Fitch Move Signals Change In Ratings Concept

This item was overlooked, for the most part, when it came out the week before Christmas, but it bears mentioning. Basically, what Fitch said was that they would take other, non-credit-specific factors into account when producing a rating for a security. More specifically, they would consider a security's liquidity in rating derivation.

Deep down, I've always had a soft spot for Fitch. The third man in in essentially a two-man race, Fitch has been willing to take an outlier stance on things. When this is done and you're right, everyone thinks you're a hero. If you're wrong, well, the market, like most things, has a short memory. Fitch has to be given credit for trying.

Here's why they shouldn't do it. First, credit ratings should be just that, a rating of credit or, put is simpler terms, the risk that a security will default. In recent months, the rating agencies haven't done that well on that score. To make the simple letter/number ratings be burdened by greater amounts of variables would make the less useful and less predictive. Second, why would we think that a rating agency liquidity value would be valuable? What do they know about liquidity? In general, no one has been terribly accurate at valuing liquidity, so why would we believe a rating agency, which doesn't trade anything, be good at it? Fitch (and Moody's/S & P), stick to what you know.

This doesn't mean it couldn't be done, but it would be a tremendous undertaking requiring vast amounts of continuous real-time data, complex algorithms with an ability to process all that information and teams of real people with in-depth trading knowledge monitoring all of it for reasonableness (Who would pay for it, maybe a new government agency? Better still, the UN.). If you could do it, then maybe you could have simple 1 to 10 scale for liquidity, with the number constantly changing to reflect market conditions. Then it could be taken to the next step, a centralized location for all fixed income trading. Type in the bond, bid/offer, size, and the matching could generate a liquidity number, which in turn, can be passed electronically to the market makers (this is ridiculous, of course). Better yet, maybe the system could produce a liquidity "thumbs up or down", similar to FFIEC test on Bloomberg for MBS.