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Jul 17

CIT making credit rating system look foolish again

Posted by MQuinn in Credit RatingsBanksbankruptcy

As I was trolling through the morning headlines, this Reuters item stood out:

Fitch, S&P see CIT bankruptcy in near-term

I was hoping the story was from a few days ago, if not weeks. I've been under the impression that a CIT bankruptcy was "imminent or inevitable" for at least that long. Alas, it was from this morning and based on news releases yesterday.
Now, to be fair, the triumvirate of Moody's Investor Services, Standard & Poor's and Fitch Ratings had the troubled lender at junk ratings for some time, unlike in the cases of Enron, WorldCom and Global Crossing. Enron, of course, is the most infamous example of the agencies being slow in reacting, with the energy company holding an investment grade rating until four days before it filed for bankruptcy.

But as in the case of Enron, where S&P was the first to slash the rating below junk after it determined a takeover by Dynegy wasn't going to happen, CIT was holding onto what ratings it had based on hopes the U.S. government would swoop in and help it. The problem in both those cases is that actions out of the companies' control influenced the ratings. The ratings were not solely based upon the underlying soundness of their businesses, as one would hope.

Fitch downgraded CIT by eight notches yesterday after it became apparent the government deemed the lender was small enough to fail. Eight notches is a ton. That means the possibility of government intervention weighed heavily on the ratings and how heavily wasn't known until the cut was made.

Though the ratings agencies have a myriad of critics for an equally large number of reasons, they are still an integral part of the financial system. They are privy to information that the investment community is not and yet the investment community is far quicker in responding to what information it does have.

I'm not calling for a knee-jerk reactive credit system. I'm well aware of the havoc that would create. But I do have a problem where ratings are propped up by hopes of white knights and government intervention and not brought down to realistic levels until something has already become inevitable.

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