ratings agencies

  • 30 Nov 2012 at 11:36 AM

Skeptical Investor Puts Trust In Ratings Agency

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.

Our question today is instead: are S&P idiots? Here is Muddy Water’s latest offer:

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 »

Have you finished reading Judge Jayne Jagot’s 43,000-page opinion in the Australian CPDO case yet? Good, because we’ve got to move on to other things.1 Like: what does it all mean?

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.”

They also point out that the statute of limitations will protect most crisis-era ratings at this point. And here’s John Carney: Read more »

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 »

If someone builds structured credit securities out of some dodgy stuff, and someone else rates those securities AAA for no particularly good reason, and someone else sells those securities to you without reading the offering memo, and you buy those securities without any due diligence since you figure that the structurer and rater and broker wouldn’t all be messing with you, and it turns out they were, and the stuff blows up, and you end up losing a lot of money on the AAA rated securities, the natural question for you to ask, this being America, is: whose fault was that?

That question is being asked in all the best circles these days, and the answer is probably “everybody’s,” as it usually is. One place it’s being asked and slooooowly answered is in a New York federal court considering the case of the Cheyne Finance SIV, which is special for at least two reasons. First: there is a widespread belief that credit ratings are opinions, and opinions are protected by the First Amendment, and so you can’t restrict the creativity and expression of those free spirits and S&P by suing them when their opinions turn out to be, well, wrong. But for (weird!) reasons we’ve discussed, the judge in this case, Shira Scheindlin, is unimpressed by those arguments, so this is a rare lawsuit against ratings agencies that may actually go to trial.

Second: this SIV may – may – have been the origin of “structured by cows.”* Read more »

They’re gonna downgrade their outlook from stable to negative though, just in case. [WSJ]

The role of the hero who has been in the belly of the beast and emerged to slay it seems to be psychologically rewarding,* because people keep trying to claim it for themselves. Like this Geoffrey Tomes gentleman, who bared his soul to tell DealBook that he “was selling JPMorgan funds that often had weak performance records, and I was doing it for no other reason than to enrich the firm.” You imagine him racing to tell DealBook about this revelation, imagining his welcome into the Greg Smith Hall of Heroes, and being a little disappointed that everyone was all “wait, what, did anyone on earth not know that was exactly what you were doing? Why did they think you were pushing JPMorgan products? That’s what banks do.”

Similarly there is a certain amount of “duh, obvs” to the recently unsealed documents in the lawsuit over the Cheyne SIV. But they’re still funny. Cheyne was a conduit stuffed with mortgages and home equity loans that exploded in the face of some people, who are now suing Morgan Stanley, who built it, and the rating agencies, who did sort of a not-so-great job of kicking its tires. From their filing unsealed yesterday: Read more »

  • 17 May 2012 at 2:30 PM

Fitch Could Not Think Less Of Greece Right Now

Fitch ratings agency downgraded debt-crippled Greece deeper into junk territory on Thursday, warning of a “probable” Greek exit from the euro currency union if new national elections next month produce an anti-bailout government. Fitch said it had cut Greece’s rating by one notch, from B- to CCC, the lowest possible grade for a country that is not in default. [AP]