Tuesday, 21 August 2007

Today's second post - the markets

As promised, here is today's second post. A lot less disgusting than the first - again, as promised.

After we had returned from A&E, while trying to eat and drink something to fill my stomach (if you have read the first post, you will know why), Mrs. Gripe and I turned on the early morning news. There was a story about the credit markets, and particularly the contribution of CDOs to the current squeeze. In discussing it, they mentioned that the ratings agencies had given AAA ratings to many of the tranches of debt - and consquently asked an analyst from Moody's whether the blame could be lain at the door of the ratings agencies.

Naturally, he was very much of the opinion that he wasn't to blame. He pointed out that the credit ratings agencies are about rating creditworthiness rather than market liquidity of credit instruments (which is much of the cause of the current squeeze). OK, fine, up to a point.

On the other hand, however, part of the problem is that many companies have ventured into buying credit derivatives as a way of earning from surplus capital. This has made it unclear exactly where many of the credit losses will end up (and therefore what the financial institutions' exposure is, and how much of their offloading of this risk will itself default). As Warren Buffet said when he called credit derivatives 'toxic waste', "it's only when the tide goes out that you see who is swimming naked".

Therefore, although they could only look at creditworthiness in rating CDOs, the liquidity of CDOs and other instruments must be a factor in other firms' financial stability (and hence creditworthiness) by determining how much risk they had exposed themselves to and how easy it would be to offload.

Therefore, weren't the ratings agencies in a perfect position to bring some much-needed transparency to this market by making firms disclose more (if not all) of their credit derivative liabilities?

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