Misgivings about ratings agencies

For all the talk of all this being such a deliberative scientific process . . . to have this decision was remarkable to me.”

That was US Congresswoman Jackie Speier speaking. She went on to say that the analysis “should have been disciplined, and they should have gone back and looked at their modelling”.

She further said that they had made a political determination, not an analytical one, and that she was “flabbergasted” by this approach.

So, who was Speier talking about? Well, she was talking to the CEOs of ratings agencies Fitch, Moody’s and S&P Global Ratings.

And what was she talking about? This discussion took place in 2008 and focused on the spectacular bankruptcy, and then total collapse, of Lehman Brothers Bank in the US. Lehman was one of the casualties of the US subprime home mortgage implosion, which started in 2007.

What got the Congresswoman so upset was that, up until the day Lehman went bankrupt, the three ratings agencies had rated Lehman between AAA and A. They were spectacularly wrong.

Speier then asked the three CEOs if anybody in their firms had been disciplined or fired for being so wrong. They said no, they had been bargaining on a big bail-out coming from somewhere to save the day.

Speier answered: “But that’s not analysis, that’s an opinion. I can have that kind of an opinion, and I’m not an analyst. How could you possibly make that kind of a decision based on an opinion when you have millions of people relying on that?”

Subsequently, the US Department of Justice sued S&P over its role. A professor of finance at the University of Texas-Austin, John Griffin, in referring to the agencies, said: “They understood that they were pushing the envelope on these products, but they didn’t care. They were focused on the profit they were getting from the deal.”

For some time, I have felt uncomfortable about the ratings agencies. How can some financial firm in the US make an accurate determination of South Africa or any other foreign country?

What concerns me more is that the determination is carried out by financial people. Okay, I do not know the exact composition of their teams, but I picture a group of half a dozen banker folks at desks looking at financial figures.

Can they factor in the spirit of progress in South Africa? Can they factor in a whole load of other nonfinancial factors, which are so critical to real progress? Think of companies or organisations that became successful against all odds. Or those which started in places, or under circumstances, that caused many to predict that they had no chance, but which actually came out most successfully. I can think of a number of such companies or organisations.

From time to time, business schools invite me to teach a course on strategy. I enjoy the student interaction. One thing which I teach, and which is international opinion, not just mine, is that there is always a default scenario. That is the one which seems to be the correct, obvious one. Truth is that the default scenario almost always turns out to be the wrong one. So, you have to allow for others, not only reason- able others, but also unreason- able others. Think of what has happened to the oil price in the past. It swung up and back by 300% in a year and a bit. Who would have predicted that six months before it started?

So, how can the foreign ratings agencies pronounce what amounts to a default scenario for South Africa? I understand that they can look at certain macroeconomic figures and give broad-brush advice, but to make ‘rulings’, to my mind, is presumptious and wrong. This is particularly so when their pronouncements then result in such visible economic effect.

When I teach strategy, I point out that you have to have a band of options and be prepared to change fast because circumstances change. You are in real trouble if you just believe your default scenario.

I do strategy analysis and development for all sorts of companies, including a couple of major banks. I am often surprised at how limited their vision is or how much they cling to a default scenario because it is the one they hope will come true.

Reality, almost always, turns out to be that it is not a case of just changing some financial numbers on paper that makes the difference but, rather, it is a set of actions and innovative ideas that make all the difference. Of course, the personal drive and determination of the people involved is a critical factor.