Moon Kil Woong

Rating Agencies Won't Be Able to Shut CalPers Up Easily

WE Heasley you are correct that CalPers is, like all government retirement systems underfunded, and is playing the blame game somewhat. However, they are also correct the ratings agencies were complicit in poor ratings.

Regarding ratings agencies. They have a vested interest to both overvalue all bonds and also undervalue municipal bonds below AAA or AAA equivalent because that way they need to get a monoline insurer to insure them which is yet another lucerative revenue stream for them.

I suppose having a national rating system would also prove insufficient because of the way government plays games with even standard stuff line unemplyment and other economic statistics.

The only way I can think of is some ratings agency composed of an equal weight of both buyers and sellers of bonds with no insurers involved. You would think financial institutions would do something like that. However, as we are finding out, they seem better at begging the government for help when they mess up than actually bothering to get anything right. If bonds were always correctly valued, their magin and edge might evaporate and they would have very few excuses for being wrong.

Rating Agencies Won't Be Able to Shut CalPers Up Easily

Buy a clue. You are correct. The issue is more dicey. Ratings agencies assess municipal bonds from payment by the municipality as well as the monoline insurers. Of course, the funny thing is the better the municipalities are and the worse they are rated is results in the bigger advantage monilines get insuring municipal bonds that are rated lower than AAA in almost all cases even if the municipal bond has never defaulted or is expected to within reason. By doing so monolines are insured a cut of the profit insuring them even if they otherwise wouldn't need to.

A sweet deal indeed. It gets even sweeter. The monolines, which may not have enough assets to back even a fraction of what they insure like AIG then pay to have the ratings agencies give them a AAA rating so they can keep insuring bonds that they could not cover if the economy collapses and there is even a fraction of defaults in what they insure. Thus, we have seen with the blowups in derivatives, that all the guarantees they issue are a house of cards and their bonds are becoming untradable. It is these that banks quietly try not to talk about.

Thus, the municipal bond issue where municipalities get te short end of the stick for being better off is directly related to the bonds that are too toxic to touch which are all connected to the shoddy work of ratings agencies and monoline insurers issuing CDOs and other badly crafted guarantees.

The ratings agencies are guilty of overrating and under rating bond prices for the same reason: Conflicts of interest when it comes to how they are paid. So far, although there is talk of reform nothing has been done about it (something about money again probably).

usmayors.org/usmayorne...

articles.moneycentral....

Thanks for your shrewd question buy a clue. Although this relationship was not the central topic of the article it is certainly worth a read as well.