Expert word

Remember Arthur Andersen

Weather men never make mistakes:
They simply mix up the time and place.

For simplicity’s sake one can say that rating agencies exist to predict defaults. Therefore it is possible to judge the quality of their work based on bankruptcy statistics. If every company pays its debts, if the market is in full order and there are no defaults and delays in payments, then what difference does it make what credit rating a company has?

The main reason for the existence of credit ratings and their rating agencies lies in the imperfection of our world which can easily turn a prosperous company or one that appears to be, into a bankrupt by triggering external shocks and internal problems. The job of such agencies is to provide accurate predictions about the probability of a default as reliably and objectively as possible.

The American hypothecary crisis has become a serious strength test for major rating agencies. Many believe that the latter are much to blame for starting off the crisis. Why?

At the beginning of the hypothecary boom in the USA one of its largest agencies determined in its methods that a default in combined credit (when in addition to a mortgage a borrower takes another loan to refinance his down payment) is no more probable than that in ordinary mortgage credit. Besides, the risks of the mortgage market and all other relevant securities were not considered to be high, even when the market did become overheated and the rates began to grow following the FRS discount rate rise.

The specifics of rating tranches during securitization (when the least risky tranches were given top ratings) do not help to decrease risks, either. The matter is that unlike classical rating (when an emitter or a company passes all relevant data to an independent agency and that agency should in turn provide an objective assessment of its credit status) , rating agencies become involved in the process as advisers from the very beginning of securitization rating. They in fact form and structure transactions in order to optimize the rating level and the cost of transactions.

And this is fraught with a clash of interests; the Enron case set off a wide wave of debates about auditors. Can auditors simultaneously act as advisers on reporting and account? Does it result in a conflict of interests? This question is highly controversial at present. However, no one will argue that under the circumstances both sides benefit from an excellent auditor conclusion and top ratings alike.

The European Union has announced its plans to investigate the activities of rating agencies to find out whether they provide adequate risk estimates. The EuroCommission for the Internal Markets will be headed by Charlie McCreevy whose job will be to check the management of agencies for a possible conflict of interests. The process now under way is fraught as it questions the very format of major US rating agencies’ business and the objectivity of their assessments.

Remember what happened to Arthur Andersen?