Monday, August 8, 2011

Analysis: Why Congress and Standard & Poors deserve each other

Having Standard & Poors downgrade the creditworthiness of the United States, and warn it about further downgrades, is a little like having the Catholic Church lecture scout leaders on the proper behavior toward boys. The moral authority seems to be wanting. S&P, you may recall, is one of the ratings agencies, the others being Moody's and Fitch, that greased the skids of the financial crisis by awarding AAA ratings to tranche after tranche of mortgage bonds called collaterized debt obligations, or CDOs. Recall that, unlike U.S. Treasuries, backed by the full faith and credit of the United States, CDOs were underwritten by garbage mortgages - that is, backed by no documentation "liar loans," and other Alt A subprime pond scum handed to borrowers who otherwise couldn't get a nickel's worth of credit at their local dry cleaners.
S&P stamped CDOs with the same grade it had previously awarded to a precious few companies, such as Exxon and Microsoft. More than 30,000 CDOs got the AAA blessing from the agencies. S&P couldn't pull its snout out the trough even when it became apparent in 2007 that the mortgage bond pigout was over. This email from an S&P employee, uncovered by a Congressional investigation, says it all: "Let's hope we are all wealthy and retired by the time this house of cards falters." In their absorbing history of the financial crisis, The Devils Are All Here, Bethany McLean and Joe Nocera bared the behavior of the agencies. Even when their own analysts began sounding the alarm, senior management refused to stop the money machine; and if the analysts became insistent on being scrupulous, the agencies got different analysts. Why? Because their clients, big banks such as Lehman Brothers and Goldman Sachs demanded that the CDO machine keep on cranking, until it collapsed utterly. (See how the U.S. downgrade will change the global economy.)
And let's be clear: this was all perfectly legal. "S&P's ratings do not speak to the market value of a security or the volatility of its price and they are not recommendations to buy, sell or hold a security; they simply provide a tool for investors to use as they assess risk and differentiate credit quality of obligors and the debt they issue," testified Rodney Clark, head of ratings services for S&P to the House subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises. In other words you can't take our word to the bank, but you can take it to the poor house. When investors such as the Wyoming state pension system subsequently sued after many of the CDOs crashed in value, the industry stuck to this "Its just our opinion" defense and won. The U.S. Second Circuit Court of Appeals ruled last August that the agencies were not "underwriters" or "control persons" even if they were in bed with them. The fundamental contradiction of the industry is that the companies who issue the securities pay the ratings agencies for the grade; independence is always suspect, and the courts upheld it.
One of many ironies of the S&P downgrade is that the three ratings agencies have so much power because the federal government , in the form of the Securities and Exchange Commission, handed it to them. As our former colleague Barbara Kiviat pointed out in this space, the power of the big ratings agencies dates to the post Depression era when the government increasingly relied on them to bless new issues for credit wary investors. Then, in 1975, the SEC iced the cake, designating a number of companies as "nationally recognized statistical rating organizations," or NRSROs. If you were not an NRSO as a ratings agency, you were SOL. Why would anyone issue bonds rated by an agency that wasn't government-approved? The SEC designation had the unintended effect creating a market lock for the bigger firms.
That S&P would slap the hand that legitimizes it is wonderfully perverse given last week's debt deal. The Tea Party supposedly hates Wall Street so much that it ignored warnings that its Taliban economic policy - threatening to decapitate the economy unless it got its way on spending cuts - would spook the markets, since the Street abhors uncertainty. For a moment, it looked as if the Tea team won, in that the market didn't tank as the deal wrangling went on and on. Instead, the market cratered post-deal, because this compromised compromise left so much up in the air. Republicans had been chastising the Obama Administration for creating uncertainty, yet they allowed their own radical wing to impose it for the foreseeable future. (Clearly, uncertainty about the resolution of Europe's sovereign debt crisis contributed to the market troubles, too. ) So S&P in effect, fired a shot across the Tea Party's bow: you mess with Wall Street, you will be punished. It had another for Obama: Lead, follow, or get out of the way. And the two parties blamed each other. "It happened on your watch, Mr. President," screamed Michelle Bachman, exhibiting the full extent of her knowledge of economics. In making its decision S&P said the downgrade "reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011." (See "Economics Bloggers Slough Off the S&P Downgrade.")
Here's the other laughable irony. Congress had a chance to rein in the ratings agencies, but demurred. Even though the statutory authority that gave S&P, Moody's and Fitch an oligopoly on ratings was complicit in their contribution to the crisis, Congress nevertheless refused to remove the NRSRO status. The solons bought the idea that smaller agencies would be crushed if an unfettered free market was imposed on the ratings industry.Read more...

0 commentaires:

Post a Comment