Bloggers Downgrade Ratings Agencies

Online pundits ponder "why now?" and "what next?" after debt rating agencies adopt new criteria on mortgage-backed securities

As investors began to sift through the fallout of Standard & Poor's and Moody's decisions to likely slash the credit ratings of billions of dollars of bonds backed by subprime mortgages, many finance bloggers are posing twin queries: "Why now?" and "What next?"

In what the online financial news site MarketWatch called "a huge harpoon into the heart of the mortgage credit bubble," S&P, which like BusinessWeek is a division of the McGraw-Hill Companies (MHP), would likely cut the ratings on about $12 billion in debt and announced it would revise its criteria for assigning ratings on mortgage-backed securities in the future. Moody's (MCO) followed suit, announcing that it would downgrade more than $5 billion in bonds.

Coupled with weak earnings reports from Alcoa (AA), Home Depot (HD), and Sears (SHLD), the announcements helped fuel significant losses in the Dow Jones industrial average, S&P 500-stock index, and Nasdaq composite, each of which lost more than 1% on July 10 (see, 7/10/07, "Stocks: Another Subprime Stumble"). (Stocks rebounded on July 11, but that was before Motorola (MOT) warned of a loss in its current quarter, and a big deal between General Electric (GE) and Abbott Laboratories (ABT) was scuttled.)

Don't Forget the Pillow

But with the subprime mortgage market reeling for most of 2007, due to a surge in foreclosures, online pundits seized the chance to snipe at the credit-ratings agencies for the late change in direction. At Macro Man, an anonymous blogger identifying himself as a "global financial markets trader" sarcastically wrote that a source inside the ratings agencies had leaked a "Subprime Analysts Toolkit" consisting of a pillow, an alarm clock, and a rear-view mirror. "The most important piece of technology is the pillow. This part of the toolkit is the most actively used by analysts, as they tend to spend most of their time asleep," Macro Man wrote. Eventually, he continued, the alarm clock wakes them up, and they look backward to see what's already happened.

Taking a more cynical approach, blogger Jack Crooks, writing at Crooks on Currencies, described the agencies' reluctance to reduce ratings earlier as a "subprime fee manufacturing machine" powered by the following equation: "Higher Credit Ratings = Higher Fee Generation."

Others wondered what the broader implications of the agencies' move would be, if investment-grade bonds are downgraded to below-investment grade or "junk" status. Writing for Toronto-based Wellington Financial's blog, CEO Mark McQueen pointed out that some of the bonds facing possible downgrade by S&P were rated AA or A. But some 366 were in the BBB category, "which in many cases means that the bond in question is no longer investment grade if it is dropped two notches (from BBB to BBB minus to BB+). This will ensure that some funds might be forced to sell, by the terms of their investment policy, these formerly BBB-rated bonds once they slide to sub-investment grade status."

Remodeling Boom is Over

It all points to possible problems ahead for the economy, some bloggers say, because deepening housing woes could have a cascading effect. According to Calculated Risk, a blog written anonymously by "a senior executive, retired from a public company, with a background in investing, finance and economics," there's "evidence…that the housing slump is spilling over into consumer spending." Disappointing earnings forecasts by Sears and Home Depot point to that possibility, Calculated Risk said. "If this housing bust is similar to the early '80s or '90s, real home improvement investment will slump 15% to 20%," he predicted.

Home Depot's and Sears' lowered earnings expectations show "slackening consumer appetite for home remodeling," writes Salon's Andrew Leonard in his How the World Works blog. The rating agencies' move to downgrade bonds backed by subprime mortgages will make it tougher for some strapped homeowners to refinance. Citing a recent Fed report showing a 6.4% increase in credit-card expenditures, Leonard suggested that "now that cash from refinancing is no longer an option, we're whipping out the plastic." That's "triple-un-good," he wrote.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE