DUDE: Rug pee-ers did not do this.

       -- The Big Lebowski (1998)

Prominent in the vast and ever-growing bestiary of people being blamed for the ongoing financial crisis are the credit rating agencies. It is their ongoing downgrades of structured paper -- stuff on which they slapped triple-A ratings a few years ago during a fog of slavish stupidity -- that has gutted the balance sheets of so many firms, causing them to keel over precipitously.

That's the argument anyway. To be fair, it's not new. People have been blaming credit ratings agencies for some time, and they have a point or two, but they're still mostly wandering afield.

First, credit rating analysts are generally sweet people, but they're not universally the sharpest tools in the financial shed. After all, when faced with the numbing work of weeks dawn-to-dusk building sterile spreadsheets that max out Microsoft Excel's row/column counts, and still being bullied by jejune debt issuers, who among them wouldn't have historically jumped over to Goldman/Morgan/CreditSuisse/UBS/etc., for 5-10x the salary? In other words, the people who hang around at agencies for a while tend toward numb lifers or newbies, neither of which you can expect to untangle the myriad nuances of the latest Constant Proportional Collateralized Mortgage Debt Obligation thingie sprung on them by lethally talented structured finance sorts. It just isn't a fair fight.

Second, and somewhat more seriously, credit ratings agencies are  a government creation. Through a collection of overlapping indifferently updated regulations, they have ended up with a nifty oligopoly as Nationally Recognized Statistical
Ratings Organizations, which is not only a mouthful of opacity, but mighty profitable, as they are required if you want to rate issues, and competitors are kept out. It is why it's more profitable for agencies to be paid by issuers, as opposed to having a subscription model: You're kind of the DMV of the debt highways. Either way, the reason why the credit rating agency ratings are so seriously hooped is more about government stupidity than about credit rating agency malfeasance: Ratings have never really needed to be that good.

Third, and this is something most people seemingly don't get, credit ratings change over time. Not only that, they change in ways that feed back into themselves. Consider the case of a company whose debt was triple-A at issue, but whose stock has now fallen. That makes it more difficult for the company to raise money and satisfy its liabilities, so you have to think about cutting the rating. But cut the rating and the stock will fall further, leading to more trouble raising money, leading to a lower rating, and ... well, you get the picture. It's a classic feedback loop, and there is diddly you can do about it. Pretending share prices don't affect credit ratings is silly, but once you acknowledge it then you acknowledge the possibility of a death spiral as the two get into a low-altitude hug and your company slugs, liabilities last, into the ground.

Combine a government-created oligopoly, rapid financial innovation, negative feedback loops, and a horsepower gap between the issuer and rater, and what you have is a recipe for a big problem. And that is precisely what has happened. It must be obvious by now, however (to paraphrase The Big Lebowski), that the credit rating rug pee-ers are not the issue. The credit ratings agencies could hardly been better designed by government to provide structured finance issuers with cover for regulatory arbitrage.  And what's what has happened, much to our collective financial pain.

So, do we reform the credit ratings agencies? Sure. Stop them from being paid by issuers. I'm fine with that. But why stop there? Why not reform them right out of existence? We don't have a rating requirement elsewhere in financial markets, let alone in the real world. There are no government-certified equity or mutual fund ratings agencies, even less restaurant ratings agencies, or bicycles. So why do we have credit ratings agencies? The market does a better job of rating debt securities anyway, via this thing you have heard of called credit spreads. The only things that hurt spreads as de facto ratings agencies are that they are transparent, straightforward and inexpensive, all of which make them much less fun than doling out licensing largesse to new credit rating agencies.

I've been scanning the SEC's just-released rule banning shorting of financial stocks. According to the SEC, a staggering 779 stocks are covered by the order, which goes into effect immediately. The SIC codes covered are 6000, 6011, 6020-22, 6025, 6030, 6035-36, 6111, 6140, 6144, 6200, 6210-11, 6231, 6282, 6305, 6310-11, 6320-21, 6324, 6330-31, 6350-51, 6360-61, 6712, and 6719. I'm sorting through the list of companies now.

At the same time, the SEC is instituting a new institutional disclosure form for weekly short sale activity in non-financial stocks. Starting now, the form must be completed on a weekly basis (!) in any week when a fund manager initiates, adds to, reduces, or closes out a short position. The rule comes into effect on September 28, 2008, and expires on October 2nd, unless extended by the SEC (which I'm assuming it will be).

What a mess.

More here.

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[Update] A few quick nuggets from perusing the list:

• Some SEC dyslexic likely meant MPB, which is Mid Penn Bancorp, and they blocked shorting of MBP instead, which is Metabolic Pharmaceuticals.
• Lehman is on the list, which is hugely reassuring given its current bankruptcy status.
• The SEC is blocking shorting of NAHC, which is Nigerian Aviation Holding Company. Damn Nigerians. It's not enough they have all the best scams; they get shorts blocked too.
• Silver State Bancorp is on the list. Recall, it's a failed bank already seized by the FDIC.

