Rating agency worker: 'I am genuinely frightened'

The global meltdown terrified the City. But many are more worried that no controls have been introduced since 2008

• This monologue is part of a series in which people in the financial sector speak about their working lives

'I was on holiday in the runup to the collapse of Lehman Brothers, when the crisis exploded. It was terrifying, absolutely terrifying.' Photograph: Linda Nylind for the Guardian

We are meeting in the heart of the City after the banking blog called on rating agency employees to talk about their experiences. The man I am meeting is British, in his early 40s, a fast talker and very friendly, the sort of person to apologise profusely when arriving four minutes late. He orders an orange juice.

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"Every time I read about a new financial product, I think: 'Uh-oh.' Every new product is described in those same warm, fuzzy phrases: how great they are and how safe. Well, that's how credit default swaps and asset-backed securities were explained when banks were introducing these.

"I still get so angry when I think about it. Taking a job at a rating agency seemed a perfect match: drawing a good salary while providing a service of genuine value for society. We need ratings to work out how safe a company or an investment bond is, what the risk of default might be. If you can't trust it, you shouldn't do business with it – it's that simple.

"The reality was very different. What's making me even angrier is that we don't seem to have learned from the crisis. It's back to business as usual. I am no longer with a rating agency, and when I ask former colleagues what lessons they've taken away from the 2008 debacle, they give me a blank stare and say: 'That wasn't us, that was Moody's and Standard & Poor's.' But we just lucked out: our methods were similar.

"Moody's and S&P are the two major credit rating agencies in the world. Between them, they control 80% of the market and they are large, rich and powerful. Then there's Fitch, desperately trying to get the training wheels off and grow. Finally, there are specialised smaller agencies, one of which I was working for.

I was there when the great collapse of 2008 happened, giving me a ringside view. My agency was incredibly lucky never to have expanded into areas we didn't understand. Our head office was very conservative. This saved us.

"I was on holiday in the runup to the collapse of Lehman Brothers, when the crisis exploded. I remember opening up the paper every day and going: 'Oh my god.' It was terrifying, absolutely terrifying. We came so close to a global meltdown. There I was on my BlackBerry following events. Confusion, embarrassment, incredulity … I went through the whole gamut of human emotions. At some point my wife threatened to throw my BlackBerry in the lake if I didn't stop reading on my phone. I couldn't stop.

Now here we are four years later, and the most incredible thing has happened – we've learned nothing from the whole thing. Everybody pretends it's all OK. Sometimes I feel finance has reacted to the crisis the way a motorist might respond to a near-accident. There is the adrenaline surge directly after the lucky escape, followed by the huge shock when you realise what could have happened. But then, as the journey continues and the scene recedes in the rearview mirror, you tell yourself: maybe it wasn't that bad. The memory of your panic fades, and you even begin to misremember what happened. Was it really that bad?

"If you had told people at the height of the crisis that four years later we'd have had no fundamental changes, nobody would have believed you. Such was the panic and fear. But there we are. We went from 'We nearly died from this' to 'We survived this'.

"Have you read Gillian Tett's Fool's Gold about the crisis? It was exactly like that. You had bankers who did not understand their own complex financial products but thought that they did, and then raters who took their word for it. And nothing has fundamentally changed.

"As most people understand by now, lots of sub-prime mortgages were bundled by banks into financial products and sold on to investors. These believed they bought a very safe thing because the products had been rated triple A, which meant that there was only a 1% or so chance of a default.

"When the crisis hit, it hit hard, reality kicked in and the rating agencies suddenly downgraded triple A products to junk status in a matter of days. I won't call it fraud; I will call it a 'desperate revision of history'.

"Overall, it was more incompetence than outright fraud. If the sub-prime mess had been a huge conspiracy, it would have been very, very difficult to keep that a secret all these years. Too many people were involved. As far as the rating agencies were concerned, it was incompetence brought on by short-termist, bottom-line thinking by senior management who just wanted to make money. That meant rating as much as possible, as often as possible.

