ProPublica

Journalism in the Public Interest

Standard & Poor’s Triple A Ratings Collapse Again. The Question is Why?

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Two weeks ago, Standard & Poor’s put out a press release: The credit rating agency warned it was poised to downgrade almost 1,200 complex mortgage securities.

So what? Isn’t that dog-bites-man at this point?

Well, two-thirds of these mortgage bonds were rated only last year, long after the financial crisis. And S&P was supposed to have taken the distress of the housing crash and credit crisis into account when it assessed them. But in December, the ratings agency admitted that it had made methodological mistakes, including not understanding who would get interest payments when.

As everyone knows by now, the credit ratings agencies played an enormous role in creating the conditions that led to the financial crisis. Their willingness to slap Triple A ratings on all manner of Wall Street- engineered mortgage rot was enormously lucrative for the raters but a disaster for the global economy.

Unfortunately, as the episode in December shows, the credit ratings agencies are still struggling to get it right. These likely downgrades arose in a small corner of the market called “re-remics.” What you need to know about them is that they were do-overs. Wall Street took bonds that had collapsed (and which the agencies had mis-rated the first time) and re-bundled them again. Generally, the top half was rated Triple A, supposedly exceedingly safe.

The agencies rated billions of dollars worth of these bonds, mostly just in the last two years. With shocking rapidity, even some of those Triple As have defaulted.

The lesson is that the agencies are still susceptible to problems that plagued them before the crisis. “What we’ve seen in re-remics truly does encapsulate everything that was wrong not just with ratings agencies, but with banking system as a whole prior to the boom," says Eric Kolchinsky, a former Moody’s executive who tried to blow the whistle on ratings problems at the firm.

During the mortgage securities boom, bankers knew more about their bonds than the ratings agencies and took advantage. A similar problem occurred here. “Chances are that if a bond is getting re-remicked, it’s a bad bond and the holder wants to forestall the inevitable reckoning,” says Kolchinsky. The ratings agencies somehow missed that.

There also looks to have been “ratings shopping,” in which issuers seek out the most lenient firms, rather than the best. S&P, according to Kolchinsky, was slower to downgrade residential mortgages than Moody’s. Lo and behold, it nabbed the bigger market share in new offerings of residential securities. And then it had the big debacle.

An S&P spokesman didn’t respond to a question about the ratings shopping issue. In an email, he said: “A great deal has changed at S&P over the course of the past three years. We have significantly strengthened the ratings process.” One new aspect, he pointed out, is that the firm now has a policy to correct errors publicly.

The state of the ratings agencies might be less worrisome if effective regulatory oversight were coming. Unfortunately, the Dodd-Frank reforms of credit ratings are in limbo.

Here’s the problem: Credit rating companies have long contended that their conclusions are protected by the First Amendment, much as if their ratings were as irrelevant to the markets as, say, your average financial column. Dodd-Frank tried to change that, designating the agencies “experts,” just like lawyers or accountants, when their ratings were included in S.E.C. documents for certain kinds of offerings. That would make them liable for material errors and omissions in their ratings.

But the agencies revolted. They refused to allow their ratings to be used in offering circulars, freezing up the markets. Panicked, the S.E.C. immediately suspended the rule for six months, pending more study. Then in late November, the SEC extended the delay indefinitely.

“For ratings reform to be successful it needs to provide incentives for rating agencies to be objective. The Dodd-Frank Act achieves some of that, but absent the legal liability, or accountability, it’s much weaker,” says Gene Phillips, a former Moody’s analyst who runs a ratings consulting firm.

So much for that. And the news gets worse. In early December, the SEC issued an obscure notice that it doesn’t have the money to implement big parts of the Dodd-Frank reforms. And now that Republicans have taken over the House, the SEC’s budget for fiscal 2011 (which started back in October) is an even greater question mark.

One thing on hold: Creating the “Office of Credit Ratings” to oversee the powerful firms.

This office could wield enormous influence. You see, Dodd-Frank tabled many of the most important ratings agencies controversies, pending studies of the issues. If the S.E.C actually produces the zillions of reports it’s supposed to over the next several years, every employee should be awarded an honorary Ph. D.

But since the S.E.C. can’t afford to create the office in the first place, we’ll probably still be waiting by the time the next crisis hits. Meanwhile, the agencies’ rubber stamp factories are humming, much to the delight of those on Wall Street with very short memories or very deep pockets.

Jessie, you may not understand this - but - if they wanted to get it right, they would get it right. And they may not ‘know’ they want not to get it right .Get it?

Nissim Sasson

Jan. 5, 2011, 8:09 p.m.

