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Tickers in this Article: MHP, MCO, NEWCQ
Ratings agencies Moody's (NYSE:MCO), and Standard and Poor's, a division of McGraw-Hill (NYSE:MHP), have become scapegoats in the aftermath of the subprime blowup.

Many issuers of debt tied to subprime are now expected to see ratings downgrades from these two, but, as with most crises in the financial markets, these downgrades are too little too late. In this article we'll first examine the mistakes these agencies have made, and then we'll look at how the agencies themselves could actually make for solid long-term investments given their recent pummeling.

Delayed Information
The problems are obvious. The markets depend on these agencies for the credit ratings the provide, and they typically wield substantial power over the market. If one of them downgrades the debt of a company, it will cost more for that company to raise debt. In the same fashion, since Moody's and Standard and Poor's had investment grade ratings on most of the subprime debt, the markets thought everything was fine. (To learn more, see What Is A Corporate Credit Rating? and Junk Bonds: Everything You Need To Know .)

Home buyers were able to take out mortgages and then simultaneously take piggyback loans to make their mortgage payments. There was apparently nothing wrong with this according to the agencies. Only now, after many of these risky loans are collapsing, are the ratings dropping as well. When downgrading those piggyback loans, Moody's cited deterioration in the housing markets, and aggressive underwriting as the cause of the problems. If the investment banks can continue to create investment grade rated debt out of thin air, of course aggressive underwriting is going to occur. They were late to the game with ratings downgrades as evidenced by the fact that companies such as New Century Financial (OTC:NEWCQ) was downgraded only after it went into bankruptcy.

MCO and MHP Oversold?
The ratings agencies have dropped the ball. They should be scolded, and they must make efforts to be more proactive with ratings. That is what they are expected to do. But, despite the recent errors, they will likely remain an integral part of the markets.

And now that I have ranted against them, I will explain why maybe its good time to do some research into possibly buying their stocks. McGraw-Hill (which gets about a third of revenue from Standard and Poor's) and Moody's are each down significantly since their highs in late May. Were they doing the lending for these bad bonds? No, but they are being punished like it. These companies have overcome similar criticisms in the past, such as their positive views of Enron as it fell apart. Odds are, they will overcome again, and the markets will continue to rely on them.

Risky Business
Moody's and Standard and Poor's have benefited from the escalation in risky debt issuance. The debt markets have been in turmoil now, and issuance of new debt will likely slow considerably. The cost of issuing debt has risen sharply, and the main risk for the ratings agencies, will be a downturn in new issues of debt for the time being. While this is a legitimate concern, I think this anticipation has been more than priced in by the recent nosedive in the shares of these companies.


The Bottom Line
There is definitely still risk that the shares could see more red, especially if the credit markets freeze up even further. It may not be for the meek hearted, but with the shares at current levels, the risk/reward ratio seems quite attractive. Moody's and Standard and Poor's will continue to play an integral part in the financial markets, and I would suggest that if you can deal with short-term volatility in the stock prices, you could benefit from these companies nursing their bruises over the next couple years.

For more insight, see Finding Profit In Troubled Stocks.

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