Cramer: Clamp Down on Credit-Rating Agencies

Both Wall Street and Washington were chastened by Lehman Brothers’ collapse, which happened a year ago Tuesday, but there’s one key lesson they’ve yet to learn: Credit-rating agencies are “totally and completely broken,” Cramer said.

On Monday he called out the agencies for rubber-stamping the very mortgage-backed securities that nearly wrecked the US financial system. Even Lehman’s bonds were given the thumbs-up until just before the company filed for bankruptcy. He said he saw no reason why the credit-rating agencies should be trusted.

“We need to get rid of these people,” Cramer said. “We need to stop relying on them. They did nothing but harm here.”

Cramer’s biggest gripe is that these agencies – Standard & Poor’s, Moody’s and Fitch, among others – are paid by the businesses whose debt they rate. He likened it to a movie studio paying a film critic for a review. As ludicrous as it may sound, though, revenues at the top three firms between 2002 and 2007 doubled to over $6 billion from $3 billion. And Moody’s had the highest profit margin of any company in the S&P 500 for five years running. Big business created a system “where anything can get a positive rating,” Cramer said.

That is, until the ratings agencies panic at the last possible second and downgrade after it’s too late to make a difference. Lehman went under exactly so. S&P, Moody’s and Fitch remained positive on the ailing investment bank over the summer and still refused to warn the market of Lehman’s declining credit quality as late as Sept. 12. In fact, on that day S&P put Lehman on credit watch but never issued a downgrade – even despite the company’s pre-announcement of a massive third quarter loss on Sept. 10. Come Sept. 15, though, D-Day for Lehman, both S&P and Moody’s cut the firm’s credit rating significantly.

Analysts are mixed up in this, too, Cramer said. Rather than conducting their own research, they merely relied on agency ratings for their endorsements of Lehman right up until the bankruptcy. Michael Mayo of Calyon told investors on Sept. 5 that Lehman could go to $28 from $16, but by Sept. 10 the stock was at $7.79. Regardless, and despite the pre-announcement, Mayo reiterated his buy call. The next day he downgraded Lehman to a “hold,” using an $11 price target. The problem? By then the stock was at $3, Cramer said, and headed to $1. When the bankruptcy filing was announced, Mayo just discontinued coverage, never admitting his mistakes.

Way back in 2002, the Bush SEC knew there were problems with this system but never followed up. President Obama’s administration proposed new legislation in July, but Cramer doubted it was stern enough to make an impact. In the very least, he said, the business model that drives these agencies needs to be changed. A New York federal judge had a chance to do just that in early September, but never did. Cramer urged Washington to take action, saying, “We need real reform here.” A year has passed since Lehman’s collapse, and still Wall Street trusts ratings that are “bought and paid for by their clients.”

“The system must be changed to one where the financial film critics,” Cramer said, “aren’t paid by the movie makers.”

Call Cramer: 1-800-743-CNBC

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