Why the Ratings Agencies Flunked

Bill Ackman, a hedge fund activist with Pershing Square Capital, named Egan-Jones as his ratings firm of choice when he recently presented his controversial prediction at an investors conference in New York that bond insurer MBIA (MBI Quote) could go bankrupt by the second quarter of 2008.

Ackman famously released a report questioning MBIA's Triple-A credit rating in late 2002. In 2007, shares of the bond insurer dropped 70% on credit worries, and on Dec. 20, the company revealed that its total exposure to bonds backed by mortgages and collateralized debt obligations is about $30.6 billion.

The major ratings agencies just recently put the company on negative credit watch, signaling a downgrade. As the largest insurer of muni bonds and other types of financial products, MBIA is at the heart of the country's financial system, and its deterioration threatens to have far-reaching effects on the economy.

Barrier to Entry High

Egan-Jones beat the big guys across the board on the bond insurers and the subprime mess, and Ackman attributed its superior performance to its business model. That said, he questions whether the firm, even with its new designation, will ever compete with the major ratings agencies. With around 20 employees and just over 400 clients, Egan-Jones focuses on corporate credit, issuing ratings on around 1,250 companies that each have more than $100 million in outstanding publicly traded debt. Egan declines to provide annual revenue and earnings figures, but he says the firm is profitable.