I agree with Sandy’s comment 100%

Mr. Eisinger is right on target - an unbiased “A” from someone who is not getting paid based on how high a grade he gets.  Analyst ratings protected by free speech?  Oh fer cryin’ out loud, they were PAID to issue an EXPERT analysis.  And paid again by the issuers for their EXPERT advice on how to get an “A”.  Such a blatant conflict of interest is at the heart of the entire global financial meltdown.

At this point,  aren’t the ratings meaningless?  Who puts any faith in their opinion about anything anymore.  Trillions of dollars were lost in AAA-rated securities just a short while ago.  Who believes anything the rating agencies have to say about anything?

Sadly, the fools fool the fools. Lawyers are involved. Investment ‘pros’ are guided by law. Ratings are used by law.

Sadly, the fools fool the fools. Lawyers are involved. Investment ‘pros’ are guided by law. Ratings are used by law. Lower grade paper is ineligible for some institutions or accounts.

Carola Von Hoffmannstahl-Solomonoff

Jan. 6, 2011, 3:27 p.m.

Remember all those breast-beating articles that appeared circa 2007/2008, laying out the frauds and stupidities that pumped the housing bubble and the mortgage securities meltdown? For about 10 minutes it looked as if something had actually been learned…

I doubt not the presence of “one hand washes the other”; the inner circle of American high finance - the big banks and Wall Street - bringing pressure to bear to forestall revealing the truth until the HNWIs can pull out.

The ordinary American, of course, is excluded from that tender care…after all, your small investor’s role is prey, not predator.

And let’s not forget - the smart rate the paper - and hope the rating agencies get it wrong. When Wall Street walks from fiduciary and eats what it kills, dislocation means profit - stability means losses.

There are no secrets, only the secretive.

Wall Street was not ‘right’ when it was a collection of partnerships held together by a master general partnership, The New York Stock Exchange. The honest man was a rarity. Today, the NYSE is toast, the general partnership may exist in marriage, and it is not fashionable to use the word fiduciary. That stuff is gone. In its place are private placement, dealing, trading as principal, front running in the name of market making - and black holes that the SEC cannot find and would not understand - speaking of SEC, all they want is what the others have: money. Their route is counsel to, not regulators of. In all this, the survivors are bigger, more opaque, more dangerous - and oligarchy rules.

That was an interesting observation that Sandy Lewis made - in particular, the section re “speaking of SEC [...] Their route is counsel to, not regulators of…”

It is simple fact that the best way to avoid…complications…is to know when and which way the enforcement agency is looking; at best, you want people inside that entity determining what will be enforced.  Consider, for instance, Republican Issa’s solicitation of 150 lobbyists’ assistance in writing future legislation.

This has been true for so long, it is a standard feature in all works of fiction - and most non-fiction - concerning “the mob”. 

But Wall Street…once America made the mistake of “flood-up/trickle-down” economics, which incentivized greed, disincentivized social responsibility, and permitted unholy amounts of liquidity to accumulate in the hands of the equally unholy…

Well, those billions…trillions…make Wall Street the ultimate moral Borg:  As a rule of thumb, you will be assimilated.

That would include the SEC.

Who gives a rats.
The whole sorry heap is going to be superseded by the 5,000 year old culture of the Chines, backed by Gold and some judicially aimed lead.
The sooner the better.

The wonderful thing about life is that each newborn is born totally dumb. There is always a fresh piece of dumb ready to be taken. Whether he fall to Standard, Poor credibility or a Fundy selling heaven, there is a new sucker born every minute.

The predacious among us need to feed upon such sucklings; the view may be as unsavory as watching a vulture devour a blue bird, but it is not dull.

Michael Goldman

Jan. 6, 2011, 11:46 p.m.

This is just one glaring example of the powers of the greedy and ethically corrupt and bankrupt .....  the politician’s who refuse to do the right thing .... despite the financial crisis Republicans deny the need for strong regulation, Frank/Dodd did not address the failurfe of the rating agencies (which require accredidation to conduct business), Greenspan refuses to accept responsibility for creating the low interest rate environment and supporting the housing boom, Clinton hasn’t said a word about his administration’s enabling the disaster, Wall Street (investment banks and major commercial banks) deserve every word of the severe approbation they received and more!, Obama doesn’t even currently address the issue, hardly a sole has gone to jail, the accounting profession hasn’t even been criticised, lobbyists got rich selling their soles to the Wall Street satins, and the only ones to suffer are the innocent milliions of American citizens whose families (including the children) have been severely hurt and suffer unquantifiable financial psychological damage.

How can ANY person even try to invest in anything? These people are concerned with one thing:self enrichment…they could care less what happens to you or your savings….its crazy and so corrupt it can’t be fixed…..and now we want to “privatize” social security?..Do you know what these geniuses will do to that money….start with the typical 25 or so percent administrative fee and go from there. Do you have any idea how much money they will rake off the top…instead of this money being paid out…it will actually make the health insurance industry look responsible…Wait…just kidding….

