Here's proof that credit rating agencies are just the worst

Credit rating agencies were vilified during the financial crisis for failing to detect risk in the subprime market before it was too late.

And in a recent note to clients, Sivan Mahadevan’s team at Morgan Stanley looked at the “Fallen Angel Spread,” or difference between the lowest-rated investment grade debt (BBB rated) and the highest-rated junk debt, and discovered just how clueless rating agencies really are.

According to Morgan Stanley, “It appears that rating agencies are oftentimes ‘late to the game,’ as their ratings decision usually occurs after materially negative information has already been well disseminated in the investor community.”

The chart shows BBB spreads widen ahead of a downgrade and blow out on the downgrade event.

However, once the downgrade is digested, the BB spread tightens. It seems then that for investors, the rating agency opinion only matters after the fact.

Interestingly, Moody’s Corporation’s stock price plunged 76% to a low of $US17.95 per share in February 2009 after the company and other rating agencies were criticised during the fallout from the financial crisis, but has since climbed 510% to its current level near $US110 per share.

Moody’s has significantly outperformed the S&P 500, which is up 211% over that time.

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