Bill Gross on the incompetence of the ratings agencies

Firms such as PIMCO with large credit staffs of their own can bypass, anticipate and front run all three, benefiting from their timidity and lack of common sense. Take these recent examples for instance: S&P just this past week downgraded Spain “one notch” to AA from AA+, cautioning that they could face another downgrade if they weren’t careful. Oooh – so tough! And believe it or not, Moody’s and Fitch still have them as AAAs. Here’s a country with 20% unemployment, a recent current account deficit of 10%, that has defaulted 13 times in the past two centuries, whose bonds are already trading at Baa levels, and whose fate is increasingly dependent on the kindness of the EU and IMF to bail them out. Some AAA!

Now let’s go the other way. GMAC, that only too recently near-bankrupt finance company, carries recently upgraded B ratings from the rating services. Profiles in courage for all three, I say! I mean the U.S. government has injected $20 billion of capital and owns 65% of the company. It’s the auto industry’s equivalent of FNMA and FHLMC, except those are AAA and GMAC is B with a “positive outlook!” For that, you can buy a GMAC two-year bond at 6½% (8% with what are called “smart notes” that Investment Outlook readers can buy through their broker), while you receive only 1.2% at Fannie and Freddie. Vive la différence!

~Bill Gross, founder, PIMCO, "Investment Outlook", May 2010

Paul McCulley on the ratings agencies

[The breakdown of our financial system] was about the invisible hand having a party, a non-regulated drinking party, with rating agencies handing out the fake IDs!

~Paul McCulley, PIMCO, as quoted by Bill Gross, date unknown

Bill Gross on the ratings agencies

In all of the hullabaloo over Goldman Sachs, a CQ analysis of the rating services – Moody’s, Standard and Poor’s and Fitch – has escaped front-page headlines. Not that a number of observers haven’t been on to them for a few years now, including yours truly. Back in July of 2007 some of you will remember my description of their role in the subprime crisis. “Many of these good-looking girls are not high-class assets worth 100 cents on the dollar. You were wooed, Mr. Moody’s and Mr. Poor’s, by the makeup, those six-inch hooker heels and a ‘tramp stamp.’” Now, it seems, I was a little long on humor and a little short on the reality. Tramp stamp and hooker heels do not begin to describe the sordid, nonsensical role that the rating services performed in perpetrating and perpetuating the subprime craze, as well as reflecting the general deterioration of investment common sense during the past several decades. Their warnings were more than tardy when it came to the Enrons and the Worldcoms of ten years past, and most recently their blind faith in sovereign solvency has led to egregious excess in Greece and their southern neighbors. The result has been the foisting of AAA ratings on an unsuspecting (and ignorant) investment public who bought the rating service Kool-Aid that housing prices could never really go down or that countries don’t go bankrupt. Their quantitative models appeared to have a Mensa-like IQ of at least 160, but their common sense rating was closer to 60, resembling an idiot savant with a full command of the mathematics, but no idea of how to apply them.

~Bill Gross, founder, PIMCO, "Investment Outlook", May 2010

Jim Rickards on similarities between Greece and the US, gold as an alternative currency

I'm having trouble finding a Greek metric where the US isn't as bad or worse, or will be shortly. You look at where our deficit-to-GDP ratio is, you look at where our debt-to-GDP ratio is going, money creation and other things-- we look a lot like Greece.

One big difference is that we can print our own money. But where does that get you? That's really the problem world-wide.

In every asset class, investors no longer think about the fundamentals, they think about government policy. In China, the question is, can the government prop up the housing market? In Europe, can the government prop up Greece? In the United States, can the government prop up the banks? We don't think about the fundamentals or balance sheets anymore.

[The US dollar and Treasuries] are the only place to go, but there are limits to that. The G-20 and the leaders may try to go to the IMF and SDRs to take the dollar off the hook, the market may go to gold on their own. So, it's kind of a race between SDRs and gold.

~Jim Rickards, senior managing director of market intelligence, Omnis Inc., CNBC Squawk Box, May 5th, 2010

Jimmy Cayne on the fantasy belief of politicians that legislation can alter reality without cost

If it was easy as just saying it and then doing it, it would've been done already.

~Jimmy Cayne, former CEO, Bear Stearns, Financial Crisis Inquiry Commission testimony, May 5th, 2010

Myron Scholes on the importance of risk modeling

I haven’t changed my ideas. A bank needs models to measure risk. The problem, however, is that any one bank can measure its risk, but it also has to know what the risk taken by other banks in the system happens to be at any particular moment.

~Myron Scholes, 1997 Nobel prize in economics winner, "Crash Course", NYT Magazine online preview, May 5th, 2010

Franklin Raines on the erosion of credit standards

Most of the erosion in credit standards happened on Wall Street, it didn't happen amongst the GSEs. Wall Street led with the securitization of subprime loans, they led with the securitization of non-performing loans, loans that didn't fit the Fannie and Freddie standards. So, they really were the engine.

~Franklin Raines, former chairman and CEO, Fannie Mae, CNBC, May 4th, 2010