According to an article on Bloomberg today:
Moody’s Investors Service has created a new unit that surprises even its own director.
The team from Moody’s Analytics, which operates separately from Moody’s ratings division, uses credit-default swap prices as an alternative system of grading debt. These so-called implied ratings often differ significantly from Moody’s official grades.
The implied ratings frequently show that swap traders think debt is in more danger of defaulting than Moody’s credit ratings signify. And here’s the kicker: The swaps traders are usually right.
In fact, by their own admission, the track record of Moody’s is downright abysmal:
[The new unit’s managing director, David] Munves says that over one year, the implied ratings have been a more accurate predictor of defaults than Moody’s ratings. The Moody’s unit reports that implied ratings for one year have a 91 percent accuracy ratio compared with an 82 percent ratio for Moody’s official ratings.
In other words, the failure rate of the Moody’s rating service (which generated $2.3 billion in revenue last year and justified the building of a new headquarters in lower Manhattan) was 18% vs. 9% for the market. As noted short seller Jim Chanos remarked last July:
It’s a great business model as long as you can get people to pay for it. If they have no predictive power over that which they’re rating, then why bother?
Of course, the credit ratings business is no product of the free market, but a government sanctioned and protected oligopoly. In fact the valuable “NRSRO” status (Nationally Recognized Statistical Rating Organization) is conferred by none other than the SEC, another worthless gatekeeper and brainchild of the state.
As Chanos noted in a WSJ op-ed exactly two years ago, these lessons could have been learned by anyone paying close attention to the Enron implosion:
Time and again, when confronted with negative financial “surprises” by corporate issuers during the last decade, the “independent” ratings agencies fell down on the job. This kept slow-on-the-uptake investors dancing on the decks of numerous financial Titanics, while those heeding other signals (such as the burgeoning market for credit-default derivatives) prepared to man the lifeboats.
Whether it was the hubris of not wanting to precipitate a run on the bank (as if it wasn’t happening already!), or the incompetence of one ratings agency analyst admitting to not having read the company’s SEC filings, the shortcomings of an analyst-based ratings agency system became apparent in the Enron fiasco. Market-based price-discovery agents, such as short sellers in the equity market and purchasers of credit-default insurance in the bond/derivative markets, supplanted the Big Three ratings agencies as accurate predictors of Enron’s financial distress.
As philosopher George Santayana famously wrote in 1905, “Those who cannot remember the past are condemned to repeat it.”