Wednesday, March 05, 2014

S&P Ratings Business Under Fire From Australia

S&P just can't catch a break.  They came under the US Department of Justice's scrutiny while competitor Moody's escaped attention.  Now an Australian judge has found S&P liable for the ratings it gave to poor investments.  More rulings like this in the developed economies will make rating complex securities almost impossible due to liability exposure.  I say "almost" because a ratings agency will have to place such severe limits on its assessments as to make a firm opinion meaningless.

The old principle of caveat emptor is slowly succumbing to a culture of settling scores.  Investments are risky and more complicated investments carry more risk.  Whatever hides inside all of the moving parts of derivatives can blow up the whole instrument.  Sophisticated investors should know this but they feign ignorance when they think litigation can compensate them for bad judgment.  The courts should be a remedy for fraud, not stupidity.

I have no sympathy for investment banks who knowingly package garbage into an security and misrepresent it as a good deal.  Those people are liars and phonies.  The prevalence of such behavior on Wall Street's sell side should be sufficient warning to institutional investors that complex derivatives are at best unnecessary and at worst a disaster waiting to happen.  Ratings have always been mere icing on the cake.  The cake itself has always been of questionable nutritional value.

McGraw Hill Financial (MHFI) doesn't have to throw away S&P just yet.  The unit's index services are a very important brand in the financial sector.  Capital IQ is indispensable to countless traders and analysts, until of course something with deeper Big Data analytics comes along.  Potentially mortal wounds to credit rating services don't have to destroy an entire enterprise.

Nota bene:  Alfidi Capital does not rate derivatives.  If the Alfidi Capital Blog or research reports describe a stock, bond, or other security, such a description is always in the context of what I do with my own money.  In other words, my opinions are only useful for my own decisions and not for anyone else's situation.