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Bonds Are a 'Safe' Investment: A Big Lie Gets Even BiggerMost investors probably think that when an investment ratings service like Moody's, Standard & Poors or Fitch gives a company, financial institution or security the highest rating of "AAA," it carries the least possible level of risk. Most investors would think that this rating would be reserved for United States Treasuries and only the most secure of companies like Berkshire Hathaway (NYSE: BRK.A), Johnson & Johnson (NYSE: JNJ), or United Parcel Service (NYSE: UPS). Actually, this happens to be the case, and these companies are among the very few to receive AAA ratings outside of financial institutions.
So what happened in the case of the Collateralized Debt Obligation (CDOs), where the ratings agencies determined that high-risk securities batched together had a smaller chance of default than the individual securities? Perhaps that is the case, but triple-A? Well, it seems to me that large investment banks knew they needed the AAA ratings to have a marketable security. They went to the ratings agencies that understood this and the agencies created the rational or plausible deniability to support the rating. This may be a bit harsh, but it does seem that the ratings agencies were working in reverse: first establish the rating and then the support for the rating. The ratings services are all heading for cover and many of the previously AAA-rated securities are being re-evaluated.
I'm sure there is a lot I have yet to learn in this arena, and perhaps a few readers can shed some light on this subject as well, but I, for one, cannot understand how the risk of owning a JNJ or BRK (or treasuries -- unbelievable isn't it?) can be equated with the aggregated risk of sub-prime loans repackaged and convoluted to sell to the unknowing, or even greedy.
This distortion brings me back to the subject of worthy reading material that came up in this week's Sunday Funnies: Barron's "The Art of Successful Investing," where I remembered (in the comments) the classic 1954 book by Darrell Huff, How to Lie with Statistics, which is still in print. Some of you may not agree with me that it is an investment book, but I would put it forward as a must-read. It is cleverly written, simple to understand, short and to the point. Illustrations by Irving Geis help to inform the reader quickly.
I think someone interested in successful investing should establish basic guidelines and one of them is a healthy touch of cynicism. Huff writes well and this book can be shared with children as an early primer serving many purposes. Whether you are reading a press release, quarterly statement, government estimate (really) or analysts prognostication, you should be able to do your own analysis. You should try to get a grasp of whatever -- if anything -- is being flung at you is truly meaningful. The book is full of examples, graphs and charts, a turn of phrase, and sometimes some sleight-of-hand to offer what appears to be a strong argument for something that, in fact, proves nothing.
The book will give you no investment advice -- that is not the purpose. But it will make you a better investor, and from that standpoint it qualifies as an investment book to me. I'm sure in the weeks to come we will start seeing many stories, extrapolations, tables, charts, and graphs to explain the actions of the ratings agencies. There will probably be some litigators somewhere eyeing them very carefully, as well -- no doubt, they will have read the book.
Those of you who are new to BloggingStocks can check out my other stories and read Chasing Value or Serious Money to find more potential opportunities and verify my track record as well.
Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture & planning firm.
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