High yield bonds, often known as junk bonds, have been very popular investments since the financial ...
Rating Agencies Out of Touch?
10/14/2013 12:00 pm EST
The problems with rating agencies during the mortgage crisis are well established and MoneyShow's Jim Jubak analyzes comments that suggest they haven't learned from the past.
One of the criticisms of generals is they always fight the last war. You know, you build the Maginot Line, because you remember World War I, and then the Germans simply send their tanks around it in World War II. Well, I would be happy if the ratings agencies, the ratings companies—there's not really agencies, they're just companies, like S&P, Moody's, Fitch—showed any signs of having remembered the last war. The last war, in this case, is the Lehmann-AIG Global Financial Crisis that started with the US sub-prime mortgage sector, and now what we're getting is a sense. I have a sense that the reports that are coming out of these rating companies don't really show an understanding of what went wrong then.
Remember that these ratings companies, if we give them the benefit of the doubt, got blindsided because they didn't really understand how all these instruments worked, and what I saw—we got a report from Moody's on October 7 that said, basically, "Hey, the debt ceiling is no big deal." Even if Congress doesn't extend the debt ceiling, doesn't raise the debt ceiling, the US isn't going to default, and it's really no big deal, no big deal, no big deal. Okay, here's my problem with that, which is, it's no big deal, if what you're doing is looking at this and going, "Oh, okay, so the US doesn't raise the debt ceiling and interest rates go up like 130 or 30 or 40 basis points with the long-end maybe," so you get some kind of effect, but it's not really a big deal. Interest rates are higher, growth may be a little slower, not the end of the world, but the thing that you don't really get a sense of in this report, or in any thinking that's going on in Washington right now, is how things are connected.
For example, at the very short-end of the treasury curve—this is for treasury bills of four or five weeks duration—you're seeing rates there go really through the roof. Basically, between the last auction on October 9 and the auction before that, a week before, yield in this sector has gone from 12 basis points; that's .12 percentages points, from 12 basis points to 35 basis points. A huge shift in a week, and you go, "Okay, so it's just 20 basis points, what's the big deal?" Well, the big deal is that this market is connected to all these others, and it's not so much the yield increase that's troubling, it's why it's happening, and what you're seeing is the big player in this short-end of the market is the Money Market Funds, and what they're doing is they're not buying short paper, because they're worried about whether this paper is any good, whether it's going to be tradable, and I think that's the key issue there. Worried that if they put money in this, it may not be something they can sell when they need to sell it to redeem money that shareholders are coming in for. They're basically pulling out of the market.
Fidelity, which runs about $430 billion dollars in Money Markets, decided about a month ago they weren't going to buy any new short-term paper that matured between October 18 and the next three weeks, the crunch time right after when treasury says it's running out of money. Last week, they said, "Well, not only are we not going to buy any new paper, we're going to sell what we have," so they're basically out of the market. If you're a Money Market investor, you think that's a good thing—safety first—and I think it is indeed a good thing. The problem is, of course, this market is connected to others; that Money Markets are a big player in the short-term commercial lending market—commercial market for commercial banks. Banks go to fund their cash needs in this market by issuing short-term paper themselves.
Well, if Money Markets are starting to sit on more cash and if they're starting to get really worried about short-term money, are they going to cut back on their availability of funds for this market? It's what happened in the Lehmann-AIG crisis. The Money Markets basically stopped lending money in the short-term market totally; the market freeze, and if we get that same kind of thing, where the market seizes up, Money Market funds are not making money available to banks, you certainly get a much bigger effect than simply a change from 32 basis points to 35. If this market freezes, the fed has got to provide a trillion dollars worth of liquidity or whatever it would need, as they did back in the Global Financial Crisis, so that's why it's a big deal. All the pieces are connected. We don't know how they're connected. One of the big things we learned in the Global Financial Crisis is the system has got lots of connections, that we don't understand by looking at it from our perspective. That's what I'm worried about going forward. That's why I think Moody's is wrong. That's why I think this is a big deal and that we ought to get this done before we really do something that we don't understand that's wrong.
This is Jim Jubak for the MoneyShow.com Video Network.
Related Articles on BONDS
It’s important for traders to watch various resistance levels like we have in the Dow right no...
Guggenheim’s sale of their ETF business to Invesco has been completed, and the BulletShares fu...
In early March, the 10-year yield was circling 2.87%. Now it is circling 3.00% for the first time in...