Stephen Foley: The drive to make the big calls first can prove dangerous in ratings firms


Click to follow
The Independent Online

Outlook: I am all in favour of breaking the oligopoly of the big three credit-rating agencies, but there is a right way and a wrong way to do it.

We just had a terrifying example of the wrong way. A man called Sean Egan almost destroyed the investment bank Jefferies on Thursday. His firm, Egan-Jones, was admitted to the elite club of recognised rating agencies in 2007, with the hope of generating some competition for Standard & Poor's, Moody's and Fitch (without any of the conflicts of interest that plague the big three). The firm only really shot to prominence this year, when it was the first to abandon the US government's AAA rating, weeks before S&P.

Mr Egan knows that being first with the big calls is the way to build a reputation, which must be why it was tempting to pile on to Jefferies this week.

The company, a broker-dealer like the collapsed MF Global, has been the subject of a classic bear raid. Because it is not a bank, it has no deposit base or government backstop. It is also leveraged about 13 to 1, which is not high by pre-financial crisis standards but does make it vulnerable to a collapse in confidence. It has about $2.7bn (£1.7bn) in exposure to eurozone sovereign debt. But all of this was the case last week, too.

What changed? Mr Egan says that "the operating environment, post-Lehman, post-MF Global" is what changed, though of course he just means post-MF Global, since I think Lehman Brothers collapsed a little while ago.

Jefferies was underwriter for an MF Global bond sale a few months ago, so its name was top of mind when MF went under on Monday and people began hunting for "the next domino". Never mind that it had no exposure to MF Global, and that its eurozone exposure was offset by $2.5bn in short positions, as Mr Egan was told. Citing "the operating environment" is just a clever way of saying that the bear raid that got under way on Monday might be successful in bringing down Jefferies.

Mr Egan's downgrade fed into that, sending shares plunging 20 per cent and threatening to trigger a crisis of confidence among the broker's clients. If it had gone under, no doubt Egan-Jones would be trumpeting that it was first to call attention to the danger.

Actually, I don't disagree with Mr Egan's concerns about leverage ratios among broker-dealers, who are allowed to have dangerously lower capital cushions despite them being in a much riskier business than banks. But the timing of his firm's call on Jefferies looks irresponsible, even cynical.

Building a credit-rating business entails not just getting it right, but being seen to get it right, and who can blame Mr Egan for working hard at self-promotion. None the less, the way he described his firm's call on Jefferies on Thursday – "it hit some of the blogs late last night and then it went viral this morning" – is odd. The whole incident leaves a very bad taste in the mouth.