The New York Times reports that McGraw-Hill Co.'s (NYSE: MHP) Standard & Poor's (S&P) has downgraded bond insurer ACA Financial Guaranty Corporation from A to CCC, a sub-investment grade. S&P is saying that ACA's financial guarantee is worthless and thus bond holders must write-down the assets ACA insured.
As of September, ACA insured $7 billion in municipal and $43 billion in corporate debt. S&P's downgrade could cost Merrill Lynch & Co. (NYSE: MER) $3 billion and Canadian Imperial Bank of Commerce (NYSE: CM) estimates it will take a $2 billion write-down.
A few decades from now when economic historians look back on the current financial market implosion, there will be books written about the role that ratings agencies played in blowing up the bubble and then bursting it. That's because the ratings agencies competed with each other to offer the highest ratings to bundles of loans such as Collateralized Debt Obligations (CDOs). Now that this market has collapsed, the ratings agencies see no profit in rating new CDOs so they're trying to salvage their reputations by bending over backwards to downgrade those same debt instruments.
The delisted ACA Capital Holdings needs to cough up $1.7 billion by January 18, 2008 because it contracted to do that if its rating fell below A. This is also a problem for The Bear Stearns Companies (NYSE: BSC) -- about which I posted earlier today -- which owns 29% of ACA. As the ratings agencies continue downgrading debt issues and their insurers, the true costs of the current system will suddenly become apparent.
As a teacher, I can imagine the mess that would result if my students competed to see who could pay me the most money to get an A in my class. But that's the relationship between the ratings agencies and the banks. As I posted in August, the ratings agencies competed with each other to offer the highest ratings to the securities the investment banks issued. The ratings agencies willing to give the highest rating won the bidding.
That little wrinkle in the system will need to be fixed in order to restore confidence in our credit markets. In the meantime, those ratings downgrades could us trillions. The interesting question is whether all the value created while the ratings agencies were blowing up the bubble will be completely wiped out by what they are now destroying.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.
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Reader Comments (Page 1 of 1)
12-20-2007 @ 7:23PM
Sidney said...
And who the bleep is Peter Cohan? Was he privy to the ratings process? His comments, without proof, may well be libelous. As for his not holding any position in MHP, so what. Are any of his relatives short MHP? I guess it's open season on the ratings agencies, you can say anything, post any bullsh*t you want without having anything to back it up and it will go unchallenged.
12-21-2007 @ 10:01PM
Aaron said...
Peter Cohan happens to understand the role of Standard and Poor's relevance to the current credit situation. If you read all of his articles, you will see that he is somewhat of a Nostradamas in the financial world. S&P has recently lost all credibility in my mind. I don't know how they got so big to begin with.... They are just now starting to learn about the importance of researching covenants involving their customer's debt. Yes, I wrote "customers." A company pays S&P to be rated. Get a bleepin' clue Sydney. S&P has flip flopped on so many investors so recently. Moody's is no less guilty either. I just read that they have re-affirmed Fannie Mae's debt. Why is Freddie stock lower than Fannie. I guess that people are still naive to credit risk...
12-21-2007 @ 10:40AM
mt57 said...
I have no idea who the "us" is who were "cost ... trillions." The proposition is far from self-evident. The causation argument seems superficial, like the "for the want of a nail" nursery rhyme. As they say in my kids' grade school math class, show your work.