Welcome to Media Co-op Investor!
Note: this will be the last company entry in the Media Co-op Investor Series. The final pieces in the series will feature stories on our annual report to media coop fake-shareholders, the currency markets, and living (stock market) free.
The Media Co-op Investor Series aims to help the general public understand the stock market, how it works and the major companies which benefit from it.
Every two weeks (or once a month) we examine an element or term in the stock market, how the Toronto Media Co-op has done fake-investing in companies on the Toronto Stock Exchange as well as highlighting specific large Canadian companies, why their price has gone up and down and what they are all about.
To learn more go here.
This Week's Term: Credit Rating Agencies
Got to love these brief and fleeting moments in history, when the words 'Credit Rating Agency' (CRA) make it into the lexicon and companies like Standard and Poor become household names.
The political crisis in the US over the government debt ceiling (the amount of money that the US Congress allows itself to borrow every year) is telling, and a great way to understand the bond markets.
For those who didn't follow exactly what was happening: a fight erupted between US politicians over whether or not to make themselves run out of money by August 2nd. After painful bickering, one side was able to procure no tax increases for the wealthy and over $2 trillion in mostly social spending cuts over the next few years. Because of that, the US is able to keep borrowing money to pay its bills up until after the 2012 elections.
In response to these shenanigans, on Friday, August 5th, Standard and Poor, one of the leading credit rating agencies, cut the US government's credit rating from AAA to AA+.
Global financial calamity ensues. But why?
Because Standard and Poor is a major CRA and CRA's have become one of the most important institutions in the financial system.
There are currently dozens of CRAs across dozens of countries (including Canada's Dominion Bond Rating Service); however, relatively recent estimates put the market share of the Big Three - Standard and Poor, Moody's and Fitch - at 95%.
The Big Three were created between 1850 and 1920 with the simple aim of reporting on how risky it would be to own a stock or lend money to a company, state government or city.
By the 1970's, the US was using the Big Three to help break down bank regulations. The US government gave the Big Three status as Nationally Recognized Statistical Rating Organizations (NRSROs) which gave them quasi-regulatory power to rate government and company debt. This allowed banks and financial entities to lower capital requirements (take money they were legally required to hold in case of an emergency and invest it in 'safely' rated agencies).
It also allowed three companies, two of which are private, to create an situation similar to an oligopoly for rating the safety of debt and other financial instruments.
Between the 1970's and 2003, the Big Three were the only CRA's allowed to 'rate' debt in the US and rose to global importance with the parallell growth of the financial system in the US.
With the explosion in lending up until the financial crash of 2008, CRA's became more important in regulating the safety of corporate and government debt (i.e. how much interest to charge it), and structured finance (the safety of colateralized debt obligations or CDO's; the things that brought down the global economy in 2008).
Because CRA's play such an important role, the first-ever down-grading of the US's debt 'rating' by one of these private companies was a watershed moment. US debt is essentially considered to be the strongest and safest investment in the world. One of the three major rating agencies has basically said the safest investment in the world isn't 100% safe.
Overnight, it became harder for the US to borrow money from a large group of investors. Because many massive investment companies (like pension funds) are only allowed to lend (invest) to countries or companies with a AAA credit rating, they all of a sudden are no longer able to lend money to the US. However, that didn't stop stock investors from doing so. Money flowed out of the equity markets (stocks) and into US debt (treasury bonds) and gold which were still considered safer bets. However, this likely wont last.
The real fear is in 'hidden dominos'. Sadly, economists don't really know all the effects that could unfold from a US downgrading. A variety of events could unfold which could threaten parts of the financial system in ways that few are forseeing.
Which brings us to the great financial crash: CRA's often get it wrong and when they do all hell breaks loose. Credit agencies played a major role in rating risky financial products as safe - credit derivatives like CDO's, company debt like Lehman Brothers - during the financial crisis.
People invested trillions in 'safe', structured investments but the CRA's often had no idea what the hell they were doing. Lehman was only lost its AAA rating after it completely collapsed while the analysts who rated it kept their jobs. In fact because the Big Three sell 'advice' to companies and governments on how to get a good rating for their debt, they are often in a conflict of interest in terms of how they rate.
Millions of their AAA-rated credit derivatives poisoned the financial system and are now worthless.