"The big change in rating agencies started around 10 years ago. Before that time Moody's was seen as boring, quiet, nerdish. Analysts there were seen as researchers, studious types. Then new management came in and they threw this out of the window. They pushed a culture that was driven by a desire to just keep rating. And they hired people that reflected their thinking.

"Imagine you are a rating agency and you see this new product coming in. You realise: if we rate it, we can keep on rating products like it, as this is the beginning of a continuing stream. And a huge stream it was: thousands and thousands of products offered for rating – and each for a fee.

"But, at the same time, rating agencies senior management have become so focused on the bottom line. There's constant cost-cutting. Demanding more from fewer and fewer people. Obviously, the quality of a rating declines when there's less time to study a company and its business plan. In my time at the company, there'd be no paid overtime, no time off after you worked through the weekend, let alone a word of thanks.

"Ultimately the work suffers, more so when there are endless internal restructurings. Two heads of department in my agency had their department organised out of existence overnight. A little while later, one was resurrected when top management realised what it had done. Higher management often doesn't properly understand what's going on in its own organisation. They are constantly redrawing the map, to the point where it feels like the map has become more important than the journey.

"When asked about the crisis, rating agencies use the defence that the bankers who designed those complex financial products did not understand them themselves. So how can rating agencies be blamed for not understanding them either**?

"But you shouldn't just rely on the information given to you by the people whose product or company you are rating. Imagine a doctor who bases his diagnosis only on what patients themselves are telling him. If they are lying to him, the doctor is lost. If they are lying to themselves, ditto. Or imagine you went to rate the UK and all you do is ask George Osborne how things are with the country.

"With every new financial product, raters should be asking: have the products been tested properly? Are they modelled for all possible conditions, so boom as well as bust times? Do we even know what it does in every phase of the economic cycle? Do we know how the product is likely to evolve over time, how will it behave when it develops into a bubble? The thing is, you cannot ask these questions if you are permanently understaffed and under-experienced.

"Young analysts are much cheaper than experienced ones. And giving people a thorough training again costs money and takes a long time. If you're young, you will assume that what you've seen until now in your life is 'normal', when it might not be. More than that, young people lack not only experience in business but also in life*. When interviewing management, you need to be able to read people, to have developed alarm bells for when they might be lying to you – or worse, lying to themselves.

"This problem exists on both sides of the divide. Many of the most dangerous financial products are designed by the same kind of fresh-faced, straight-out-of-university boys and girls. They have never seen a market panic. They are too young to know the true face of the market; they don't see how products can be misused. What they do see, and tell their bosses, is how their product can make money.

"Finance is continuously evolving, so you have highly niche financial areas that fewer and fewer understand. This all but guarantees misunderstandings. Rating agencies have mostly generalists and very few niche specialists. Often you get someone specialised in product A to rate product B, even though they are 20% different. This is where misunderstandings are quite likely to arise, when a specialist mistakenly believes that his expertise is applicable to adjacent niches.

"I am genuinely frightened. What are the ratings agencies missing at the moment? What are the companies that they're rating developing? What's the next miracle financial product and how badly is it being misunderstood?

Also read

Ratings Agencies - The Power of Modern Day Astrologers 

Warren Buffet - a Jaded Sage?

The jaded sage
By Chan Akya in Asia Times Online

Warren Buffett, besides being the Sage of Omaha and one of the wealthiest men to ever walk this planet, is also an American hero. A man who popularized the notion of investing your savings prudently, taking a knife to Wall Street excesses and more recently, the architect of an effective minimum tax for rich Americans. All in all, your regular billionaire next door.

Of course I can also recount all the reasons why anyone who bothered to print this article and read the first paragraph got disgusted, crumpled the paper into a little ball and threw it into the nearest waste bin.

You know, stuff like his holdings in major American scams like Moody's which he purchased due to the massive profits they were making from selling fake triple-A ratings all around. Or his rescue of such amazing firms as Goldman Sachs in the midst of the financial crisis, in effect protecting them not so much from aggressive market speculators but perhaps the major regulatory bodies as well (Mr Buffett is a known supporter of and donor to President Barack Obama).

