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Somebody Has to Say It

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Just when you thought the debt ceiling crisis couldn’t get any uglier, Standard & Poor’s has downgraded the U.S. sovereign credit rating on the rationale that the government’s political infighting is an excessive risk, given the country’s debt load. That is weak sauce for downgrading the world’s single largest national economy, one that is still half again the size of China’s and has not actually missed a payment yet. To downgrade the U.S. over the political fracas that ensued last month over the debt ceiling is like getting your credit card canceled because Amex heard you had an argument with your spouse.

That S&P downgraded a number of top life insurers as well for their investments in Treasuries raises more questions about the methodologies of rating agencies than anything else. The financial stability of the life insurance industry is always a fair thing to question, given how many peoples’ financial security is riding on it. But for companies such as the Knights of Columbus, TIAA, USAA and New York Life to all get downgraded at the same time shows that either the industry is deeply out of whack, or the people rating it are.

I suspect the latter. I began my career at the A.M. Best Company, where I came to the conclusion that rating in general is a flawed business. One episode I recall clearly was when a California workers comp writer called Golden Eagle was raided by the California DOI in 1997. The move came as a bit of a surprise, as the company had – until the day of the raid, anyway – adequate ratings. So when the raid came, the ratings world looked foolish for having dropped the ball on what was supposed to be its core competency: determining insurers’ ability to pay for its obligations.

My favorite detail about Golden Eagle was that at the time of the raid, out in the company’s parking lot was a car abandoned by one of the company’s top executives, with a “How to Speak Spanish” cassette still in the tape deck. So much for this company being “adequate.” Whoever was rating Golden Eagle at the time surely failed the public just as much as it failed its own stakeholders. And yet, the Golden Eagle debacle is not the only one of its kind. Executive Life, Mutual Benefit, Confederation Life and Reliance Financial are just a few companies that all had decent ratings up until the moment when they collapsed.

Much like the NAIC, ratings agencies such as Standard & Poor’s and A.M. Best do not answer to the public they ultimately purport to protect. Normally, the free market is a great regulator. But not so much in the case of ratings agencies, where a black mark on one’s credibility comes as little solace to people whose lives and livelihoods are negatively impacted by bad ratings. Just ask anyone who got wiped out by the AIG collapse. No wonder the SEC is demanding rating agencies improve their transparency and integrity.

The silver lining to the U.S. downgrade is that unlike other ratings gaffes that have somehow eluded public scrutiny, S&P has acted on such a grand scale that it cannot possibly slip below the radar. If we need proof of that, one needs only to recall how a St. Louis banker hired a banner plane to buzz lower Manhattan–where the Standard & Poor’s office is located. The banner read: “Thanks for the downgrade. You should all be fired.” Indeed.


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