Saturday, 19 June 2010

The Daliy Reckoning

The Daily Reckoning Weekend Edition
Saturday, June 19, 2010
Taipei, Taiwan

  • The "fallout" from the biggest ratings folly the world has ever known,
  • But is it just back to "business as usual" for the big three?
  • All that, plus the reckonings from the week gone by for your private, weekend reading pleasure, and more...


Joel Bowman, reporting from Taipei, Taiwan...

You'd think there was a real, bona fide recovery going on the way the markets behaved this week. The Dow was up almost 2.5% for the five sessions when we checked late Friday afternoon. Fears over the financial health of Spain and the rest of Europe seem to have been pushed to the backburner, at least for the time being, and despite a few tidbits of rather flaccid economic data, the major US indexes held up very well.

We'd image more than a few swimmers are thinking it's probably safe to go back into the water. To them we say, let us know how all that goes for ya. We'll be here on the beach, where the sun is warm and the sharks can't breath.

Sticking with the predatory animal metaphors for a second, we imagine fellow reckoners are familiar with the phrase "to put the fox in charge of the henhouse." You may have heard it used in reference to the SEC, the helplessly incompetent "police" of Wall Street that, while missing some of the biggest scandals in US investing history over the past few years, were busy downloading porn...all on the taxpayer dime, of course. Or maybe you saw it used to describe the "big three" ratings agencies, the government-ordained super sleuths who alone possess official sanction to determine the creditworthiness (or not) of an investable debt instrument.

Both institutions were, in their own greedy, conniving ways, feasting at the expense of the investors they were supposed to be protecting. So, what ever happened to these guys? Penalties? Fines? Rotten tomatoes, even? Hardly.

Ian Mathias, contributing editor for
The 5-Minute Forecast, has been on the case for us. He filed this fascinating/disturbing report yesterday afternoon...

Rating Agency "Reform" Cut to "Study"
By Ian Mathias
Baltimore, Maryland

When it comes to the post-crisis world of American finance, there's one thing we can all agree on:

Something's got to give when it comes to ratings agencies.

Over the past decade, we've all witnessed the "big three's" role in the credit crisis. S&P, Moody's and Fitch gave their famous AAA ratings to an array of troubled securities, companies and nations. Not only did they issue the wrong ratings - and correct those ratings far too late - but their dubious business model was put under the spotlight, too... ripe with conflict of interest and suspicious relationships with their Wall Street clients.

Thus, rating agency reform would appear to be a legislative home run...a slow moving softball pitched right into the sweetspot of financial reform.

Well, Congress just effectively whiffed.

Earlier this week, the House and Senate removed the one amendment in the coming financial reform bill that addressed the ratings agencies. In its place - really, you can't make this stuff up - Congress will commission a two-year SEC study. The SEC, apparently not busy enough, will spend the next couple years poking and prodding the agencies and ultimately deliver Congress a report, which will announce whether a conflict of interest really does exist, and the Commission's advice as to how to fix it.

Now, we will admit, the "reform" that this study will replace was a complicated mess. The brainchild of Senator Franken, it was a plan all too typical of Washington: The amendment would have empowered the SEC to set up a new agency with its own fun acronym (the Credit Rating Agency Board, or CRAB) which would in turn give the ratings agencies new sets of hoops to jump through and papers to file. In short, we don't' blame Congress for wanting a different solution.

But a commissioned study by the SEC? C'mon.

What Congress ought to do is act, not create a sub-panel, or a study, or punt this to the next class of congressmen (which is essentially what this study is doing). What's needed is a tough decision - one that will have immediate consequences and send a message to the ratings world: Either get it right, or as Donald Trump would say, "you're fired."

We certainly don't have a monopoly on all the right ideas, but why not start by stripping S&P, Moody's and Fitch of their status as Nationally Recognized Statistical Ratings Organizations? The SEC bestows such a distinction. Basically, the biggest, best, most trusted raters in the world are given the NRSRO seal of approval, which is supposed to assure clients and investors that they're trustworthy. It's one of the central reasons why the "big three" have such a chokehold on the ratings universe. Only seven other firms - in the entire world - hold the distinction.

So, how do you get this SEC blessing? Read their explanation... and try not to snicker:

"The single most important factor in the Commission staff's assessment of NRSRO status is whether the rating agency is 'nationally recognized' in the United States as an issuer of credible and reliable ratings by the predominant users of securities ratings."

Are S&P, Moody's and Fitch not "nationally recognized" fools, at best? Is there a living soul left that would consider their ratings "credible and reliable?" Here are some more SEC standards for the NRSRO privilege:

"The [SEC] staff also reviews the operational capability and reliability of each rating organization. Included within this assessment are... the rating organization's independence from the companies it rates... the rating organization's rating procedures (to determine whether it has systematic procedures designed to produce credible and accurate ratings)..."

