Author Topic: Alternatives to rating agencies?  (Read 527 times)

Unionville

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Alternatives to rating agencies?
« on: March 24, 2023, 03:08:29 PM »
After watching the Big Short years ago, and looking into it myself, I lost faith in rating agencies.  Are there other places you go to get more reliable information? Or do you still rely on the big 3 (Moody’s, Fitch, and Standard & Poor’s).  Forgive if this has already been asked. I did a search on MMM for alternative rating systems but didn't get many results. 

ChpBstrd

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Re: Alternatives to rating agencies?
« Reply #1 on: March 27, 2023, 07:11:03 AM »
One key issue is that financial statement manipulation and fraud can occur, and all the ratings agencies can work with is what the company reports. This is how Enron occurred, and it's part of the story of how a lot of the "NINJA" mortgages of 2005-2007 got approved and packaged as highly rated securities. If a company lies, they will get a high rating.

There are only a few ways an individual investor can mitigate the risk of owning the next Enron, Worldcom, Theranos, FTX, etc. First, buy what you can see in terms of physical products being sold or technology being implemented. Avoid what you cannot see, such as opaque markets only insiders can enter, technologies from one-trick-pony companies that seem to be on the cusp of something, unregulated business spaces, or new ways to make gold from lead.

The second risk, IMO, is that the ratings agencies do not account for black swan risk events that are hard to quantify. For example, their reports might mention something like "the bank's asset base may be stressed by rising interest rates", which is quantifiable, but then they'll miss the second order effect that a deteriorating asset base could cause bank runs, particularly at banks with a high percentage of uninsured assets, and the third order effect that bank run contagion could occur.

You have to think out these scenarios yourself.

 

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