Even that supposed act of folksy good humor ("my secretary pays a higher tax rate than I do") hides an ugly word: "legacy". Mr Buffett is old and if he had wanted to pay higher taxes, well he had the last 60 years in which to do it.

But I don't care about any of Mr Buffett's flaws any more than I lose sleep over that stupid woman who unfailingly puts mayonnaise on my sandwich despite being told not to every day. My getting upset doesn't change a thing, and just ends up spoiling my day: it's easier for me to just buy my sandwiches somewhere else. That's where I left Mr Buffett - that is, until his latest investment letter hit the web and through acts of generosity by my friends, made it into my inbox. Ten times over.

Cold on gold
I don't know why so many of them did that - but it may have something to do with his statements about irrational choices that investor make about assets. He writes:

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth - for a while.

Okay, so if I understand this right, Mr Buffett objects to the fact that gold cannot be manipulated, conjured up out of thin air and that it draws a bunch of people weary of Keynesian money printing into its fold. I am not going to suggest that Mr Buffett is thick or something, but isn't all of the above the very point about owning a store of value in the first place?

I don't know about you, but if I could travel through the centuries I would sure as hell like to have in my pocket something that would still be worth something in purchasing power that approaches its current value.

Imagine the following scenario: your grandfather leaves us some wealth but you only get it 50 years later. Now, what would you have liked that "wealth" to have been: cash in US dollars or gold coins? Of course other assets would have worked better - "shares in Apple" for example. Then again, if your grandfather had given you shares in Apple and you got them in 1998, your general feelings of gratitude towards him would have been a somewhat dimmer.

Then Mr Buffett goes on with his diatribe:

Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce - gold's price as I write this - its value would be $9.6 trillion. Call this cube pile A. Let's now create a pile B costing an equal amount. For that, we could buy all US cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

... A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops - and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Yup, valid points there. Then, again Mr Buffett, I wonder how those farmers would pay for the oil to use in their harvesters and how those oil workers would pay for all the grains they would need to eat. Would they own shares in each other and pay the other party dividends in kind? Or would they transact with a common currency, like gold?

And all the analysis misses the point about corporate fraud, that uniquely American preoccupation that has seen many a top firm go completely bust because of financial and accounting shenanigans. If Mr Buffett had mentioned BP instead of Exxon (and written this article two years ago rather than now) he would have had egg on his face. (See also "BP, Bhopal and Karma", Asia Times Online, June 19, 2010, one of my past articles on the subject of corporate responsibility.

Mr Buffett misses the point entirely about what gold is and what it is supposed to do. In a world where investors have ample reason to lose faith in governments and the financial system, the position of a common store of value that is recognizable and usable across all humanity and is itself beyond religion and politics in terms of being manipulated around (besides being no mean feat by itself) is made stronger, not weaker.

That is not to say that I am recommending you folks to buy gold and nothing else; my view has always been that a building up a little hedge for your financial assets with physical gold is no bad thing. I don't speculate in gold nor do I believe you should.

Of course, he clarifies similar points later on his spiel as follows:

My own preference - and you knew this was coming - is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM and our own See's Candy meet that double-barreled test. Certain other companies - think of our regulated utilities, for example - fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets. Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See's peanut brittle. In the future the US population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.

Really? The best that Mr Buffett can conjure up as stores of "productive" assets are those that generate software consulting services, sugared water with noxious chemicals and over-sweet artificially flavored foodstuffs? Is it possible that all of these companies will even exist 200 years from now, or will a bunch of lawsuits or corporate fraud take one or more of them down as they have many an American corporation?

This is neither about questioning his investment choices nor indeed to taunt a proud American on that country's potential failings. The investor letter though is emblematic of the core ill plaguing the West now; namely a failure to question the current logic of organization underpinning the economy.

On the other end of the scale, it is not immediately apparent that a deleveraging America would need as many cans of sugared water with noxious chemicals as it does now; nor indeed that the current system of savings through stocks could survive a Japan-style lost decade when the locus of the economy shifts from consumption to production.

In a different way of thinking, it is a good thing that Mr Buffett writes his letters the way he does now. Two decades from now, economists and students of finance may ponder the madness of our times that made a man like him the foremost investing genius in the world.