In theory, credit-rating agencies are to companies what Kelley Blue Book is to cars. They reveal the "true value" of a firm's securities after taking into account "wear and tear." A higher grade indicates lesser risk and greater "resale price." A lower one equals big risk and rapid depreciation.
In reality, however, this is not the case with credit-rating agencies. So often, a rating service will assign unit "x" a good-to-excellent grade -- only to find it cast into the "JUNK"-yard soon after.
In his 2002 New York Times Business Bestseller Conquer the Crash, Elliott Wave International's president Robert Prechter revealed the danger in judging a financial entity by its ratings cover. In his 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.”
The name "Enron" might ring a bell. On November 30, 2001, the company maintained an "investment grade" rating. Four days later, it filed for the largest bankruptcy in U.S. history.
Flash ahead to today. On July 31, 2009, Standard & Poor's rating service pushed the leading bond insurer Ambac into junk territory -- TWO years TOO late.
Fact is, 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 Ambac's foundation. Yet -- the mainstream experts continued to keep their faith in the firm, while the raters continued to uphold its triple-A status. Here, the following news items from the time say plenty:
- July 2007: "[Ambac] had minimal exposure to subprime mortgages, and should fare better in terms of losses. Ultimately, it's going to weather this." (New York Times)
- December 2007: “The reaffirmation of Ambac’s Aaa rating should be a big positive for the shares.” (Bloomberg)
- February 2008: "Investors sent Ambac shares up amid hopes that the broad credit-market losses may soon subside. The Standard & Poor's decision to keep the firms triple-A rating shows the strength of our capital base." (AP)
Our team of analysts couldn’t have disagreed more. 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" on the right-hand side of the chart below.
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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