Sunday, September 20, 2009

Crack in the Firmament

"Shares in two companies that own credit-rating firms, Moody's Corp. and McGraw-Hill Cos., declined on Thursday in reaction to a court decision that rejected the companies' longtime claim that the First Amendment [FA] protected them from lawsuits. ... But US District Judge Shira Scheindlin ruled on Wednesday in a 68-page opinion that the ratings of certain securities--those that were distributed to a limited number of investors--don't deserve the same free-speech protection as more general ratings of corporate bonds that were widely disseminated. ... SIVs typically used short-term debt to buy long-term assets, largely residential mortgage-backed securities. The model broke down when these complex securites started to fall apart during the financial crisis, prompting lenders to shut off their supply of cheap short-term funding. Pieces of the SIVs sold to investors were rated AAA by leading ratings firms, meaning they were considered as safe as US Treasury bionds, only offering significantly better returns", Nathan Koppel, Andrew Edwards and Chad Bray at the WSJ, 4 September 2009, link:

Judge Scheindlin's ruling is very narrow. Congress should strip the rating agencies of any FA protections. Think how absurd these SIVs were, they borrowed short and lent long. Mismatched maturities is a banker's prescription for disaster. I read a 1587 treatise on banking which warned against this. Apparently the raters did not know this. What fools. How could SIVs be "as safe as US Treasury bonds"? Do the SIVs have their own Fed to print money to prop them up? Or are the raters correct, T-bonds are junk paper?

1 comment:

Anonymous said...

Maybe those that warehoused all the toxic garbage in the SIVs felt confident in the Feds ability to maintain a steep enough yield curve...

And felt even more confident in the dependent position the credit rating agencies had on them for revenue and profit. It was a sweet connection between the investment banks and credit raters.

I think that I've said before the best quote of the crisis came from Bill Gross (July 2007):

"Well prudence and rating agency standards change with the times, I suppose. What was chaste and AAA years ago may no longer be the case today.

Our prim remembrance of Gidget going to Hawaii and hanging out with the beach boys seems to have been replaced in this case with an image of Heidi Fleiss setting up a floating brothel in Beverly Hills.

AAA? You were wooed Mr. Moody’s and Mr. Poor’s by the makeup, those six-inch hooker heels, and a “tramp stamp.” Many of these good looking girls are not high-class assets worth 100 cents on the dollar.

And sorry Ben, but derivatives are a two-edged sword. Yes, they diversify risk and direct it away from the banking system into the eventual hands of unknown buyers, but they multiply leverage like the Andromeda strain.

When interest rates go up, the Petri dish turns from a benign experiment in financial engineering to a destructive virus because the cost of that leverage ultimately reduces the price of assets. Houses anyone?

Congress stripping the First Amendment right of raters? I think that there is a proposal for that... sounds good to me... raters should say whatever they want but have sound documentation and consistent methodologies.