On Friday, July 11, the pandemonium surrounding Fannie Mae and Freddie Mac’s fall from financial grace prompted some panic-stricken citizens to ask the most dreaded of all questions: If the U.S. government is forced to bailout the flailing mortgage giants, will the leader of the free world lose its coveted AAA status?
To which leading ratings service Moody’s Inc. responded -- fat chance. In their professional opinion: “Even under a real stress scenario, US debt is well within the guidelines for the top credit rating…”
Since when do those three little letters guarantee a first-class seat on the Fail-Safe Express? The truth of the matter is: as a shield against decline and further downgrade, top ratings are as effective as a hard hat in an avalanche.
The first date that comes to mind here is November 30, 2001. The world’s largest marketer of natural gas and electricity has gone from cash cow to dry bone. Its share price has plummeted 99% ($90 peak to under $1), with an estimated $68 billion loss. Once “America’s Most Innovative Company,” it is now America’s most insolvent one. YET -- the company continues to enjoy an “INVESTMENT GRADE” rating.
The company’s name was Enron. Four days later it filed for the largest bankruptcy in U.S. history. That, dear readers, isn’t missing the boat. That’s staying ON the boat, as in the Titanic steaming into a giant iceberg.
AAA Does NOT Spell “S-A-F-E” -- In his 2002 book Conquer the Crash, Elliott Wave International's Bob Prechter revealed the danger in judging a company by its rating cover. Learn all of CTC’s myth-busting insights today with your very own copy.
In Bob's own words:
“The most widely utilized rating services are almost always woefully late in warning of problems within financial institutions. They often seem to get news about a company around the time that everyone else does…. In several cases, a company can collapse before the standard rating services know what hit it.”
Enron may seem like a distant memory, but what about the world’s two largest monoline insurers Ambac and MBIA? Since the start of 2007, deep and obvious cracks such as slipping share prices, billions of dollars in write downs, and underperformance began to appear in the foundation of both companies.
Yet even as the subprime mortgage industry imploded (in March 2007), and even as the stock values of both Ambac and MBIA were slashed in half (in November 2007), Moody’s ratings service continued to uphold the insurers’ Aaa status. In the words of one December 2007 Bloomberg: “The reaffirmation of Ambac’s Aaa rating should be a big positive for the shares.”
Our analysts refused to wear the rose-colored glasses. First, the March 2007 Elliott Wave Financial Forecast alerted readers to the “extension” of the subprime debacle across the “depth and breadth” of the credit universe and wrote: “Ultimately the economy will turn down and AAA credits will follow the subprime line shown” in the chart on the left.
Then, the November 2007 Elliott Wave Financial Forecast addressed the “mounting losses” at Ambac and MBIA and offered the right-hand illustration of how rapidly the “credit crunch is climbing the quality ladder.”
Only after the shares of Ambac and MBIA had plummeted 90%-PLUS did Moody’s Investors Service Inc. downgrade their Aaa status on June 19, 2008. If that’s how the cream of the crop performs -- I’d hate to see the crop.
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