XXX-Ratings May Save Us From Financial Armageddon: William Pesek

Twelve-hour flights are a chance to catch movies you might not expect to be good entertainment -- such as “Too Big to Fail,” Hollywood’s take on the meltdown of Lehman Brothers Holdings Inc.
I watched it while flying from Tokyo to New York and kept thinking about what Lehman’s failure says about the Olympus Corp. scandal back in Japan. The off-balance-sheet risks, the tax havens, the impenetrable accounting, the smarmy and delusional executives saying all’s well, the hapless regulators.
Then it hit me. The world of finance should become more like the movies, with a rating system that actually makes sense.


In Japan, the public obsession is with whether Olympus executives will get jail time, or whether a corporate icon will be delisted. The real story, though, is how the business of finance gets done in the age of globalization.
For all the talk about transparency and the magic of markets (SPX), finance still thrives on opacity and public relations. It’s an art form with a small army of bankers, accountants and advisers moving complex, Dali-esque deals around the globe faster than even they can follow. It’s not just that the average investor can’t make sense of these transactions; they aren’t supposed to.
Rather than wasting taxpayer money on investigations and new red tape, why don’t regulators convert themselves into ratings companies? If the movies can red-flag objectionable or risky material with its “XXX” and “R” ratings, our financial regulators can, too. Let’s face it, with XXX you know what you’re going to get.

XXX Warning System

Let’s start with an XXX warning label on any company incorporated by way of a post-office box in the Cayman Islands, British Virgin Islands, Cook Islands, Jersey or any other kiss- and-don’t-tell jurisdiction. The message would be if you invest in this outfit, you may have no idea what this company is up to and you might lose your shirt.
If pension fund managers invest mom’s life savings in companies with XXX ratings without shareholders knowing, they go to jail. No exceptions. Instead, they would have incentives to invest in AAA shops (those safe for grandma) that make no use of offshore counterparties where it’s impossible to trace beneficiaries and that are fully compliant with U.S., U.K. or other regulations and tax codes.
Ratings as far away from XXX as possible would enjoy a sizable valuation premium. Not only would it scare up mountains of missing tax revenue that sovereign-debt issuers so desperately need, but it would make markets safer.

Star Power

Come on, can anyone really say our global credit-rating system works? Look no further than Standard & Poor’s downgrade of U.S. debt this year. Afterward, investors couldn’t get enough dollar-denominated securities. Then there’s MF Global Holdings Ltd., which S&P, Moody’s and Fitch Ratings all rated investment grade a week before bankruptcy. Congress is right to investigate whether Jon Corzine’s star power and political connections clouded judgments of the New York-based firm’s viability.
Recent events say much about the way markets continue to operate more than three years after Lehman blew up. Any system that allows debt issuers to shop around for the best rating is destined to be corrupt.
There’s lots of money to be made from slapping the desired rating on this mortgage-backed security or that sovereign credit. The combination of greed and creative analysis makes it hard to know what is legal and illegal in an increasingly global world.

Financial Cliff

Our credit-rating system also shows how little things have changed. It missed the Asian crisis 14 years ago and Russia’s default a year later. It was asleep on the job when technology stocks crashed, Enron Corp. imploded, the U.S. housing bubble inflated, Wall Street lost all sense of responsibility and Europe veered toward a financial cliff.
So, really, when credit raters raise China’s sovereign rating or bump Citigroup Inc. up a notch, it might be a sign to sell and brace for trouble. If 2008 taught us anything it’s that regulators are a few years behind the financial alchemists.
Had movie ratings for businesses been in place, we might have been deprived of the terrific scene in “Too Big to Fail” showing former Lehman Chairman Richard Fuld trying to sucker Korea Development Bank into buying his train wreck of a firm. Korean officials, very wisely as it turned out, sensed they were being played. Fuld, portrayed by the brilliant James Woods, quickly gets on the phone to find an easier mark.
We have seen this picture before, and a sequel may be in the works for 2012. We know how the first installment turned out. Regulators can and should protect investors and entire economies on the front end. If Hollywood can do it, the overseers of Wall Street can, too.