Rating Agencies May Just Get Their Due

Includes: MCO, SPGI
by: Don Fishback

[update below]

If you’ve read this blog for a while, you know that I pretty much place the blame on the financial crisis on the outsourcing of responsibility. The regulators thought the banks would be responsible to shareholders. That made watching the banks unnecessary. Lenders thought that since most loans were securitized and sold, that the only thing that mattered was that the paperwork looked good. Who cares if what’s on the paper was false, or that the homeowners had no prayer of paying the mortgage once the teaser rate was recast.

And as far as those who bought the securitized mortgages, how many of them bothered to look at the actual mortgages themselves when ratings agencies like S&P (MHP), Moody’s (NYSE:MCO) and Fitch all blessed the bond-like investments with AAA ratings? Based on those ratings, investors believed that these bonds were as safe as Treasuries! It was the ratings that created the pool of never-ending liquidity that funded the mortgages that fueled the boom. When everyone realized that the ratings were bogus, the house of cards collapsed.

The reason I mention all of this again is because Barry Ritholz pointed to a very interesting update on the ratings agency world: litigation and liability!

I’ll just say this. To me, seeing how I’m located in what was once the burley tobacco capital of the world, the position the ratings agencies are in is a similar position to the tobacco companies' many years ago:

IMAGE Camel Are Ratings Agencies Finally About to Get Their Due?

Back when World War II was fought, few believed that cigarettes were dangerous. Later on, when some people began to suspect that tobacco was not as safe as most believed, industry experts were trotted out to tell the world how safe cigarettes were. Heck, you even saw ads touting how doctors loved them! Eventually the world realized that cigarettes were not safe at all, and that the insiders were either wrong or had purposely misled the public.

Now take that same paragraph and replace cigarettes with AAA-mortgage derivatives, and you’ll see an nearly identical pattern:

In the early days of mortgage derivatives, few believed they were dangerous. Later on, when some began to suspect that there were unanticipated dangers, the industry went on a furious lobbying campaign to tell the world that these derivatives were safe. You even had some financial masters tell the world how much they loved CDOs and the rest of the alphabet soup products. And here we are now. The supposed masters have been proven wrong. And in some cases, people have found evidence that the inside experts purposely hid knowledge that the risk was far higher than what was being disclosed to consumers of the product.

It seems as though Calpers is going to take the same approach as smokers who bought and smoked the cigarettes, and the states who collected tax from the sale of the cigarettes. Calpers sued. In their lawsuit, the pension fund holds itself completely blameless and admits that their own analysts had no idea what they were investing in when, according to the lawsuit, they say, ”no amount of due diligence” by its own analysts could have given Calpers “actual knowledge” of how conflicts of interest at the ratings agencies affected their assessment of SIVs or how heavily exposed the securities were to subprime loans. Yet, Calpers still invested more than a billion dollars of other people’s money in this crap.

And, in what is undoubtedly the pièce de résistance of coincidence, Calpers lead attorney’s name is Tabacco!


Tracy Alloway at FT Alphaville has more on the lawsuit, including a scan from the actual complaint courtesy of Zero Hedge. Here’s the thing that stands out to me. It’s where Calpers admits they had no idea what they were investing in:

“The exact make-up of assets was treated as confidential, lest anyone, even investors, learn CUSIP level data of what was contained in the SIVx and be able to copy it.”

These fiduciaries invested more than a billion into an investment vehicle and had no idea what that investment vehicle contained? ARE YOU KIDDING ME? Talk about passing the buck.

The purveyors of these investment vehicles kept investors such as Calpers completely in the dark, so pensions and other investors had no idea of the risk or reward potential of the asset. What’s shocking is that these investors believed that lack of information made the investment even better. It wasn’t a flaw. It was a feature!

I just wonder when some pensioner decides to follow Calpers litigious lead and sue Calpers for mismanagement of his or her pension.