Failure of international credit rating agencies

[Naveed Yaseen]

By M. Ziauddin
Early this year many prestigious credit rating agencies lost their own credit ratings for having rated doubtful financial firms and dubious derivatives as sound investments. There was a talk as well to take these agencies to courts for misleading their clients.

And now the FBI is said to have started investigating top managements of collapsed banks and financial institutions for fraud. It is suspected that these managements were well aware of the looming crunch but still led the unsuspecting investors on to the garden path driven by nothing more than greed.

In Britian, Prime Minister Gordon Brown and Chancellor Alistair Darling blame in part the City for the credit debacle. In their opinion the City by distributing huge bonuses and massive pay checks ostensibly conmpensating for their ‘performance’ kept goading the managers to take ever more risks, so much so that in this blind frenzy they turned the market into one huge international gambling casino.

Too many investment managers are said to have been paid too well for performance that looked impressive but contained the seeds of catastrophe. And when the catastrophe arrived, investors were wiped out and the burden was passed on to the taxpayers, yet managers kept the bonuses they collected in the years of plenty.

The next step now is said to lie with the Financial Services Authority (FSA), the City regulator, but the problem is said to be easier to spot than to solve. The most practical way forward is said to be for the FSA to consider incentive schemes as part of its overall review of the stability of financial companies. But the first line of defence against perverse pay schemes, however, are still said to be the shareholders of financial companies. They are said to have done too little so far, and they have suffered more than most as a result. One expects more diligence in future.

Meanwhile, manufacturing which held up well in the early months of the credit crunch, is beginning to feel the squeeze. Their two main concerns are said to be falling orders as the economy cools, and tougher restrictions on the credit terms they enjoy with both customers and banks.

Some have noticed a “ratcheting effect” as companies that trade with each other are starting to restrict the amount of credit they provide for the next company in the chain. Behind this, it appears, are tougher conditions on borrowing throughout the economy.

As a result of the tougher credit environment, banks have increased overdraft charges by two percentage points in the past year to about 10 per cent. At the same time, while customers a year ago were happy to provide 40 per cent of the cash for a machine when they placed an order – well before they took delivery – now they are likely to say 33 per cent is the maximum they are prepared to pay up front.

The impact of credit restrictions is said to cut significantly into cash flow, which will inevitably have an impact on profits over the next year. If manufacturers have battled through the first year of the credit crunch without too many wounds, it is hard to imagine they will be so fortunate in the months to come.

The plight of the manufacturing sector is likely, say some economists, to push the Bank of England’s Monetary Policy Committee (MPC) closer towards an interest rate cut. MPC is unlikely to dismiss the inflationary threat altogether, not least due to the recent rebound in the oil price. But it probably would see the inflation threat being replaced by the economic fallout from the credit crisis as the main policy concern.

The rise in the reported sales balance of the UK CBI distributive trades survey from -46 in August to -27 in September is not considered a sign that conditions on the high street are improving. Indeed, this is still the third weakest reading in the survey’s 25-year history. And at face value, it is consistent with a slowdown in the official measure of annual retail sales growth from August’s 3.4 per cent to around zero.

Given that this balance was previously pointing to annual sales growth of around -1 per cent, September’s rise is probably just the survey moving back to a more realistic level rather than signs of an underlying improvement. Indeed, large retailers such as Argos and Next have recently reported sharp falls in sales.

And the BRC survey is also pointing to a slowdown in sales growth, albeit to a more modest two per cent. Overall, conditions on the high street remain very weak. Falling house prices, declining real incomes and rising unemployment mean that they are going to get worse before they get better.

Overall, even a modest strengthening in the CBI survey would still reinforce expectations that household spending is likely to fall next year.

Housing market activity extended its precipitous fall into August, no doubt helped by the uncertainty generated by the speculation about potential stamp duty measures.

While that uncertainty has now been cleared up, there appears no realistic prospect of a rapid end to the housing market correction. BBA data released on Tuesday showed that in total, 95,790 mortgages, with a combined value of £10.3 billion, were approved in August. In volume terms, all mortgage approvals were 42 per cent lower than a year earlier.

New mortgages for house purchase fell to 21,086 in August, five per cent lower than last month’s (downwardly revised) record low and less than one-third of their level a year earlier. Loans for re-mortgage also fell sharply, from 52,911 in July to 47,765 in August. Loans for re-mortgage were last lower in January 2001.

The speed, and magnitude, of the fall in housing market activity has been unprecedented. Indeed, in the history of this series, there has never been such a rapid, or sustained, decline in mortgage approvals as that seen in recent months. Even the long-term term bears of the housing market, the Capital Economics Ltd. a London based research firm, said it has been repeatedly surprised on the downside! “What does seem clear, however, is that there is no let-up in sight for this housing market correction.”

http://www.dawn.com/2008/09/29/ebr20.htm