Rating agencies swinging the job axe

By: Daryl Ching, Clarity Financial Strategy

John Greenwood from the National Post, published an article about DBRS closing their European offices. DBRS eliminated about 70 positions, which represents about one quarter of the entire workforce and includes individuals from their Frankfurt, Paris and London offices. The article also points out that Moody's eliminated 275 people last year out of a total workforce of about 4,000 and Standard and Poors will be looking to reduce its workforce by about 3% this year.

The rating agencies have been hit hard by the global credit crunch, as investors had relied on their ratings to make purchases of structured product. Their credibility has come into question. People have pointed the finger at DBRS for their unique General Market Disruption liquidity protocols and their CDO methodology that permitted mark-to-market triggers. S&P and Moody's will need to explain why they stamped AAA on numerous US subprime mortgage transactions, of which many have been downgraded and are facing liquidation and losses today.

Many people have asked me if I think the rating agencies will survive. I think it really depends on how they respond to the current situation. As for DBRS, in response to the events in August, they have changed their liquidity criteria to Global Style Liquidity, which is more resilient that the previous type. DBRS's use of market-to-market triggers for CDO transactions has also been called into question as the underlying credit default swaps are generally under water. The indication we have received from Mr. Crawford's Committee is that we are moving away from mark-to-market triggers with the CDOs and replacing them with spread-loss triggers. The outcome of the restructure proposal will be a true test to determine if rating agencies are continuing to use their current methodologies or if they have revised them in light of the current situation. S&P and Moody's will need to explain how they got comfortable stamping the highest rating on US subprime transactions.

Investors will be demanding some answers. My advice for the rating agencies is for them to come forward, take responsibility for errors in their criteria, explain how they happened, and address what steps they will be taking to prevent them from happening going forward. Rating agencies play a vital role in the capital markets, but every step must be taken to restore investor confidence at this point. Whether the rating agencies survive or not will depend on their actions over the next few months.