Keep Your Mouth Shut!

| June 1, 2010 | 0 Comments

Sometimes I get so frustrated I want to YELL at my computer screen.  Do you know what I mean?  You’re surfing the web or reading the paper, when you come across a provocative article.  It’s often something simple… and you can feel your face get flush.  Your blood is literally about to boil.

It’s a different topic for everyone…

Maybe you get mad over local taxes going higher.

Or out of control government spending.

Or stupid laws passed by the idiots in Washington.

Or a recent zoning board decision.

Or dumb decisions made by your school board.

Everyone has a different hot button.  But for me, my blood was boiling last week and it had nothing to do with the usual suspects.  What got me so mad… so hot under the collar… was a tiny little press release.

And it took all I had not to yell at my computer screen… “Keep Your Damn Mouth Shut!”

Some people just don’t know when enough is enough.  And last week I had had enough.  What made me so mad was Fitch Ratings downgrading Spain.

This news was like a horrible umpire calling a strike… two hours after the game is over and everyone’s gone home.  It’s just ridiculous.

So who is Fitch?

In the investing world, there are three major credit ratings agencies… Standard & Poor’s, Moody’s, and Fitch.  They are tasked with a simple objective… review bond issuers and give them each a rating.

The better the issuing group (company or government), the better the rating.

Each rating agency has its own label… Some use “AAA” as a top rating, others use a single “A”.  Any way you slice it, “A” is the best.  And like in grade school, “B” is second best… followed by “C”.

High risk bonds get a designation of “Junk” or no rating at all.

Every one of these ratings agencies claim to be independent.  They pretend that their independence allows them to judge a bond without influence.  Fat chance I say!

It’s nice in theory… but let me ask you a question.  Do you know how the ratings agencies make money?

The governments and companies looking to issue bonds pay the ratings agencies.

It’s like the home team handing an umpire a bag full of money to call a game.  He then claims he’s independent because he’s not an employee… he’s only charging a fee.

Legally, it might not be a conflict of interest, but it smells fishy to me!

The ratings agencies act in the same way.  Now I want you to remember, these agencies were giving top ratings to CDOs and subprime mortgages in 2007 and 2008.  The very same CDOs and subprime mortgages that collapsed and started the credit crisis.

The credit ratings agencies always seem to be a day late and a dollar short.  It would be funny if the consequences weren’t so grave.

You see, they hold a lot of power over the markets.

How’s this for a twist… the funds relying on ratings agencies are often obligated to buy certain bonds and ignore others.  For example, the most conservative bond funds can only buy highly rated bonds.  And most pension funds are limited to investment grade bonds.

These rules are designed to ensure they are investing in quality.

But these requirements are a double-edged sword.

When a bond loses its rating, these very same funds are required to sell… regardless of the situation.

If a fund has owned a particular bond for years and years and likes the investment, it doesn’t matter.  They are forced to sell the position… just because the bonds are downgraded.

It’s kind of stupid if you ask me.  If a company or government bond is getting downgraded… the value of the bond is probably falling.  The downgrade forces funds to exit their position.  All this selling pressure only sends the value of the bonds lower… further destroying the value of these bonds.

Sometimes being calm and thinking rationally is the best step.  But when a ratings downgrade happens, calm gets thrown out the window.

Now you’d think the ratings agencies would be looking to the future. They’d tell investors not to step on a particular landmine.  But that’s not the case…

We witnessed it with subprime CDOs… then other mortgage-backed securities.  Most recently we’ve seen it with Greece… and now Spain.  The ratings agencies regularly downgrade bonds AFTER the problems are already well known.  (Way to be on task there boys!)

I’ve been talking about problems in the EuroZone for months now.

Spain was a country long ago identified as having too much debt and a faltering economy.  And just last week, Fitch downgraded Spain. Seriously… Why last week… Why not say three months ago?

The ripple effect was clearly visible… The downgrade of Spain forced a number of bond funds to exit their holdings.  Bond values fell… and international investors started fleeing the EuroZone.  The Euro fell in value tick by tick because of the downgrade.

It’s just ridiculous to me.  Why does a rating agency who’s constantly behind the curve carry so much weight?  I really wish they’d just shut their mouths.

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Category: Bonds

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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