Credit Rating Agencies Cower From Credibility

Several provisions in the new financial regulatory reform bill have scared the three rating agencies (Standard & Poors, Moodys, and Fitch) to refuse to have their ratings included in any documentation prepared for new issues. The new regulations leave the rating agencies exposed to liability if the bonds they rate do not perform as they are supposed to. We saw over the last few years during the financial crisis that these rating agencies did a very poor job of well, rating, particularly the bonds backed by mortgages, etc. So, they should be scared. If I weren’t very good at what I did, I wouldn’t put myself out there either.

The problem is that the SEC requires all new bond issues to be rated. Why? So uninformed, unintelligent, and lazy investors wouldn’t have to do their own due diligence on the bond offerings before deciding to invest. That’s how it was done in the good old days. But that process evolved into one where investors blindly followed the rating provided by one of the big, bad (bad as in not good at what they do) rating agencies. What happened? First of all, they had huge conflicts of interest, getting paid by the very entities whose securities they were rating. Second, they admitted after the collapse of several highly rated issues, that the offerings were much more complicated than they expected. Duh!

Now they are refusing to allow bond issuers to use their ratings in an ‘official’ capacity. In other words, they will continue to rate the bonds, but ‘you can’t really quote us on that’.

To some extent, the same analysis can be applied to the three consumer credit reporting agencies. (Transunion, Experian, Equifax) They provide credit scores indicating to banks, credit card companies, etc., the creditworthiness of a borrower. No one knows how they come up with those credit scores, and I bet if you called someone at each respective agency, they won’t tell you. Actually, they can’t tell you..because they don’t know. You can make payments on time for years and your credit score will be 750, let’s say. Forget to make one payment and you’re back down to 550. Ah, the penalty for forgetfulness is 200 points! Now, you have to remember to make those same payments for another 10 years before you get back up to 750. I’m exaggerating of course, but I’ve experienced this first hand.

Anyway, back to the topic at hand. During this financial crisis, borrowers with credit scores well above 700 ( a very good score) defaulted on many of their debts, including home loans, credit cards, lines of credit, and auto loans. Admittedly, some borrowers lost their jobs, others had burdensome losses on investments, and still others strategically decided not to pay their debts. So can we conclude that someone who defaulted on their debts despite a 700+ credit score was overrated? Perhaps! But how did a $300,000 per year wage earner with $200,000 in credit available have the same credit score as a $20,000 wage earner with $7,000 in credit available? (Sorry, I keep going back to pointing out the flaws in the scores.)

But I can’t help it!! I had my credit report pulled and found no less than 19 errors on my credit report. Those 19 errors had an impact on my credit score. I called to ask them what my credit score would be if those errors were corrected, but they couldn’t tell me.

Admittedly, it’s not always their fault. In one case, I made a payment on my mortgage, on time, and the day after the payment was due, the mortgage company sent me my money back and reported the payment as late! They sent me my payment back!!! Of course, they reported a late payment because as of the day they sent me back my payment, they no longer had my payment, making it late. Funny, but not so funny. I tried to call them to have them send back ALL of my previous mortgage payments going back 8 years, but they said they couldn’t do that. In this case, it was the mortgage companies fault, but the other 18 errors were the fault of the credit bureau.