Who can you trust...the ultimate breakdown of confidence and why the rating agencies are co-conspirators and are part of cycle of greed that exists on Wall St.? By Bob Canter, Performance Realty Solutions.

Implications: This writer has been waving the caution flag for over three years about the fact the credit rating agencies were not truly doing their jobs in protecting the investment community. The reason I know this is due to the fact that when rating agencies rate the bonds that contain the “Collateral” their job should be to underwrite the value of the underlying assets. They do not do this as they take the position the loans have already been underwritten by the originators who of course have valid appraisals that back up the values upon which the loans have been made. As anyone in the industry knows, it’s a rare day when a property does not appraise out. What they say they rate are the borrowers (hmmm?)... They rate the terms and conditions of the bond, everything except the most important aspect... the properties.  

Analysis:  When marginalized loans are made, you must really take a closer look at what’s under the hood. The appraisal is no more than looking at the blue book value of a car as analogy. This is especially true in residential real estate as the entire appraisal methodology has become almost automated or done from a desktop via software programs. When it comes to commercial there is so much more that needs to be understood about each and every property, such as tenant credit quality, concentration of types of businesses within a particular building, lease rollovers, deferred maintenance, current cash flow, and how well the property is managed etc. At the same time a complete market study is needed to understand the local market dynamics at play where the individual property is located. By local market, that is determined by the size the market where the property is located and knowing if the competitive market area is 1 mile, 3 miles, 10 miles or just a few blocks as is the case in urban markets such as NYC. If anyone thinks for one second the rating agencies did this type of analysis I have the proverbial bridge to sell them.   Although there is plenty of blame to go around for the sub-prime credit mess, the problem as the article so accurately points out is the fact the credit rating agencies are the last gatekeeper to determine what the credit quality of the debt is going to be rated. It is outrageous that the rating agencies would actually provide “guidance” to the market makers of the bonds as to how they can manipulate them to have them be rated Triple “A”. That is a direct conflict of interest, and they can try and defend themselves from what is probably just the beginning of their legal woes as evidenced by the Teamsters Union’s lawsuit against Moody’s. The fact remains the credit agencies have a bad history for the past 10 years or so, beginning with Enron.  

The other problem must be with the investment officers or asset managers who are investing in these debt instruments not to ask themselves how is it conceivable to have such high ratings when as previously mentioned only US Government bonds and perhaps 5-6 corporations have the ability to float debt at the same rating. We all know the answer, and that is greed. What should be deemed almost fraudulent are these bonds that got such high ratings would carry higher rates of returns than if they had more accurate or lower ratings. Of course many pension funds and institutional buyers of these investments are prohibited from buying what would be deemed “junk bond” status. So the market makers knowing full well this requirement and went about and manipulated how these bonds are to be rated with input from the rating agencies who are then paid to rate the bonds/debt.    

This practice has had as a result the vote of no confidence that has occurred in the credit markets. This is why even with Federal Reserve intervention the credit markets will not be righted so quickly and there will be true and warranted skepticism buy the buyers of all debt because the trust of the rating agencies has been broken. Whatever happens going forward will not cure the lack of confidence, until the rating agencies are brought to heel just as the big accounting firms were made to do after the Enron/MCI debacles.  

However the lesson learned once again is that investors be they individuals or institutional must do their own due diligence and ask the hard questions. What good is the investment only to have it go bad in the near future when the flaw in the underlying fundamentals finally come to light? Caveat Emptor everyone.