- 27 Feb 2013 at 3:12 PM
- 04 Feb 2013 at 5:10 PM
One day – one day soon – the Justice Department will sue S&P for mis-rating a bunch of CDOs, and when that happens let’s all read the complaint and then meet back here to discuss it, okay? [update!] In the meantime we have S&P’s preemptive denial:
A DOJ lawsuit would be entirely without factual or legal merit. It would disregard the central facts that S&P reviewed the same subprime mortgage data as the rest of the market – including U.S. Government officials who in 2007 publicly stated that problems in the subprime market appeared to be contained – and that every CDO that DOJ has cited to us also independently received the same rating from another rating agency.
I submit to you that this is not a great defense, though it has a certain intuitive appeal. If in fact it turns out that S&P knowingly gave terrible CDOs AAA ratings because they were being bribed by investment banks or whatever, then it doesn’t help them much that Moody’s, say, gave the same CDOs the same AAA ratings with pure hearts and empty minds.1 Intent matters; being evil makes you more liable than does being stupid.
More interesting, though, is the claim that “S&P reviewed the same subprime mortgage data as the rest of the market.” First of all, that’s an almost magically ridiculous statement. (Though, also: true!) S&P’s credit ratings not only had the force of quasi-law in 2007 when they were bopping around misrating CDOs: they still have the force of quasi-law today, and there’s no plan to change that. Basel III regulations rely on ratings-agency ratings all over the place. And yet S&P has no actual advantage over anyone else in deciding what’s a good credit risk.
So why would you rely on S&P to tell you what’s a good credit risk? Read more »
- 22 Jan 2013 at 4:07 PM
The SEC’s press release touting its triumph over rebel-without-a-cause rating agency Egan-Jones gives just the slightest impression that it was written in embarrassment. A trope of SEC press releases is “[thing we are enforcing] is among the most important things in the whole wide universe”; this is hard to say with a straight face when the defendant is guilty “essentially, of filling out forms wrong,” as Jesse Eisinger put it last year. But two SEC enforcement bigwigs give it their best shot:
“Accuracy and transparency in the registration process are essential to the Commission’s oversight of credit rating agencies,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “EJR and Egan’s misrepresentation of the firm’s actual experience rating issuers of asset-backed and government securities is a serious violation that undercuts the integrity of the SEC’s NRSRO registration process.”
Antonia Chion, Associate Director of the SEC’s Division of Enforcement, added, “Provisions requiring NRSROs to retain certain records and address conflicts of interest are central to the SEC’s oversight of credit rating agencies. EJR’s violations of these provisions were significant and recurring.”
To be clear what happened in the Egan-Jones case was, as we’ve discussed before:
- In 2008, Egan-Jones told the SEC “we have issued 200 ratings and they are on the internet.”
- A few months later, Egan-Jones corrected the number of ABS and muni ratings from 200 to 23.
- The correct number was actually zero, as you could tell by looking at E-J’s website.
- Four years later, the SEC noticed.
“‘Accuracy and transparency in the registration process are essential to the Commission’s oversight of credit rating agencies,’ said Robert Khuzami, Director of the SEC’s Division of Enforcement,” though not so essential that the SEC would get around to noticing admitted inaccuracy inside of four years.
So, I mean: don’t fill out forms wrong! Read more »
- 05 Dec 2012 at 6:03 PM
You can see why no one likes rating agencies. It’s not exactly a surprise to anyone that Greece’s debt situation is Not Good, so the fact that S&P just downgraded Greece to selective default is (1) not particularly helpful to anyone attempting to make an investment decision re: Greek bonds and (2) not particularly helpful to anyone else either.
