Standard & Poor’s and the other credit ratings continue to deceive

The great deception of Standard & Poor's

In brief: Standard & Poor's playing a double game. Credit ratings do not reflect the real picture and distort.

Countries can desperately cling to their credit ratings “AAA”, trying to keep borrowing costs low, but this does not mean that the corporate sector shared their concern about this issue. Average rating companies, valued agency Standard & Poor’s, dropped from “A” in 1981 to “BBB-” today.

This is the lowest possible “investment grade”, in other words, to “junk” was left alone step. By itself, this indicates a change in the intentions of both creditors and borrowers. Traditionally, institutions owning corporate bonds, were forbidden to buy anything other than securities of investment grade. Bonds could fall to junk level in the event of deteriorating financial condition of the issuer, but they were not at that level from the beginning. However, in the 70′s and 80′s. Michael Milken of the investment firm Drexel Burnham Lambert realized that there is a group of investors who want to take the risk of a diversified portfolio of junk bonds because of their additional revenue. And indeed, over time, an additional yield of these bonds is more than compensate investors for the risk of default. Lesson Milken stood the test of time, even though the bankruptcy of Drexel.

In the 90′s and early 2000. More and more people were willing to take risks for higher pay, since returns to cash and government bonds gradually decreased. Established dedicated funds “bad debts”, which is enthusiastically buying underpriced bonds, as investors comb the cost stock market in search of bargains. After the bursting of the dotcom bubble, activists urged pension funds to diversify their risks so that the securities are no longer a dominant position in their portfolios. However, the prolonged period of low interest rates and the occasional very mild recessions contributed to the growth of hedge funds and private equity companies that relied on leverage to increase their income.

The arrival of these new investors, perhaps marked by strong fluctuations in credit spreads (the excess returns to be paid by companies to cover the risk of default). In the midst of a credit bubble in 2006, spreads have fallen to historical lows. According to Jay Ritter of the University of Florida, the market often underestimates the risk of default on junk bonds. Mass emissions junk bonds provides companies large reserves of cash. In a few years before these stocks are depleted and the company will be in a quandary. Lowering the spreads, investors reduced the cost of capital and led the company to borrow funds in large quantities. At the same time, the desire for a high credit ratings out of fashion. Executives, stock up cash, was ordered to return to their shareholders that they have invested into other assets. According to the standard theory of corporate finance, first described Franco Modigliani and Merton Miller, the source of funding for firms, whether debt or equity, does not affect its value, just in different ways crushed cash flow. However, the theory does not account for the tax treatment for different types of finance. In most countries, interest payments are deducted from the taxable amount, and payment of dividends – no. The tax system may have contributed to the fact that the company borrowed more money, though, said Ritter, according to studies, the relationship between corporate tax rate and debt is insignificant.

Anrey Torbinski
2010-07-21 21:40, Economics.

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