Credit Rating Agencies

As we have seen over the last year or so, the credibility of rating agencies is hardly what we expected. Thinking about it now, does not make it difficult to understand why the credibility is not necessarily in the investor's interest.

Some problems with rating agencies for investors:

1) Credit rating agencies compete with each other to win business. Price in this case will not make a difference for companies who are listed on the stock market or companies who wish to issue bonds or other financial instruments.

2) Companies will want their ratings to be as good as possible, regardless the real risk involved, similarly investors do not want ratings to decrease as that would mean they may need to restructure their investment portfolio, involving costs of exiting and entering new investments.

3) Rating agencies are not responsible for the ratings they give which lets them off the hook if something does go wrong, such as in the case of Lehman and many other banks.

Some thoughts towards solutions:

1) Agencies will need much tighter regulations in terms of how to assess the risk of a company. This will be hard as they look at the insights of companies which could be different in each case. It could also be subjective, allowing for different views.

2) There is only room for one credit rating agency. If they do not need to compete for sales and every company must be rated by the same agency, the problem of releasing better ratings simply because they need to, would be solved.

3) Agencies would have to be held responsible for what they rate. The US congress released some internal communication yesterday between some employees of an agency held over MSN messenger:

"That deal is ridiculous," the colleague, Rahul Shah, wrote.
"I know right ... model def. does not capture half of the [risk]," Ms. Mooney replied.
"We should not be rating it," Mr. Shah said.

"We rate every deal," Ms. Mooney wrote. "It could be structured by cows and we would rate it."

It is not possible to have such irresponsible employees being in charge of ratings when thousands of investors depend upon it.

Clear regulations will need to be in place for rating agencies. If this can not be done it is the authorities task to educate investors on how ratings are done and what regulations exist to avoid them from believing things that do not exist. If authorities are going to regulate the rating agency, I believe it is their job to do it in detail and not simply come up with some ideas and allow agencies to do what they want.

Island - Being friendly or International Relations?

Banks and firms around the world are struggling and governments are coming up with rescue funds to help these in trouble. Island, so far the only state in need of several billion to keep up its economy. Interestingly enough many states around Africa and some in South America have been in trouble over the years with many people dying and nobody could care less. Island has been a rich country over the last years and now Russia, UK and Norway are all fighting to help them out. The reasons being for Norway and the UK to help are because of citizens having hidden away funds in Island to enable them to get their money back.

Sounds nice nut controversial in days where offshore regions are under attack. Also it is interesting that Russia is interested in helping but over the last weeks was unable to negotiate terms of helping Island out.

I believe the real reason for Russia wanting to help is political. Over the recent years, since the second half of Putin's presidency political tension between the US and Russia have grown. If Russia was to help Island I would expect them to demand some benefit towards them, which could for example be, allowing Russia to locate military equipment within Island. If such was the case, it would make a lot more sense for Norway as well as the UK to help out instead to avoid such a political move.

Maybe everybody just wants to be nice and helpful, but these days everybody wants to get something out of taking a risk and it sounds strange that the UK is willing to lend Island with £3 billion to help British citizens get their money back quicker.

Upper limit for bank managers in Germany?

Since the last several days, Germany has been talking about introducing a limit of EUR 500,000 per year for banks who seek help from the rescue fund. While looking at what bank managers are getting in the US despite of the low performance, an upper limit may seem to be a good idea.

I disagree with managers making several millions a year, although the limit of EUR 500,000 appears to be extremely low. Considering that around 50% will be income tax, leaving a bank CEO with EUR 250,000 net? The only thing that I believe that will happen is that this may lead to a similar quality of staff as we can see in political positions these days. CEO's of large companies should be able to make around 3 to 6 million net per year, depending on the achievements made, but not +20 million dollars for driving a bank into liquidation!

Such large salaries and bonuses could draw too much attention of steering a company into a lasting directions, only focusing on profit maximation to increase bonuses, taking uncalculated risks and driving companies into liquidation.

Something will need to be done, but I do not think that a simple regulation like this will be a long term solution. Banks that somehow make it through this crisis without help will take the "good" managers and only leave the "bad" ones for those banks. A competitive long term solution will need to be developed.

An overview of the credit crunch causers

Lehman-Brothers – 62 year old Richard Fuld, has been leading Lehman-Brothers for 14 years of his 39 year career at Lehman-Brothers. Last year he earned around $40 million and the previous years most probably not much less, yet for what exactly considering he was unable to keep the company from insolvency?

