Jim Armitage: Where’s the beef with the ratings agencies?

Outlook People find the bond markets boring. They shouldn’t. Because it was bonds, and the derivative products based upon them, that blew up the financial world in 2008. And it will be bonds, and their accompanying derivatives, that do it again next time.

The last financial crisis was brought about by investors buying them without keeping proper tabs on how likely it was that the issuer would actually be able to afford to pay the interest. Hence, you got the world’s biggest investors paying stupidly high prices for bonds based on garbage such as sub-prime mortgages.

Much of that pricing was based on the fact that the banks creating this rubbish persuaded the big credit-rating agencies that, far from being rotten financial tripe, it was pure, handreared Kobe beef.

Perhaps we should not be surprised, given the seven-year cycle of City amnesia, but similar dumbness is happening again in some corners of the market.

Take Phones 4u, where bond investors were dumb enough to still be valuing its debt at 87p in the pound even after 3 and O2 had pulled the plug. The day Vodafone walked, they fell to 30p, as sense finally prevailed.

As in the last crisis, the rating agencies didn’t spot the problem until it was too late.

Now, HSBC has issued a bond which, in the small print, says the bank reserves the right to cancel interest payments at any time. Worse still, the bonds had no “scheduled maturity” – meaning the principal of the debt had no fixed repayment date. In a note to investors, fund manager Kames describes it as more like a receipt for a charity donation than a bond contract.

But what got Kames scared was not the bond itself, but the fact that the rating agencies declared it super-safe – investment grade, in the jargon. That means it will be sucked into our pensions where it will stay, quietly ticking. Kames is furious: “The rating agencies have rolled over on their backs like the love-struck puppies they were prior to the financial crisis, begging for revenue from the investment bankers’ table.”

A couple of years back, the big regulators of Wall Street and London were full of talk of reforming the rating agency system. But nothing has been done. The agencies are still paid by the very companies whose bonds they are paid to rate. S&P, Fitch and Moody’s still control 95 per cent of the market and, with corporate bonds being issued in near record numbers, they’re making good money again.

It’s hard to tell exactly how this will all pan out, but I can tell you one thing: it won’t be boring.