The investment ratings business is like any other. You please your customer and treat them like a king or else you’ll lose them to your competition. Why would it be any different for a rating agency? It isn’t, which answers the question as to why S&P, Moody’s, Fitch, and other analysts missed the top of the Real Estate Bubble. It didn’t make business sense for them. Simple as that. A rating agency isn’t there for the benefit of those that do not provide them with a revenue stream, just like a Real Estate Agent isn’t there for your benefit but for the commission. There’s no difference between a used Car Salesman, a stock broker or a rating agency. They are all there to sell you something while making a profit in the process. It’s naive and financially ignorant to think that any professional investment advice you receive is there for your benefit, especially when you don’t pay for it. And don’t be fooled thinking that as a small client you receive valuable advice for your money from a stock broker.
An upgrade for a stock often results in increased demand for that security and provides the big player with an excellent exit strategy. When a company or city pays an investment rating agency to review its debt product the buyer of the rating expects a good review in return. The paid for review is a business cost which allows the city to sell more debt and at a better annual return. If the rating agency fails to put a positive spin on the review the buyer of the review will seek out a competitor that gets the job done. WTF Finance already illustrated the ratings politics between Warren Buffett’s Bershire Hathaway and Moody’s.
Today’s article in the LA Times highlights the game of rating politics:
“After its downgrade of U.S. debt last week, S&P cut its rating of L.A.’s general investment pool to AA from AAA. It also downgraded dozens of other municipalities with large investments in U.S. Treasury notes.”
Los Angeles stops using S&P
In response to the downgrade, which according to WTF Finance is still too optimistic, Intermim Los Angeles Treasurer Steve Ongele who was just appointed by Mayor Villaraigosa states that “We have really lost faith in S&P’s judgment”. San Mateo County of California and Florida’s Manatee County both opted to no longer renew their investment rating review contracts with S&P. Steve Ongele was also quoted stating that
“The market crash that came with the real estate debacle, it happened because folks like S&P rated AAA corporations that were not worth much of anything, corporations that are no longer there today…The fact that we have the courage to do this, the fact that we are the first city, I think that’s a big bragging right.”
This perfectly illustrates that companies and governments buy their reviews only from those ratings agencies who give favorable ratings. Overrating Real Estate companies was a problem but when your city is downgraded you opt to no longer renew the rating review contracts. How convenient and hypocritical of Los Angeles. The ratings process is a business after all and pleasing your customer is as important and essential for the bottom line as in any other sector.