Credit Rating Agencies Have Been Botching Some Important Ratings

When it comes to your hospital or health system credit rating, most CFOs do everything they can to try to get, or keep, a AAA rating. But really, what does that rating truly mean? Maybe it shouldn't mean that much.

Banks, and a host of investors, use these ratings to help guide them in their lending and investing practices but when the ratings are wrong their mistakes can misdirect a lot of people. Thanks to a host of bad predictions by ratings agencies and some rather nefarious activities by many large corporations in the finance industry, the economy took a bit of a turn and with it so did many businesses, hospitals, and investors.

To be fair, the rating agencies—of which there are 10, but three are the most well-known and used (Standard and Poor's, Moody's and Fitch)—aren't always wrong in their analysis and rating. Nevertheless, it seems in the last ten years the ones they have been wrong about have cost all of us dearly—financially. See my other column if you want to read more about that.

I have worked in finance and I have worked in publishing and I can tell you that both industries have their pluses and minuses. But one thing I didn't enjoy about finance was all the SEC compliance rules. They are truly a pain point for many working in the industry, but they are a necessary evil. That is until you realize that it's mostly toothless paperwork that's mostly filed by the honest minions while the less-than-honest folks are still doing whatever they can to earn a buck.

I suppose it shouldn't surprise me, or any of you, to learn that after the banking industry was investigated and many of them were found to be conducting business in a less-than above board manner, that now the investor's rating agencies are about to undergo scrutiny. It's important for healthcare financial leaders to be aware of how some pending legislation and legal actions might influence investor ratings in the years to come. But first, allow me to make a wild prediction—not an accusation—investigators are going to find out that ratings agencies may have been more flexible with some ratings scores than with others. Are you shocked? I doubt it.

I hate to be a pessimist, but it seems to me that money has a tendency to encourage folks to do the wrong thing. I'm not sure what happened to the moral backbones that people used to have, but it seems a lot of people would rather walk "easy street" than take in the view from the "high road"—and a lot of those people seem to gravitate toward the finance industry.

There is a fantastic article in CFO magazine this month about the credit rating disaster. Take the time to read it and educate yourself on what's going on behind the scenes—it's history that is worth reading, but not worth repeating.

The CFO magazine article recounts numerous examples of how Standard and Poor's and Moody's Investors Service have flubbed their ratings reviews for various large companies (e.g., giving Enron an investment grade credit days before it went into bankruptcy, and let us not forget about these agencies stellar predictions for mortgage-backed securities). What's always surprising to me is how they can get it so wrong, but there aren't any ramifications.

With so many people dependent on these reports, shouldn't they be more consistently correct? If a heart surgeon continually told all his patients that they were going to live long full lives, but after the surgery only half of them lived a week, I'm sure he would be fired and sued. Let's just say that as far as their educated predictions go, neither rating agency has been accurate enough lately to get a job as a fortune-teller at the circus. Is that harsh? Not when you consider how many millions of people count on these ratings and how many billions of dollars have been lost in the past few years because of their misplaced optimism (translation AAA ratings) with various large companies and banks.

As a hospital leader, you know how important outcomes are. Patients arrive at your hospital looking for help, you explain things and then give them a general prediction of the results for their treatment. Now, those "odds," for lack of a better term, aren't always right, but more often than not things go according to plan and the desired outcomes are achieved. If that wasn't the case, your hospital would be out of business, or at the very least it would be waist deep in malpractice suits.

Then again, your end goal is to make a specific person well vs. the rating agencies' goal of making money for themselves. That profit motive is their primary motivator. Now, if you are motivated to make a profit, then you are motivated to find the biggest source of money to get that profit. NEWSFLASH—the biggest source of money isn't Ma and Pa Store Owner on Main Street who is looking to invest a little money for their retirement. Nope, it's Mr. Fat Cat Big Business, the companies that need the ratings to entice Ma and Pa to invest in the first place. The ratings agencies shouldn't be allowed to profit by working with these companies.

The CFO magazine article notes that while Moody's has a compliance group to enforce laws and internal policies, a former employee testified to a House committee that the "credit policy group was routinely overridden by line managers in the name of winning business, while the compliance group was understaffed and had little professional compliance experience."

Shouldn't these agencies be required to be impartial and nonprofit? Moreover shouldn't they be run like Consumer Reports, where they operate based on paid subscriptions from the consumer, which makes them accountable to them for their results?

Some would argue that this type of action is unnecessary. After all, aren't there already safeguards in place? Yes, sort of. The Credit Rating Agency Reform Act of 2006 granted the SEC authority to inspect credit-rating agencies and required it to report to Congress on credit-rating quality and conflicts of interest or inappropriate sales practices. The ratings agencies also added their own—understaffed—internal compliance departments to keep things on the level, though honestly, how deeply are your paid employees going to dig into the company's transactions to find problems when that's their main source of income? Not that deeply. By the way the Moody's employee mentioned above who testified to the House committee was suspended from his job after he complained to the company about their practices.

Congress is gearing up to pass more financial reform legislation in the coming year, but it seems unlikely that it will do more to protect the consumers than previous legislation. The Wall Street Reform and Consumer Protection Act of 2009 passed the House in December, and asked for rating agencies to tighten internal controls, register with the SEC, bear more government supervision, and disclose more detail about their ratings methodologies. Sounds a lot like the 2006 legislation, doesn't it? But it does allow more investors to sue the agencies for gross negligence—now there's an intriguing possibility.

Another bill in the Senate, the Restoring Financial Stability Act of 2010, which calls for many of the same changes as the Wall Street Reform and Consumer Protection Act of 2009, would give the SEC authority to de-register any agency for providing grossly incorrect ratings—you have to wonder how many incorrect, or bad, ratings they'd have to give out in order to get de-registered though. I suspect that will likely be at the discretion of the SEC. Moreover, I can hear the ratings agencies arguing their cases already, "We couldn't know that Company X was swindling millions from their investors, all their financial statements looked great. It's not our fault that they lied to us."

And their argument wouldn't be totally without merit–I'm sure that companies have falsified documents to get a great rating in the past and they will do so in the future too. Nevertheless, these agencies need to step up their game and perhaps be a tad more conservative with those AAA ratings. Then again, if they maintain this poor prediction pace, they may just put themselves out of business.

As a consumer, I certainly don't place as much merit in those ratings as I once did, and neither should you. Naturally, you must be mindful not to ruin your rating, as banks will use these as measures of your stability in order to make capital lending decisions, but when it comes to investing your hospital's capital you should recognize that these ratings are just a piece of the puzzle and you need to do your own due diligence before putting your hospital's money (or your own) into any investment. After all, if the government can't find a way to regulate and penalize these folks, then it is the job of the free market to do it by not turning to them as the best source of information—because clearly they are not.