Credit rating agencies strive to restore image

New York: A year after the global credit crisis erupted, credit rating agencies still face a long process of restoring reputations and profits that took a century to build.

In 1909, a young entrepreneur named John Moody published a manual of railroad securities and assigned a letter grade to measure the risk of each bond, a major innovation at the time.

The idea was a hit, and Moody and his company established a name in the market for accurately assessing and measuring risk.

Moody's system became a force in the financial world, challenged later by rivals Poor's Publishing Co in 1919 and Standard Statistics Co in 1922, which devised slightly different grading scales. John Knowles Fitch entered the scene in 1924. The modern ratings business was born - and boomed.

Today the reputations of Moody's Moody's Investors Service, McGraw-Hill's Standard & Poor's and Fimalac's Fitch Ratings are in question because they expanded too fast into rating "structured finance debt", including instruments such as collateralised debt obligations (CDOs).

Those complex debt instruments helped fuel huge profits for banks and investors during the US housing boom between 2001 and 2007, but then saw their value implode over the past year as US home prices dropped, costing banks and investors billions of dollars in losses.

Since August 2007, Moody's shares have plummeted 32 per cent and McGraw-Hill shares lost 27 per cent of their value, leading to the departure of top executives, including the head of Moody's structured finance unit last month. Fimalac shares have fallen 26 per cent.

And billions of dollars worth of "AAA" grades have since fallen to junk bond status of "CCC" or lower, and come to symbolise something else entirely than investment grade.

"The 'Scarlet Letter syndrome' is what we're concerned about, first and foremost," Deborah Cunningham, chief investment officer at Federated Investors, said recently, referring to an American novel about a woman named Hester Prynne, who was forced to wear a scarlet letter "A", a public badge of shame for committing adultery.

Prime target

Rating companies today are the Hester Prynne of finance, the target of regulators and investors alike, scorned for assigning top ratings to CDOs that sparked a massive increase in mortgage-related debt.

Cunningham co-chairs a task force of the Securities Industry and Financial Markets Association, which issued a report last week that questioned the "quality" and "integrity" of the ratings process.

David Weinfurter, a Fitch managing director, said Fitch generally supports SIFMA's most recent report, which he said echoed earlier reports. However, one SIFMA proposal for a global advisory body seemed "unnecessary" since there are already similar groups, he said.

Other executives including Deven Sharma, president of S&P, and Stephen Joynt, president and CEO of Fitch, have said they back the general findings of similar recommendations.

Sharma said in June that financial firms will likely face earnings pressure over the next year, impacting all rating companies' business.

By some measures, the risks associated with the three main rating companies may be tantamount to a $1 trillion bomb blowing up global financial institutions' balance sheets.

Investors and world fin-ancial markets discovered the breadth of rating firms' power over this past year, in which the misaligned ratings contributed to the wiping out of more than $400 billion of value for global financial institutions. Some analysts' estimates, including the International Monetary Fund, top $1 trillion in damage before the crisis is over.

"Yes, the rating agencies made mistakes, but Wall Street bought these bonds and no one stuck a gun to their head," said Andrew Harding, who oversees about $20 billion as chief investment officer at Allegiant Asset Management in Cleveland. "There's plenty of blame to go around."

Harding said rating companies earnings may take at least a year to recover.

"They will recover from this, but they will suffer some revenue consequences," Harding said. "Their credibility is certainly shaken, but they still have reasonable credibility outside of structured finance."