That said, I admire S&P’s role as a stickler for the rules of a game that it invented and no one else is playing. Greece is conducting an essentially non-coercive exchange for its bonds at above their all-time high prices. Is that a “default”? Well, for what purposes? Legally, mostly no. For CDS, no. But for S&P, yes. (Yes, it is.) They’re paying off their debt for less than par, so default it is. And since those are the rules, S&P must pointlessly note that Greece is in selective default.1
- 30 Nov 2012 at 11:36 AM
You may be aware that noisy Asia-focused short-seller Muddy Waters is in a fight with Singaporean agricultural commodity trader Olam. Muddy Waters thinks that Olam is “an extreme example of an increasingly important conflict in modern finance: the clash between accounting and business reality,” and that “it is instructive to view Olam through the lens of failed US trader Enron Corp.” Olam disagrees, vehemently and litigiously. You can read all about it at your leisure (pro, con); I am not an idiot so I will carefully avoid taking any position on who is right and by how much.
We hereby make a bona fide offer to pay for Olam to have one of its public debt issues rated by S&P. … The Company has never before had a debt rating, and having Olam’s debt rated by S&P would be an important step toward improving the Company’s transparency. Because we will pay the expense, Olam has no good reason not to have a rating.
I love this move! On its surface this is a pretty straightforward proposal. Muddy Waters thinks that Olam is – to use simple words – a big fraud, but the only way to really know is to have inside information,1 which Muddy Waters lacks. Olam has plenty of inside information but (1) has a vested interest in persuading people it’s not a giant fraud, whether or not it in fact is, and (2) can’t reveal every piece of inside information to everyone for reasons both practical and competitive-secrecy-y. Read more »
- 06 Nov 2012 at 3:36 PM
This Election Day, Remember Your Constitutional Right To Carelessly Misrate Structured Credit ProductsBy Matt Levine
One obvious thing that it could mean is “nothing,” or at least not very much. The case involved $30 million of damages, and there seems to be an Australian class action coming that might involve more damages, but it seems unlikely that CPDOs are going to track S&P across the globe to haunt its bovine dreams. Euromoney points out some of the many barriers to suing, though it adds:
In the case of CPDOs, however, of which around $5 billion were issued, there might be impetus for investors to follow the Australian councils’ lead. The firm that funded their litigation, IMF Australia, is believed to be examining the viability of further claims in Europe (CPDOs were largely arranged by European banks and sold in Europe).
Here in America, though, S&P seems safer. Here’s the FT:
Floyd Abrams, an attorney for S&P, says: “It is highly unlikely that this Australian court opinion will have any significant impact elsewhere. The case does not involve mortgage-backed securities. And the ruling does not recognise – as courts in the US and elsewhere generally have – that ratings are opinions which are not actionable unless disbelieved by those that issued them.”
- 05 Nov 2012 at 6:11 PM
Oh man, CPDOs. CPDOs! Why was I not aware? This Australian court decision is like 3,000 pages long but it is riveting; if you built a CPDO, email me, I will buy you a drink and you can tell me all about it. My God it’s so beautiful.
The story is that ABN Amro invented a structured-credit monstrosity called a constant proportion debt obligation, got it rated AAA by S&P, and sold it to some people; it ended up in the hands of some Australian regional councils, and then it chewed their hands off. As well it might have! It was monstrous. Anyway the councils sued S&P (and others) and today they won their lawsuit, which is bad news for S&P, though they kind of deserved it.
To simplify enormously the CPDO deal was:
- You are a ten-year pool of money
- You make a levered investment in some 5-year investment grade credit indices
- Every six months you roll that investment into the next 5-year index
- If credit has widened, you have lost money and therefore lever your investment more, to try to make your money back
- If credit has tightened, you have made money and therefore ratchet down your leverage, hoping to get out in one piece
- If you keep winning you take more money off the table until you end up with your money in Treasuries for the remainder of the 10 years
- If you keep losing you run out of money and just give up, with your investors losing everything
This is obviously a martingale gambling strategy and the analogy is made extensively in the opinion but don’t worry about that now. Worry about the purity of the ratings arb here. It is breathtaking. Here is the core trick of it: S&P rated structured credit products based solely on the probability that they would pay off less than 100% of their principal plus interest, and not at all based on the expected loss if that happened. A triple-A rating required a <0.728% probability of defaulting. What this means is that: Read more »
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