For mostly good reasons, the rating agencies have become a favorite whipping boy. One complaint it that they are typically slow to downgrade because they don’t want to tarnish an issuer by being early.
The latest credits that appear to be looking weaker than their ratings are the monoline insurers, whose business depends on them marinating their AAA ratings. The rating agencies have been criticized for being too soft on these guarantors, yet as Gillian Tett of the Financial Times points out, a downgrade of the monoline insurers would have nasty knock-on effects. As she describes, Fitch is trying to finesse a no-win situation.
From the Financial Times:
A couple of days ago, the Financial Times received a furious complaint from Fitch, the credit ratings group. The reason? The FT recently wrote that Fitch had placed the ratings of monoline insurers on “watch” for possible downgrade…. Fitch hotly objected to FT’s use of the word “watch”…..to my mind this hair-splitting illustrates a bigger point: namely just how sensitive – if not, paranoid – the ratings agencies have become these days….
In recent weeks, the share prices of monolines, such as Ambac, have plunged on speculation that their ratings are about to be cut. For these monolines have guaranteed swathes of structured products in recent years, and …. they typically have very small capital bases.
However, the problem that dogs the ratings agencies is that if they downgrade the monolines, this could spark a much wider chain reaction…..
Moreover, a downgrade of the monolines would mean that all the bonds they have guaranteed would be downgraded too. And that does not just affect subprime securities, but swathes of the municipal bond market as well – which in turn could hurt mainstream US investors (such as pension funds), and borrowers (such as schools or hospitals).
This is the stuff of Washington nightmares. But the US Treasury cannot afford to be seen to be pleading with the rating agencies to go softly on these monolines right now….. Thus, in a sense, the agencies are now damned whatever they do: if they tip the muni market over the edge, they could become a political whipping boy; but if they fail to act, they will face more criticism for being too lax…
Is there any solution to this tangled mess? Fitch, for its part, is bravely trying to forge one: it indicated earlier this week that it will give the monolines a period of time in which they can raise fresh capital to avoid downgrades, if its review shows that they do not have enough capital to warrant a top-notch rating (not a courtesy it always extends to ordinary issuers).
But it remains unclear if this tactic will quell investor unease. After all, what this saga shows with painful clarity is the degree to which this decade’s wild credit party has been built on a complex set of interlocking financial flows and practices, that have often been dangerously circular in nature.
Many of these interactions have been roundly ignored recently. But what they mean is that if one key component of the current financial edifice is badly damaged, there is a real risk that other parts will come tumbling down.