Credit Rating Agencies And The Financial Crisis.

September 15th 2008 will be remembered in financial circles as the 9/11 of the global financial system.This was the day Lehman Brothers filed for Chapter 11 bankruptcy protection.
While the world struggles to control the economic free-fall it is now being accepted that the financial crisis was triggered by a credit crisis which in turn was sparked off by a crisis of confidence.Lack of confidence in what?Wall Street's expansion over the last decade was fueled by innovative financial products.Loosely regulated investment banks called the shots,and so successful were they in making money that regular old fashioned banks set up similar enterprises or participated in this misadventure through 'off balance sheet entities', in order to avoid regulatory scrutiny.
How was it that these novel financial products or 'toxic assets' as they are now called became the preferred investment over other time tested financial assets?Quite simply it was a period of unprecedented financial expansion,a time when risk taking was fashionable and to give a very old explanation 'bad money' simply drove out the 'good money' from the system.Had all the experienced bankers with degrees from fancy Ivy League institutions gone collectively blind all of a sudden?Not at all.It is here that the role of the supposedly reliable rating agencies becomes questionable.By rating products as AAA, Aa1 etc. they induced innocent investors to gobble up these toxic assets.The poor investor paid a heavy price for relying on the supposed objectivity and integrity of these credit agencies.The extent of betrayal becomes clearer when you consider that it is legally binding on insurance companies and money market funds to invest only in assets which enjoy the highest rating given by a few Nationally Recognized Statistical Rating Organizations or NRSRO's. Amongst the best known are S&P,Moody's,Fitch etc.
While various probes have been ordered into the activities of investment banks none of these agencies have been touched.It must be understood that these agencies are as guilty as the investment banks because they were paid by these banks to rate their products.In brief they had a vested interest in the various offerings going through.Interestingly Moody's, probably the most successful rating agency over the last few years,is almost 20% owned by Warren Buffet's Berkshire Hathaway.
Bringing about greater transparency in the working of these agencies is the need of the hour and what better way to do so than asking them to make public the information on which their rating is based.Till such time the SEC makes such a rule investors risk being taken for a ride by an unscrupulous or careless rating agency.

Bankers' Bonuses-Are they Justified?

One of the most important issues that came up for discussion at the recently concluded G-20 summit in London was whether bankers' pay and bonuses should be capped.Predictably the French suggestion to 'tax and cap' bankers' salaries and bonuses did not find favor with U.S. and Brirish policymakers.

Such payments by banks and financial institutions to their CEO's and key employees has caused widespread public indignation in recent days.This is because while such institutions crashed in the wake of the economic meltdown,these employees were given the option to bail out with tens of millions of dollars in severance pay and benefits.The most glaring case is of AIG which proposed bonus payments of millions of dollars to its top employees while itself availing of a $170 billion bailout from the Fed.In short taxpayers money was being used to reward employees for running such institutions into the ground.

European nations,particularly Germany and France were most vocal in their criticism of this practice.Their opposition is not unreasonable.The practice of paying bonuses definitely encourages excessive 'risk taking' by the managers.In most cases the annual bonus component of the total emoluments was higher than the base salary.This describes the scenario prevailing till a couple of years back where bankers outdid each other in distributing loans with scant regard to whether they would be recovered or not.Accounting principles ensured that the banks could show healthy profits on such loans at the end of the year and nothing mattered as long as Wall Street cheered.The race to distribute money led to innovative financial offerings such as 'teaser rates' i.e. initial low rates of interest which automatically reset at much higher rates after a year or so.Incidentally it was these types of loans which triggered the present meltdown.

These countries have suggested a sensible alternative to to the current method of paying bonuses.They have put forward a proposal wherein an annual bonus would not be paid in one lumpsum but payment would be spread out over several years, with a part being paid in the form of equity in the company.In case a particular project made a loss then the deferred portion of the bonus was not to be paid.In short bonus payments are to be linked closely to the long term profitability of a company.

While the G-20 meeting did discuss various proposals on bankers' compensation no decision has been taken as yet.Nevertheless it has been realized that something needs to be done about it.

GE CEO Speaks on How To Fix America!

In a recent speech at the Detroit Economic Club,GE CEO Jeff Immelt shared his thoughts on what he felt was wrong with the US economy and what should be done to fix it.
He was very clear about what is needed.He said.'We should set a national goal to create high value added jobs and have manufacturing jobs be no less than twenty percent of total employment,about twice what it is today.'He went on to add,'The last generation has been tougher on workers....In the fight between workers and management,the worker has suffered.'
He called for a renewed focus on manufacturing and R&D and that the US must once again become a leading exporter of manufactured goods.Here Immelt repeated the concern expressed by many that the decline in US manufacturing is seriously eroding the country's ability to innovate.With China already having become the workshop of the world can it be long before it becomes the world leader in technical innovation as well?But this requires an end to the idea that the US can retain its position as the most technologically advanced nation even as a services led,consumption based economy.This needs a change in focus from producing financial engineers selling shady mortgages to promoting proper PhD's.The US is in danger of losing the race as China now produces more PhD's than it.
The false prosperity of the bubble years has ended once and for all.If the US is to find a lasting solution to its economic problems it must rebuild its competitiveness.The government and the private sector must come together to promote scientific research,an area de-glamorized to such an extent that a dream job is only one on Wall Street and not in any research lab.Finally the hype surrounding outsourcing must be cut down.So far corporates have only talked about its increased profitability.They must now be willing to publicly admit to its downside as well.The real wages of American workers have not increased since 1980!Increased wages must follow increased productivity and profitability,if standards of living are to be raised.Allowing cheap imports is not the right way of doing this.Its time corporates stopped working to please Wall Street and started taking sound business decisions instead.