I'm Downgrading Moody's

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.  

Fool contributor Adam J. Crawford does not own shares of any company mentioned in this article. Motley Fool newsletter services have recommended buying shares of Moody's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On July 15, 2011, at 12:58 PM, DonNemesis wrote:

    Great. Basically, this article suggests that statistics, models (and yes, coupled with informed opinions) are, well, "junk”; this article can be extrapolated to suggest that if someone, oh, let’s say, an analyst at Moody's, Fitch, or S&P predicts that after two flips of a coin, both of which were tails, we get another tails, this analyst’s prediction was, well, “junk”.

    Interesting theory, but I think smart thinks otherwise. This article, and many similar unfounded, mildly ridiculous comments may just be the reason why some of us are able to make money in any market – thanks, buddy!

  • Report this Comment On July 15, 2011, at 2:46 PM, Ikarruss wrote:

    If Moody's is slow and is still considering downgradig US bonds, why are they so high?

    Note this is just a Foolish question, I guess that a 4% yield on a stock, that might have an upside is a little better than close to 0% on a indexed T-bond, just hopping for high inflation (and no dollar devaluation).

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