Great. Now Nick Leeson, who famously brought down a bank himself through the use of derivatives, is scolding us. I love, in particular, how he ties the credit crisis to being offered five credit cards after taking down Barings Bank.

The authors of this horror story - the banks themselves - are not just technically insolvent. They are morally bankrupt. The onset of these problems dates back more than a decade, with the sub-prime crisis exacerbating the problem 18 months ago. At both a micro and macro level, credit became far too easy to acquire, leading to businesses and individuals increasing their exposure at a record pace to record levels.

Who is responsible? Those same bankers that convinced you that another loan was not a bad thing. Those same bankers that convinced every wannabe property developer that they should leverage their portfolio and increase their volume of business. And unquestionably culpable were the investment bankers who wrapped up the sub-prime debt in exotic parcels and visited your offices to sell you this most fantastic investment vehicle. The property market has collapsed and probably still has further to go, the tremors from the sub-prime crises are still being felt, and the combination of the two sees the whole financial system in peril.

Quite simply, the banks have traded recklessly over the past 10 years and have put everybody's wellbeing at risk. Anybody and everybody could get whatever credit they wanted as recently as three years ago. I returned from Singapore in 1999, responsible for £862m worth of losses that brought down Britain's oldest investment bank, personally liable through an injunction for £100m, and yet within the space of a week had been offered five different credit cards. Ridiculous! Any central bank will tell you that the system exists on the premise of "responsible lending"; but the experiences of the past few years clearly show this is utter rubbish.

More here.

After radio silence throughout most of this financial crisis, President Bush (you remember him, right?) spoke today -- and he did better than I expected. I thought he was direct, calm, and relatively on-message. I'll post a full transcript when I can find one, and you can link to the video by clicking at right, here.

You can choose to disagree with the actions being taken, but at least the President is -- as I've been demanding for two weeks -- finally out in front of the parade and attempting to justify spending so much of taxpayers' money.

By the way, I'm reasonably sure there was a Bush-ism in there: I think Bush said that market manipulators will be "persecuted". While that is almost certainly true, I'm guessing he meant "prosecuted".

Quite a day on the markets now that there are no evildoers around. Check the market map, which shows that things have settled a little from early euphoria, and there is some selling in consumer staples names, plus in Microsoft and Dell, and a few other suprising names.

[via Finviz]

A bizarre and (frankly) mischievous claim is making the rounds that perhaps terrorists are behind the wave of stock shorting that has caused so many financial stocks to be taken hors pistes. I'm somewhere on the other side of dubious of this claim.

Anyway, a Carl Sagan quote to keep in mind when you hear that sort of wild-eyed thing:

Extraordinary claims require extraordinary evidence.

Works for alien abductions just as well as for "Al qaeda conducted a bear raid" claims.

I'm on CNBC's Power Lunch today at 1pm EST. Not sure what we'll talk about, as it's a fairly quiet day out there.

Here is the word cloud of Treasury Secretary Paulson's speech this morning, and it is followed by the cloud for President Bush's speech. Some interesting differences in emphasis.

President Bush:

[via Wordle]

From an email I was forwarded today, if you took this week off you missed much less than you think. Like almost nothing at all.

        **9-12-08 CLOSE**   **9-19-08 AFT**

S&P        1252                1251

DOW        11422               11391

2YR        2.21%               2.13%

10 YR      3.72%               3.75%

6MO BILLS  1.55                1.51

FN 30 5s   98-20+              98-20

Since policymakers are decrying Wall Street as newly being a casino -- haven't they been paying attention? it's been a casino for, oh ... a century or so -- I'm leaving, appropriately enough, for Las Vegas. I'll be speaking there tomorrow, and back later the same day.

I have some wrap-up musings on the implication's of this week's activity that I'm working on, so expect those later today or tomorrow.

I agree almost entirely with Roger here. While I applaud the idea of the U.S. becoming less ad hoc in its re-engineering of the borked U.S. financial system, we have gone too far in some screwy directions in the current bailout.

In particular, it might have been a political price that had to be paid, but the damage we are doing via this ban on short-selling is less liquid and efficient markets, and, in the end, a less credible financial system. It turns capital markets into a chess as played by my six-year-old, with the rules changing constantly and unpredictably.

We are grown-ups here. If regulators have specific evidence of material short-selling abuses in financial stocks, they should produce it. Otherwise, this is just the political/pandering exercise that it seems.

So you think the Dow had a great day today, the best in ages? The headlines agree with you, with banners everywhere trumpeting huge gains. But to one way of thinking they're wrong, at least when you get outside the box of thinking only about U.S. markets.

Why? Consider the following table ranking major markets around the world in terms of their gains today. The Dow? It ranked dead last, barely beaten by the Nasdaq Composite and the S&P 500.