Ontonix: Rating the Rating Agencies–Moody’s “A3” rating

Moody’s is the largest of the Big Three rating agencies. It employs 4500 people worldwide and has reported a revenue of $2 billion in 2010. Since rating agencies have been under heavy fire since the start of the financial meltdown – in January 2011 the Financial Crisis Inquiry Committee claimed that "The three credit rating agencies were key enablers of the financial meltdown" – we have decided to actually rate one of them. We have chosen Moody’s because today it is the largest rating agency.

Ratings “farce”: SMEs facing credit ratings ‘lucky dip’

I am sickened at the thought of businesses upon which OUR recovery must be based, being treated in such a manner! The impact of Rating Agency “opinions” – which by definition are subjective – upon our global economy should be evidence enough that their influence is extremely dangerous and that an alternative, common, means of rating is a MUST.

Stories such as this one highlight the potential for them to continue to wreak havoc upon any chance of a recovery. We NEED to (re)build from the bottom up and inconsistencies such as a “spread” from £8,400 – £108,000 is all the justification a reluctant lender needs.

Where will the innovation come from, if “creative destruction”, from within crumbling institutions is stifled and small business starved of funding? If finance is about making an advance (loan) in anticipation of the rewards exceeding risk, doesn’t it mean that INNOVATION is a more stable (and robust) form of currency?

The timing of this piece is of particular interest to me and to Ontonix as we have just rated a rating agency (Moody’s)…check other recent blog items…and, of course, we have our own scientific, objective, rating service!

Small and medium enterprises (SMEs) in Britain face a ‘lucky dip’ when it comes to credit ratings, Management Today reports.

Following news that poor consumer demand and rising costs have put extra pressure on SMEs, it is important to keep a good credit rating so companies can get the best prices on business insurance.

However, a new investigation into credit rating agencies has found that many are giving out contradictory ratings to similar companies.

One company received credit limits varying from £8,400 by one agency, up to £108,000 by another.

Poor credit ratings can severely harm a business, causing refused loans or high interest rates on loans that may be necessary for business growth, while also making it harder to get good business insurance rates.

via SMEs facing credit ratings ‘lucky dip’ claims new investigation.

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Ontonix: Ratings – From an Opinion to Science

In January 2011 The Financial Crisis Inquiry Committee claimed that “The three credit rating agencies were key enablers of the financial meltdown”. Failing investment banks and large corporations enjoyed investment-grade ratings days before collapse.

Rating agencies claimed that ratings represent a mere opinion. And this is precisely the problem. Rating agencies represent a fundamental source of information for investors. Investors will evidently tend to invest in assets that are judged as investment-grade rather than junk. However, the First Amendment of the U.S. Constitution protects “publishers” guaranteeing them the freedom of speech.

A method of rating does not have to be perfect (is financial data 100% accurate?). But it has to be consistent. Serious science starts with consistent measurements. You can always improve a metric, make it more accurate, but you must use it consistently. If you don’t then mathematics indeed becomes an opinion and we don’t want that.

Governance–Risk–Compliance: accept responsibility to reap the rewards!

We know we can’t make reliable predictions about our environment..but it doesn’t stop us from spending enormous amounts of money to do so. Then to pay for the consequences of getting it wrong!

Introspection needs to get serious and, to do so, go beyond, “how can we improve our margins?” Apparently we don’t like to indulge in too much self-analysis, even though identifying and addressing “flaws” at source makes so much more sense. We can influence, manage or control what we do, why and how we do it. There is very little we can influence outwith our immediate environment.

To put this into a business context and convey the message about how complex any business can become, consider the following table:

If this is insufficient to convince you that there are enough risks associated with behaviour to be getting on with please consider how many of these could be addressed by a robust Operational structure!

If you still have doubts, perhaps this extract, from a very interesting paper, will help. It was the result of a collaboration between US National Academies/National Research Council and the Federal Reserve Bank of New York on an initiative to “stimulate fresh thinking on systemic risk”.

Catastrophic changes in the overall state of a system can ultimately derive from how it is organized — from feedback mechanisms within it, and from linkages that are latent and often unrecognized

Power Laws & Complexity Management

 

Mark Buchanan is one of the best writers on this most complex of subjects and this article (click on image for link) covers exactly what it says on the tin!

I particularly appreciate that he tackles key aspects of the wider subject in such a manner as to make it readily understood by anyone with a desire to learn and apply what the knowledge.

Business leaders NEED to understand the nature of  complexity and the threat of self-generated risk (excessive complexity for poor structure, processes, etc.): risk resulting from the execution of the processes that facilitate functionality.

Also, to appreciate the systemic risk exposures communicated by organisations with whom they trade…without which they would fail…reinforces the most pressing need for in-depth assessment of existing and prospective partners…both up and downstream.

MB illustrates this point and the exposure that comes from Global Supply Networks “beautifully”, by recounting the sorry tale of the enforced departure of Swedish company Ericsson from the mobile handset market thanks to a factory fire in Mexico!

 

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