Giulia Milano

Jan. 8, 2011, 12:38 p.m.

The credit ratings agencies are one of the many and disastrous financial fabrications of the late years. It is sure that who is in the lead must have a huge influence over the politicians as they couldn’t be banned definitely (1° emendament or not). the fact is that if people look carfully they could clearly see that rationally the ratings given buy credit ratings agencies can not be that decisive and orienting as actually they are: not only the rating can be different depending from which agency it comes from (and who listens to then and if they all should take their stand on objective elements why they should come to different conclusions..?) but mainly we should answer ourself how much their ratings could be objective when their wage is linked to the society they’re making the valuation..I mean the game works something like this: If I -Lehman Brother company- I’m not satisfied about the rating S&P gives me, I change credit rating agency and I pay Moody’s to tell me that I’m more creditworthy. And if I still keep on not being satisfied..I change again agency till I find the one who gives me the mark I think I deserve. But in the mean time S&P and Moody’s have lost a very wealthy and generous client: I guess they’ll think twice before not pleasing a client..

Were ProPublica to focus intensely on ALL aspects of the debt crisis - from etiology to the present - a book would result, perhaps more than one. The rating whores are but one aspect. The News Hour and others continue to accord the rating agencies respect. This is but a small measure of the problem. With what is presently on the table, there is no chance what so ever that anything will change. In fact, it’s worse, far worse, than it was before the most recent bust. Which is what the trader wants. Traders make loads of money with instability - and little with stability. Volatility and chaos, playing with other people’s money - heads I win, tails others lose - is the only way to describe this. And The New York Times and others are loathe to attack for fear of damaging confidence. They confuse confidence with stupidity and momentum players. The world is a dangerous place - and our place in it is deteriorating daily. Rating agencies are obvious targets - but they are not at the core of this mess.

Let the challenge go to Paul Steiger. He was head of WSJ when this storm was gathering - and he did nothing. Now, financed by those at the eye of the storm, he comes with his independence - and flirts with the edge.

To the eye of the storm, Paul Steiger, or retire. You will have much to do and little time to do it.

All the best -

Sandy

Were ProPublica to focus intensely on ALL aspects of the debt crisis - from etiology to the present - a book would result, perhaps more than one. The rating whores are but one aspect. The News Hour and others continue to accord the rating agencies respect. This is but a small measure of the problem. With what is presently on the table, there is no chance what so ever that anything will change. In fact, it’s worse, far worse, than it was before the most recent bust. Which is what the trader wants. Traders make loads of money with instability - and little with stability. Volatility and chaos, playing with other people’s money - heads I win, tails others lose - is the only way to describe this. And The New York Times and others are loathe to attack for fear of damaging confidence. They confuse confidence with stupidity and momentum players. The world is a dangerous place - and our place in it is deteriorating daily. Rating agencies are obvious targets - but they are not at the core of this mess.

Let the challenge go to Paul Steiger. He was head of WSJ when this storm was gathering - and he did nothing. Now, financed by those at the eye of the storm, he comes with his independence - and flirts with the edge.

To the eye of the storm, Paul Steiger, or retire. You will have much to do and little time to do it.

All the best - and Happy New Year.

Sandy

Richard Ordowich

Jan. 9, 2011, 10:10 a.m.

Ignoring the fact the these agencies are paid by the firms issuing these securities, ratings shopping, fraud and various conspiracy theory aspects, leads to two possible conclusions as to why ratings are inaccurate. Complexity and incompetence.

Complexity because no one truly understands the complexities of the economy or the markets. Neither the X-spurts such as Greenspan or Bernanke nor the academics, nor most of Wall Street.  The only organization that may have at least a self-serving understanding of the markets is of course Goldman Sachs. Goldman hedged their bets both technically in the markets and socially by not overly subscribing to the irrational exuberance to the point of collapse. They played the game like true chess masters. Anticipating both what was happening technically and emotionally in the markets. I am sure they used the Moody’s, S&P and Fitch ratings to assess the asset value as perceived by the “street”. But internally they must have developed their own “real” ratings for these assets. This way they had the public’s and street’s perception of asset value and a more realistic proprietary inside view. Other firms such as Lehman, Merrill Lynch and of course AIG were not sophisticated enough in their asset assessments, using only the perceived public value. 

Given the complexity of the economy and the markets, firms must develop their own asset value ratings. Ratings from the agencies are used for marketing and public comparison purposes somewhat like Morningstar’s mutual fund ratings. If you are investing in securities and mutual funds based on these ratings I suggest you are either incompetent or a fool.