Ha!

So, we ask the SEC and Congress: Why not remove the "big three" from this club? In fact, since the credit crisis has proved this NRSRO status to be largely useless, why not abolish the designation all together? It's a rare situation in business legislation that a level playing field isn't a good thing...and this doesn't seem to be one of 'em.

And if it was, in fact, the SEC's own NRSRO system that empowered the big three to make such awful mistakes, what faith should we have that this new study - to be conducted by the SEC - will be of any use?

In the meantime, we can't help but wonder if shares of ratings agencies and their parent companies are a contrarian buy. Both the American free market and legislature has shown the will to reform and revolutionize this sector, but now more than ever, it appears no one will have the stones to do it. Thus, despite being so universally disliked, at this stage it's hard to see the "big three" doing anything else but business as usual.

Ian Mathias
for
The Daily Reckoning

P.S. As of this writing, ratings agency reform isn't entirely dead in the water. One item in the financial reform bill, 436(g), alters the liability exception currently granted to the raters. In essence, it would allow investors and clients to sue the raters - if the plaintiffs can prove "knowing and reckless" conduct on the raters' behalf.

In medical parlance, that's really addressing a symptom, not the disease. And proving that any of these agencies were willfully out of conduct will be no small feat. We'd also expect Big Three lawyers and lobbyists to make damn sure that, if this provision becomes law, there won't be any claw-back stipulations that would allow plaintiffs to sue for past digressions...like 2005-2008, the biggest ratings folly the world has ever known.

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ALSO THIS WEEK in The Daily Reckoning...

Is China Undervalued Right Now?
By Chris Mayer
Gaithersburg, Maryland


During the past few years, China has become an increasingly compelling destination for investment capital. But with the recent weakness in the Chinese stock market - and serious cracks showing in the façade of China's economy - does it make sense to invest in China right now?


Don't Buy the Stock Market...Buy Stocks
By Chris Mayer
Gaithersburg, Maryland


Special situations look like a particularly good spot to be in these days. Why? I'll explain below. But first, it may help to take a minute to explain what a special situation is. It's actually an old concept. The best definition may be that of the great Ben Graham - famed value investor and mentor to Warren Buffett.


Ten Benefits of Expatriation
The Casey Research Team


Everybody has their own personal reasons for expatriating, but here are some of the benefits:

1) Freedom from the global US tax net. Taxing you no matter where you breathe on this earth is wanton American exceptionalism. What other nations don't dare do to their citizens, the US government doesn't think twice about. Once you renounce, it's your choice either to live the rest of your life free of any tax net, or to pick a place you want to be year-round and opt into the tax system (assuming it's not a tax- free jurisdiction). If you do, you'll at least know you have the freedom to walk away from it by simply moving elsewhere.


Ten Benefits of Expatriation, Part II
The Casey Research Team


In yesterday's edition of
The Daily Reckoning, Casey Research shared five of the Ten benefits of expatriation. Today, we share the second five:

1) Freedom to invest without tax distortions that encourage capital misallocation. The US tax system encourages misallocation of your investment capital. It obscures the act of buying and selling securities based on a rational assessment of their value. For instance, you end up not selling a security you otherwise would simply because you don't want to trigger taxes yet. Or you hold on longer than you might otherwise to get long-term capital gains treatment. Or you sell securities you normally would keep - for "tax loss harvesting."


It's June in Florida
By Bill Bonner
Delray Beach, Florida


South Florida is entering its fourth year of a property slump. Places sell for about half of what they brought three years ago. The retail building across the street is half empty. Signs are everywhere - "Office for rent." "Ocean front lot for sale." 'Commercial space available.' Here in Delray Beach, the sun is shining. The grass is growing. Waves caress the shore. But our hotel is nearly empty. Many restaurants on Atlantic Avenue are closed. The streets are so quiet the city seems like a ghost town. Then again, it's so hot and sweaty, even the ghosts wilt.


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The Weekly Endnote: Your editor had the displeasure of meeting one of these ratings agency clowns back when he lived in Dubai. If you think you can stomach another tale of laughable ineptitude, here's a bonus "ratings reckoning" of yore to chew on over the weekend: Overrating Agencies.

And that will probably do us for this issue. Remember to tune in next week when we'll share some of your thoughts on the "Get outta Dodge" vs. "It ain't so bad" reader mail. Check out the "Benefits of Expatriation" columns above if you don't know what we're talking about. Emails go to the address below.

Until next time...

Cheers,

Joel Bowman
Managing Editor
The Daily Reckoning

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Here at
The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com
 
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