McIntyre of 24/7 Wall Street described the proposals as a sham:
The move is window dressing of the worst sort. The entire purpose behind Moody’s, S&P, and Fitch is that they have the skills to assess risk in advance, or, at the very least, will not give strong ratings to debt which is likely to be inherently volatile.
Comments on Floyd Norris’s column on the topic in the New York Times run the gamut from “A unique scale for structured securities is a good idea,” to “This is ridiculous and unbelievably outrageous. ” While the responses include the usual quota of vitriolic rants, many of them offer thoughtful and constructive feedback.
One theme that emerges is that the ratings methodology is less of an issue than the fundamental business model of the ratings agencies. Minyanville sums up the view of many: “As long as ratings agencies are paid by the issuers of securities rather than investors, they will be financially motivated to hand out generous ratings.”
No amount of new labeling, fancy packaging or legal ruses can disguise the fact that in the for-profit business of rating debt, business is awarded to the firm that provides the best ratings.
On a practical level, UsableMarkets suggests that Moody’s proposal for 21 number grades is too complicated:
The problem with Moody’s new bond rating system is not that “complex debt securities” don’t deserve a new rating system, but rather that the number system they propose is so un-intuitive. Here’s hoping their next proposal is more so.
For its part, CreditSights does not agree with Moody’s that structured finance risks are more difficult to assess:
In fact, the granularity and sheer size of the default record in most of the major structured product collateral classes suggests that expected loss estimates could be even more accurate in some securitized securities than in some non-securitized securities.
Further, in Moody’s Request for Comments – Request for Aaabsolution?, CreditSights questions whether Moody’s is serious about following through: “We would caution, though, that Moody’s has issued requests for comments on major overhauls in their approach in the past, only to back down when the market’s comments effectively reinforced their original approach.”
We would not be surprised to see market reaction to these proposals as mostly negative, which in turn could help to reinforce the ratings agencies’ original claims to comparability across asset classes.
On the theory behind that claim – that expected loss can be estimated in many structured finance sectors just as well as in non-structured securities – we would not disagree, CreditSights says. “That does not absolve the ratings agencies, however, of the need to embark on a wholesale revision of many of its structured credit ratings methodologies.”
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