Rating agencies are erring big time again, this time on China

Okay, so I've been a long-time reader and member of WSO, but created a separate account to talk about some controversial issues. The first one is about China. The reason I am writing this is that I have a strong freeling that the rating agencies are not doing their jobs properly and I think global banks who are now big in China will lose tons of money there.

To be honest, I am not quite sure how many global U.S. or European banks are active in China in the commercial banking arena over there, but I see a lot of problems because I don't think they are measuring their risks properly, at least at our bank.

The first problem I see when I look at their commercial banking activities over there is overrated ratings. Rating agencies also assign ratings very favorably to those who are linked to the government. Ratings ultimately decide the pricing and how much money as a bank you would want to extend to a given company. However, many of the companies that Western banks try to lend out to are in some way related to the local government, central government or whatsoever. If the company in question is somehow linked to these entities they will get a very favorable rating, above-single-A category no matter how terrible the company is. Also, when I see these type of companies, these are not the companies that you would imagine, for example, defense, transportation or utilities. These are any type of manufacturing firms that have no reason to be linked with the government, like, say, candy manufacturers. Not that I am saying that the companies in the aforementioned industries should be government-owned, but it's just mind blowing to see the extent to which the government is exerting influence on so many areas; this is just unfathomable from my point of view.

Then the question is, till when can the Chinese government support the massive scale of failing companies? I personally don't want China to implode because any fallout in the current situation is likely to bring back China to the 60s or 70s when the leader over there led the country to an abyss at the expense of social stability. If I had to describe the current state of China, I would have to describe it as quite before the perfect storm. Any large-scale economic fallout would prompt the Chinese government to step in using martial law to quell any riots.

What would be the trigger? I think the potential source of social instability would be their laid off workers. Even though China is mainly blamed for annihilating the steel workers in U.S. and Britain and many other countries, although nowhere near sufficient, they have been making some progress by shutting down some factories. In China, shutting down "some" factories means shedding massive scale of workers to the tune of tens of thousands or even hundreds of thousands in aggregate. They say that this alone could cause potential unprecedented crimes and even massive scale of riots if the people who have lost their jobs remaining in the city see things going further south.

So, things don't seem to be easy these days in China, or to be more precise, never it never has been. Ultimately China will have to bailout companies, but not all. Some companies will have to let their bondholders or banks to take haircuts and some will just have to liquidate, and this will be the end of any above-A category ratings for Chinese companies, irrespective of their link to the government, because an implicit guarantee from the government is no longer there.

Like the subprime, rating agencies will get blamed for this and it will be revealed again that rating agencies were once again captive in order to win business and fees from the issuers, this time the Chinese corporates. Banks who have been following the rating agencies' ratings or method will take a massive hit as well, and I can see that this will not end well.

So what are your guys' thoughts on this? Do you think rating agencies are doing their jobs well? Do you think Chinese companies, no matter how crap they are, should deserve a single A or higher rating just because they are related to the government?