Merill-Lynch – Stan O'Neal was kind enough to announce $8 billion losses before anouncing his departure with $161 million. John Thain (left) who took over Merill-Lynch after O'Neal has since saved the bank by selling it onto the Bank of America at $29 per share, at 30% of the value when he took over. For rescuing the bank and 10 months of work, he should be receiving around $50 million when leaving the company.

American International Group (AIG) – Robert Willumstad, different to most of his colleagues in other banks, Robert has refused to take his $22 million bonus when the US government had to take over after only a few months of holding the CEO position. He said, that his rescue plan did not work and that he has not earned his bonus.

HBOS – Andy Hornby, Europes youngest bank CEO could not do much more either. At the age of 39 he became CEO of Halifax Bank of Scotland in 2006. Recently Lloyds TSB acquired HBOS for EUR 15.47 billion. While still working for the company at the moment, he received Lloyds TSB shares worth around £2 million, a rather low bonus compared to other bankers.

Bear Stearns – 58 year old Alan Schwartz only became CEO in Jannuary 2008. After not being able to rescue its operations, he rescued the bank from insolvency by selling it to JP Morgan at only $236 million while in April 2007 it was valued at $18 billion. Bear Stearns was Wall Street’s 5th largest investment bank.

Fannie Mae – Daniel Dudd – after nearly driving the organization into insolvency he could nearly have received $10 million. As the US government had to rescue Fannie Mea, they did not want to pay him. Dudd should not be in large trouble as he apparently made $11.6 million dollar in 2007.

Freddie-Mac – Richard Syron – similar to the case of Fannie Mae, the US government needed to rescue the organization. Syron was one of the best CEO earners in 2007 at $19 million. Despite his Golden Parachute if his employment contract was to be cancelled early he could have made around $15 million. Similarly to Fannie Mae’s CEO Dudd, the US government does not want to pay.

Wall Street Poker

What else can be as rewarding as being a Wall Street banker. Once more will Wall Street banks try to reward their managers with $70 billion in wages and bonus. It will not be difficult to figure out that those bonuses are not for the profits they have generated.

One wonders why they deserve such bonuses, for destroying the financial system over the last year? Most probably not, once banks require financial help from the rescue funds, transparency will be demanded by regulators. For example in the interesting case of Morgan Stanley that managed to have $10.7 billion for bonuses, which would have been enough to buy the entire bank. Also the case of Citygroup was interesting, despite the reduced profits this year salaries and bonuses increased by 4%, totaling at $25.9 billion. At the same time Citigroup has accepted $25 billion from Washington’s rescue funds.

Compared to the German mentality, Josef Ackermann CEO of Deutsche Bank announced that him and the Board of Directors will only take 50% of their remuneration this year. He admitted that Deutsche Bank has also done several mistakes but yet they have not required any help so far and managed to play an important role in rescuing the Hypo Real Estate in Germany with EUR 12 billion of their own funds, nearly 25% of what they needed to survive.

Despite the performance of banks, these figures were retained for bonuses, Goldman Sachs 11.4 billion, JP Morgan 6.53 billion, Merrill Lynch during the last quarter 3.49 billion and Lehman Brothers 6.12 billion despite going bankrupt.

Critics have complained for a long time about the bonus figures, the question is how these managers can be happy taking their bonuses while watching their organization getting into these trouble. Would it not be expected of loyal employees to leave their bonuses to increase liquidity of organizations instead of pushing them into further trouble?

The German Economy

Shortly after the German financial rescue plan has been developed, the first problems have been arising. Similarly to the US the plans were to stabilizing German banks and insurers. The problem is that even banks that have been hit are not showing to much interest in those facilities.

I believe this could be because banks that wish to receive support from the “finance stability fund” need to allow for transparency within their strategy, dividend policies as well as employee salaries. Another issue is that large costs can arise from preparing to receive funds from those funds.

Some long term issues can arise from such behaviour as it will decrease the image of those banks. Ratings will decline further and investors may turn to alternative markets with higher security for a while, delaying the stabilizing of the German economy.

Possibly, this may change soon. Regulators have been looking at Great Britain’s model, prescribing banks to increase the minimum capital requirements. If this figure is to be increased to 9% many banks would be forced to get support from the finance stability fund, perceived to be a catastrophic regulatory policy by many banks.