Wednesday, May 28, 2008
Fed--Rating Agency Smoke and Mirrors
"Saving the nation's financial system from reckless banks and brokerage firms is an enormous job, heaven knows. But somebody's got to do it, so the [Fed], with its taxpayer-funded balance sheet, stepped in ... Together, they allow banks and financial firms to swap up to $350 billion in securities they cannot sell for cash or [US] Treasuries. ... This allows institutions to exchange their trash for cash that they can turn around and lend to corporations or individuals. ... One of those risks is that taxpayers may have to cover losses if a firm or bank fails to repay a loan. So far, the Fed's noble experiment seems to be working. ... To be sure, the Fed is fairly well protected against the possibility that a commercial bank will renege on the loans. These institutions provide excess collateral--typically 100 percent of their borrowings--when they tap the entity and the Fed can go after their other assets if need be. But deals with brokerage firms are another story entirely. And the particulars of those transactions worry Josh Rosner [JR], analyst and expert on mortgage securities at Graham-Fisher, an independent financial research company in New York. ... And look at the securities the Fed accepts in these swaps: residential and commerical mortgages and other asset-backed issues. Sure, the Fed requires that the securities must be rated triple-A to to qualify for a Treasury swap. But as we've learned over the last year and a half, such ratings are unreliable... Last month. Donald L. Kohn, vice chairman of the [Fed], addressed bankers at a credit market symposium in North Carolina. 'I think part of the worklist for the regulators is to re-examine the extent to which we ourselves are relying on these rating agencies to gauge the risks that you guys are taking,' he said. 'I think there was far, far too much reliance on credit rating all around.' ... Yet the Fed is doing precisely that when it accepts triple-A rated mortgage securities. 'This is classic "do as I say, not as I do,'' Mr. Rosner said. More worrisome, he added is the fact that the Fed doesn't examine the basis for bestowing a triple-A rating on these securities. Are they triple-A rated based on the soundness of the issuer? Or because of an insurance policy guaranteed by M.B.I.A. or Ambac Financial Group, the troubled financial guarantors? ... But as long as the guarantors carry triple-A's, the securities they guarantee carry them as well. But what if the guarantors themselves are downgraded? ... How much of the collateral posted at the Fed by brokerage firms is triple-A solely because of financial guarantors' insurance, which is known as a wrap? The Fed won't say. But Mr. Rosner said it only stands to reason that much of the mortgage and asset-backed collateral posted at the Fed falls into that catagory. 'Investment banks who are posting the collateral know if the securities are natural triple-A or only triple-A because of the wrap,' he said. 'Obviously the incentive would be for them to post triple-A collateral of lower quality to the Fed.' ... Clearly, it is in the Fed's interest to make sure that M.B.I.A. and Ambac are well capitalized and deserving of triple-A ratings. ... Henry M. Paulson, Jr., the Treasury secretary, said last week that the credit crisis was abating", Gretchen Morgenson (GM) at http://www.nytimes.com/ 18 May 2008.
GM, why must anyone "do it"? What's "noble" about it? The "Fed requires that the securities must be rated triple-A". So? Moody's, S&P, et al., understand the Fed's game. Would I be out of line to suggest Helicopter Ben and Hank Paulson, subtly, or unsubtly, let the ratings agencies (RA) know do not downgrade anything the Wall Street houses wish to dump on the Fed, lest they interfere with the Fed-Treasury bailouts? Did say, the Treasury's designated schtarke, Robert Steel tell the RA of 18 USC 1505, interference with the operations of a federal agency? Will Dudley Do-right save Nell Fenwick from the oncoming train? GM and Rosner, I do not believe the Fed relies on the RA for anything, but uses RA to justify it's already decided upon course of action. I await the RA downgrading Fed-held paper. Right! That Wall Street houses would "cherry pick" the securities they post at the Fed should surprise no one. See my 7 April and 3 and 9 May 2008 posts.