What’s that you say? Being trillions of dollars in debt, unable to balance a budget and constantly changing deadlines isn’t a good thing? Should you rely on the credit ratings services for timely financial warnings? Robert Prechter makes the answer clear in this excerpt from Last Chance to Conquer the Crash:
The most widely utilized rating services are almost always woefully late in warning you of problems within financial institutions. They often seem to get information about a company around the time that everyone else does, which means that the price of the associated stock or bond has already changed to reflect that information. In severe cases, a company can collapse before the standard rating services know what hit it. When all that’s left is dust, they just skip the downgrading process and shift the company’s rating from “investment grade” to “default” status.
Examples abound. The debt of the largest real estate developer in the world, Olympia & York of Canada, had an AA rating in 1991. A year later, it was bankrupt. Rating services missed the historic debacles at Barings Bank, Sumitomo Bank and Enron. Enron’s bonds enjoyed an “investment grade” rating four days before the company went bankrupt. In my view, Enron’s bonds were transparently junk well before their collapse. Why? Because the firm employed an army of traders in derivatives, which is an absolute guarantee of ultimate failure even when it’s not a company’s main business.
Sometimes there are structural reasons for the overvaluation of debt issues. For example, many investors bought the stock and debt offerings of Fannie Mae, Freddie Mac and the FHLBs because they thought the U.S. government guaranteed them. By law, it doesn’t. Back in the early 2000s, these companies simply had the right to borrow money from the U.S. Treasury Those rights proved to be grossly inadequate in the face of the housing crisis of 2006-2012. Before it was over, an embarrassed federal government had lent Fannie Mae and Freddie Mac a combined total of 34 times the pledged amount: $103.8 billion and $65.2 billion, respectively, but even that largesse could not save the stocks. Most rating services never saw the problem coming.
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