Last week, the credit rating feud between Standard & Poor's Financial Services LLC and the Chinese firm Dagong Global Credit Rating Co. Ltd - which Money Morning Contributing Editor Martin Hutchinson examined late last month - heated up.
Harold "Terry" McGraw III, chairman and chief executive of S&P said that companies like Dagong joined up with politicians and other countries to unfairly attack U.S. ratings firms.
"If you're in a populist mood, you've got to find the villain," McGraw told the Financial Times in an interview in Beijing.
McGraw referred to comments made to the Financial Times in July by Guan Jianzhong, the chairman of Dagong.
"The western rating agencies are politicized and highly ideological and they do not adhere to objective standards," he said. "China is the biggest creditor nation in the world and with the rise and national rejuvenation of China we should have our say in how the credit risks of states are judged."
While some politicians have called the U.S. credit rating business a "bone-chilling definition of corruption," McGraw states that the big three firms of S&P, Moody's Corp. (NYSE: MCO) and Fitch Ratings made honest mistakes. Many regulators and industry experts say "rating shopping" - where companies offer business to the firm that provides the most favorable rating - is a huge problem in the United States and encouraged the firms to supply better ratings than companies deserved.
Dagong released a sovereign credit ranking report in July that drastically differed from ratings from U.S. companies. Guan said his company's methodology was much more objective and more accurate than others.
"The U.S. is insolvent and faces bankruptcy as a pure debtor nation but the rating agencies still give it high rankings," Guan said. "Actually, the huge military expenditure of the U.S. is not created by themselves but comes from borrowed money, which is not sustainable."
McGraw claims that the "technical mistakes" made by his and other agencies shouldn't lead to the industry's downfall but instead will make them stronger, more competitive companies.
"Look at the accounting industry in the immediate post-Enron period - today it is as strong if not stronger than it ever was," said McGraw.
Hutchinson said the assumption that the ratings agencies were "seduced by the issuers into issuing misleading ratings" is not correct - and regulation reform that tries to fix it won't work.
"There has been no great epidemic of mis-rated corporate debt defaults," Hutchinson said. "The rating agencies simply did not understand the characteristics of what they were rating in the securitization area - they were stupid rather than venal."
While Dagong and U.S. firms continue to take jabs at each other's business, Hutchinson said the future of the U.S. ratings game could hurt consumers looking to borrow.
"The most likely outcome will be for the rating agencies to continue to rate securitizations, but very cautiously. In that case, mortgages, auto loans and credit cards will be more difficult to get, but not impossible, and the junk issued during the bubble of 2002-07 will not reappear. On balance - given the tendency of the U.S. consumer to take on too much debt - this could be a very good thing. For investors who buy bonds, credit ratings in 2011 may be somewhat more conservative than they have been. So a 2011 'AA' may be equivalent to a 2010 'AAA.' For investors who as consumers want a mortgage, credit cards or an auto loan, the future does not appear so bright."
Here is what readers had to say about the new landscape of credit rating.
Right on the money, Martin. Gee I can't understand why the Chinese would doubt us. It's not like we have a Federal Reserve that refuses to be audited, or a tax dodger running the U.S. Treasury, or a president who rifled the taxpayer till for trillions to bail out those who funded his election campaign.
Regarding your closing comments maybe a new reality TV show can be hatched from watching the Chinese government make U.S. trial lawyers walk the plank. Literally I hope.
- Moran
I say before you make an investment, analyze your potential debtor thoroughly, and if in doubt refrain from putting your money into his pocket. I know that litigation is possible: one of the most flourishing industries in the U.S., but not really productive. I prefer taking my positions after listening to qualified people like Martin, and then take my responsibilities.
- Werner S.
So China is going into the credit rating business. It's about time that investors got a fresh look at potential investments. Wasn't it the top credit rating companies in the U.S. that pronounced 'derivatives' and 'credit default swaps' to be AAA investments? And wasn't it the same people that were selling this straw that paid for the rating service? Madoff the Ponzi schemer is a lamb compared to the Wall St. terrorists.
By being fickle, our institutions and values are becoming irrelevant and in time will be replaced by others from China, India, and anyone else that can fill the shelves at Walmart and Target.
- Roman
In my opinion rating agencies should be part of the Federal Reserve and central banks of each country or any other government-run agency, or force each company and each financial product to be rated by all rating agencies (not just one, as we could be under a rating price war or worse yet, quality rating strategy to attract more customers).
- Carles
The fact is too little regulation is as bad as too much regulation. As our grandparents said: everything in moderation. Unfortunately, we have become a world of extremists (in all things).
- James
(**) Money Morning editors reserve the right to edit responses for grammar, length and clarity when posting on our Web site. Please include your name and hometown with your email.
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