My father worked in finance until he retired in 1986. Except for a few youthful diversions into things like diamond prospecting and night club management, his career was devoted to leasing, beginning as a repossessor (I love to tell people I am the son of a repo man,) and culminating as president of the leasing subsidiary of Investors Diversified Services (IDS). IDS Leasing was eventually acquired by The Equitable.
As I read a Thursday piece on FT.com by Sam Jones entitled When junk was gold I thought about how
much the credit world has changed since my dad left the finance business more than 20 years ago. His business relied upon the ratings agencies that are disected in this article, as did thousands of other businesses right up until three weeks ago when Moody's, S&P and Fitch ratings suddenly lost their meaning.
For a subscription fee, IDS Leasing had access to the professional ratings of Moody's, which earned all its revenue through a subscription service to investors. His business, and other firms in the business of credit, did not view the dependence on ratings agencies as a risk to their own business. Afterall, Moody's were experts at identifying risk to investors. A much greater exposure to a leasing company would be to forego the use of ratings in their decision making, and instead tackle the research themselves. The ratings services epitomized capitalistic efficiency. Businesses were not circumspect of ratings because the ratings agencies worked hard to avoid conflict of interest and brands like Moody's were nothing if not trustworthy.
Then, in the early nineties, "structured finance" arrived on the investment scene, launching an arms race of increasingly complex financial instruments that burdened the ratings companies to the point of abandoning thorough research, and impelling them to accept fees from bond issuers as they struggled to maintain their preeminence over the measurement of investment risk. This led to billion dollar deals rated in just hours and situations like Enron receiving investment-grade ratings just a month before its collapse. As my dad puts it, "The ratings guys were asleep at the wheel."
We are now at a point in history when trust in vaunted institutions like Moody's has been decimated and confidence in markets has slipped dramatically. From the rubble, I expect, new ratings systems will rise. Whether these ratings systems will be more like the old ones based on profit driven entities familiar to my dad's generation of investors, or new systems deriving from networks of people acting as stewards of investment is yet to be determined. I suspect that the world of finance is not ready for a social-network based ratings system, but I also believe we're only a small number of financial crises away from the power of organized crowds overtaking institutions as the dominant source of risk analysis.
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