Moody's (NYSE: MCO ) is considering a downgrade of the U.S. credit rating, an event many predict will cause widespread panic in the marketplace. But should the threat of a downgrade mean anything to investors? Because if history has taught us anything, it's that Moody's rating process over the past few years can best be described as junk.
In 2007, Moody's slapped a triple-A rating on Abacus, a portfolio of Goldman Sachs (NYSE: GS ) -created mortgage-backed securities. Abacus became an attractive investment upon receiving Moody's seal of approval.
It turns out Abacus was barely worth the paper it was written on. Moody's eventually downgraded the collateralized debt obligation after it had already lost much of its value. According to the SEC, investors lost $1 billion on the deal.
Moody's credit assessment of AIG (NYSE: AIG ) and now-defunct Lehman Brothers in the height of the subprime crisis is another ratings classic. Moody's still maintained investment-grade ratings on the two foundering financial institutions even minutes before they collapsed.
Moody's defended the rating, saying the likelihood of a government bailout played an important role in the decision.
AIG eventually did receive a bailout. Lehman Brothers, on the other hand, wasn't as lucky. The financial giant declared bankruptcy, prompting Moody's to finally cut its rating on the company to junk. Gee, thanks for the heads-up, guys.
The bottom line
If you believe there is more financial turmoil on the horizon, then don't wait on a Moody's downgrade before moving cash to the sidelines. By the time such a downgrade occurs, it will most likely be too late.