Thursday, October 20, 2011

Come on, Europe

These guys really don't seem to get it. This latest proposal out of Europe is so far beyond absurd that I'm not even sure how to respond.
In a confidential preliminary plan to reform the law on credit rating agencies, EU Internal Market Commissioner Michel Barnier seeks to prohibit rating agencies from publishing judgments about ailing EU countries. 
Barnier proposes that the new Securities and Exchange ESMA is granted the right "to temporarily prohibit" the disclosure of assessments of the ability to pay. 
Barnier has advised the rule take effect in November and wants to hold rating agencies civilly liable for damage caused by "poor" ratings.
Look, guys, you can't change the facts just by prohibiting people from speaking them. I mentioned yesterday in my Bank of America rant that toxic financial assets never went away or recovered value after 2008-09, they merely disappeared from public view due to an ill-advised relaxation of mark-to-market accounting rules. This was great for the banks in the short-term, and it allowed them to show book "profits" even while holding toxic garbage on their balance sheet. But now, we're seeing the flip-side of that balance sheet opaqueness.

A big part of the reason that American banks (especially Bank of America and Morgan Stanley) have found their stocks under such extreme pressure this year (BofA is down 52% year-to-date--from 13.34 to 6.37--even after a 24% rally in the last two weeks; MS is down 40%--from 27.25 to 16.25--even after a 40% rally off its low of 11.58) is that people don't know what they've got on their balance sheets, and can't possibly trust the bank's valuations without proper mark-to-market accounting.

Accounting fraud (or, at least, lack of accounting transparency) is NOT GOOD for stock valuations--in order for people to hold a stock, they must be willing and able to believe that what the company is telling them in their financial statements is actually true. Any opaqueness or obfuscation of truth is typically a death knell for the stock, as it allows rumor-mongering to take hold. There is little that any bank can do to defend itself against those rumors once they have taken charge, since their own lack of transparency is what empowered the rumor-mongerers in the first place.

Governments should and must know that the same rule applies to them and their debt. If people can't trust what a government is telling them, they won't buy their debt, plain and simple. Forcing rating agencies to tell people that "all is well" absolutely will not help matters. It will simply make it even harder for investors to derive the truth of the matter, which will erode their confidence and lead to frequent panics.

This latest proposal is, unfortunately, eerily familiar to those of us in the United States. It was just two months ago that the S&P ratings agency downgraded U.S. sovereign debt from its AAA rating to AA+ in the wake of the debt ceiling madness that showed us Washington at its worst. Washington's immediate response? No, it wasn't humble acceptance that perhaps their political process had some flaws that could be addressed--it was to launch an investigation of S&P for misconduct in their ratings process.

This kind of political grandstanding is wrongheaded, arrogant, and flat-out stupid. You can't change the truth simply by forcing people not to speak about it. In fact, as we've seen with banks and their toxic assets, hiding the truth simply makes you even less capable of changing it, creating a self-fulfilling prophecy.

[Mish Shedlock]

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