However, even with such a disaster in 2008, the Big Three have maintained their power. The debt crises in Greece, Ireland and Portugal, which have now spread to Spain and Italy, have been pinned squarely on the shoulders of the Big Three by some. The agencies have relentlessly lowered the ratings of each country and this has caused their costs of borrowing to skyrocket. Greece, the country lowered first and whose rating has hit lowest was recently paying as much as 30% to borrow money.
In response, to break the oligopoly, the EU has toyed with heavier regulation of the Big Three and creating their own EU-based rating system.
Both have failed to produce anything substantial in the short-term.
What we invested in this week
Nothing. The stock markets were a disaster. This week we tracked our largest Canadian Mining stocks. We theoretically-bought about $1000 worth of each company on September 15th.
How we did this week
Disaster. After running at a steady clip of around 12% profit for the last 12 months, the Media Co-op is officially in the red for the first time all year.
While our extractive companies have held their own and are basically back to zero, our consumer and financial stocks are resting comfortably in the basement.
Massive losses in stock markets have ensued across the world, wiping our one year's worth of 'growth' off the board.
ETFs, profiled in last-months article, have been abandoned as the stock market crashes.
Basically, across the board, anything considered the slightest bit risky in terms of investing is being abandoned. The world's safest investment, US debt, has just been labelled riskier.
The European Central Bank (ECB) have thrown money at Spain and Italy to lower their borrowing costs, but this can't go on for ever.
Pundits fear this is the beginning of the second round of the Recession. Given that nothing was done to structurally address the causes of the financial crisis, they could be right.
Today's Company: SNC-Lavalin
Few Canadian companies carry the weight of SNC-Lavalin in terms of name recognition, both good and bad. SNC-Lavalin is a major engineering firm with business projects all over the world. It's also known as one of the worst munitions and military contractors.
Started in 1936 in Montreal as SNC, the company mostly focused on hydro engineering before moving into other engineering products over the years. It merged with rival Lavalin in 1991 and is currently one of the top-ten engineering companies in the world with over $6 billion in revenue and 20,000 employees. It has operations in 100 countries.
The company has had its hand in several massive engineering projects over the years. It helped develop massive hydro-electric projects in the James Bay region of Quebec; mining operations in Madagascar and airports in Libya. The hydro projects in Quebec were largely developed on treaty Cree and Innu land and faced strong opposition.
SCN-Lavalin also built the Canada line skytrain in Vancouver for the 2010 Olympics. The line was widely accused of having completely bankrupted the lower-mainland transit authority, leading to its restructuring by the government. The company was also forced by the BC Human Rights Tribunal to pay $10,000 each to 39 temporary foreign workers who had worked on the project because of discrimination.
In the 1990's, SNC-Lavalin was implicated in a financial scam of the government in Kerala, India. The company has been charged in the case and an arrest warrant was issued this year for a former SNC-Lavalin vice-president in connection with the ongoing case.
In 2005, strong pressure was put on the company for agreeing to produce hundreds of millions of bullets for the US military, fighting heavily in Iraq at the time.
Opposition has risen to their construction of nuclear reactors in East Asia.
The company also has a tremendous knack for following Canada around when it's up to its worst.
They were awarded the contract to make the security fence during the G8/20 in Toronto. The fence was widely criticized as a symbol of the undemocratic nature of the G8/20 as an institution and was the subject of numerous denunciations and protests. The summits became the site of largest mass arrest in Canadian history.
In addition, SNC-Lavalin received a $20 million contract for the new embassy in Haiti after Canada participated in a coup against the democratically elected Haitian leader. It has also been the largest Canadian private contractor in the occupation of Afghanistan.
We fake-bought SNC-Lavalin shares in September for $50.66. The crash in the stock market in the past week has forced their shares down to $48.99 for a loss of 3.3% or $33.
Archive
September: Potash Corp
September #2: Suncor and ARC Energy Trust
October: Shoppers Drugmart and Barrick Gold
October #2: Scotiabank and Power Corporation of Canada
November: Cameco Corp and TransCanada Corp
December: Saputo and Bombardier
December #2: First Quantum and Manulife Financial
January: Quarterly report
February: Magna
March: Brookfield Asset Management
April: CN Rail
May: Gildan Activewear
June: Teck Resources Ltd.