Incompetence in the ratings relates to the fact that the models used by these agencies are decades old. These agencies have a franchise with little chance for competition. As a result they are not motivated to develop new models, preferring to continue to milk the cash cow.

To the point of these agencies using the Frist Amendment to defend themselves. I think that’s revealing. They are explicitly stating these are opinions and they are not liable for errors and omissions. As a result their ratings are the equivalent to the opinions of Glenn Beck, Bill O’Reilly, Jon Stewart, Ben Bernanke, Bernard Madoff or Jim Cramer. Anyone betting their money on the basis of these “opinions” is once again either incompetent or fools.

Perhaps the best way of dealing with this rating problem is to label each rating similar to the way cigarette packages are labeled. “This rating maybe hazardous to your financial well-being”. Reliance on this rating may lead to a total loss of all your money”.

As to periodic updates to these ratings, I suggest ratings should carry expiry dates on them like food. “This rating opinion expires on mm/dd/yyyy”.

Richard Ordowich is essentially correct. But it’s worse. Mr. Ordowich may not know that Goldman played AIG like a fiddle, that this was originated at Gs by one individual, and controlled by others. The man to watch for is Dan Jester - now living in Texas. The CDS and the power of placement were used. Europe was bagged. It seems ProPublica is allergic to hardball. As with most, Steiger wants to give the impression, but when given the means to attack, he blinks. Consider his funding source. Perhaps Goldman will donate. Are donors public?

Dan Jester was deeply involved at GS, at AIG with GS, at treasury for Hank Paulson. Jester reported to David Viniar - who reports to Blankfein.

Goldman will not allow Dan Jester to speak - or he will not speak.

Nor will the head of arbitrage - c. 2007 - speak.

This is the way it is.

The “system” as it stands cannot prevail in the long term.
Watch for ugly years….2011 thru 2014 due to millions of potential home defaults.
No jobs bolstering the ability of the consuming class to participate in this “global” economy necessarily means more loosers than winners in America.
A good comment above about “traders….needing…volatility” for profits fits the markets today perfectly.
This is not a “market” for the “average” investor.
This is a market for those who are trading for their own pockets.
That may be the “essence” of modern capitalism but it means absolute death for our society.
“Regulatory Capture” and the constant revolving door of employment between our now proven corrupt politicians (too many of them) and “important” industries including the financial one precludes any “reform” of the system that is totally corrupt and greedy to the point of criminality which no-one in the judicial system seems capable of sowing together into a tapestry of that criminality.
The Italian Mafia is an infant compared to the machinations of the financial oligarchy in this country.
The “slimy octopus” fits our whole financial system….on the face of the public.
A pox on all too many politicians and their handmaidens and colluders, the financial and judicial world.
Of too much of this are revolutions and civil war made.

http://www.nytimes.com/2009/06/07/opinion/07cohanWEB.html?scp=1&sq=sandy lewis&st=cse
OP-ED CONTRIBUTORS
The Economy Is Still at the Brink
By SANDY B. LEWIS and WILLIAM D. COHAN
Published: June 7, 2009

SIERRA should print his name. Be proud to speak truth.

The New York Times OP ED editor, David Shipley, asked (me) to remove Use Immunity and RICO from the OP ED - and I refused.

SIERRA’s concept is 100% correct.

Worse - journalism - names on request - knows. And blinks. It is quite amazing.

Better yet, FBI and the US Attorney, District of New Jersey, (effectively) blinks.

The bureaucrat seeks work later. Eric Holder is a bureaucrat. Sadly, the man himself, and I vote for him - and probably will again - is part of this.

Ultimately, the truth will emerge. This is too big to keep quite forever.

Sandy

Sandy Lewis, Lewis Family Farm, Inc., Essex, NY 12936 - 518 963 4206.

OP-ED CONTRIBUTORS -

The New York Times
The Economy Is Still at the Brink

By SANDY B. LEWIS and WILLIAM D. COHAN
Published: June 7, 2009

To borrow terminology from Bruce Schneier, it’s about interest and capability. It’s in our interest for ratings agencies to be rigorous & theirs to be lenient. Only they have the capability so we need to align interest. The obvious way to align interest with capability is liability — that is, make the ratings agencies liable for errors & omissions.

Catherine Tripp

Feb. 6, 2013, 1:06 p.m.

Eric Holder announced a civil lawsuit against S&P yesterday.  HUZZAH!  And yes, there are alternatives - check out free risk.org.  S&P has had a monopoly with sugary conflict of interest on top for WAY too long.

Jesse Eisinger

About The Trade

In this column, co-published with New York Times' DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at .(JavaScript must be enabled to view this email address)