ratings agencies

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 »

There are many great businesses in the world but surely none is as great as being paid money not to do stuff. I was in that line of work for two glorious months in the summer of 2011 and I’m pretty sure it was the peak of my career. Counterintuitively this business is not always massively scaleable,1 but there are some examples. My favorite is that in the 1980s companies would pay Skadden Arps a retainer fee to prevent Skadden from representing a hostile acquirer; I have idly suggested that David Einhorn look into charging similar fees to direct-marketing companies who want peaceful earnings calls.

If I were Moody’s I’d have a sliding scale of CMBS fees that goes like:

J.P. Morgan seems to have opted for false economy: 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 »

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]

  • 24 Apr 2012 at 6:00 PM

Quo usque tandem abutere, Egan-Jones, patientia nostra?

Lawyers all know the old case in which a guy sued another guy over a dead fox that Guy A chased and Guy B caught. Who owns the dead fox?, the case asks. It’s hard to care. My professor asked the better question, which was: just how much was a dead fox worth? The answer, it turns out, is “significantly less than the amount you’d have to spend on lawyers to become a famous old case.” So why did they spend so much on lawyers? Unclear. But the moral of the story is that if you see a lawsuit over something really trivial, it’s probably about something else. My professor added, “usually a love triangle.”

So who is Sean Egan sleeping with? He is, of course, the president of Egan-Jones Ratings, which the SEC sued today over … well, the SEC complaint is amazing: Read more »

  • 30 Jan 2012 at 6:25 PM
  • Credit

MF Global Was Doing Great Until It Wasn’t

“Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone,” but every banker also seems to forget the modern corollary, which is that, if you have to prove you are worthy of credit, however good may be your arguments, don’t do it over email. Here’s someone who forgot that and does it surprise you to find his name in the same sentence as “House Financial Services Subcommittee on Oversight and Investigations”?:

A week before MF Global Holdings Ltd. collapsed, its chief financial officer told Standard & Poor’s in an e-mail that the futures broker had “never been stronger.”

S&P provided the House Financial Services Subcommittee on Oversight and Investigations with an excerpt of the e-mail from MF Global CFO Henri Steenkamp. S&P also informed the panel that Jon Corzine, then MF Global’s chief executive officer, met with its analysts on Oct. 20 to reassure them that his $6.3 billion bet on European sovereign debt was no threat to the firm, according to a Jan. 17 letter obtained by Bloomberg News.

U.S. lawmakers will turn their attention to the role of the ratings companies in the failure of MF Global at a Feb. 2 hearing after summoning Corzine, the former governor of New Jersey and Goldman Sachs Group Inc. co-chairman, to two hearings in December. S&P ranked MF Global as investment grade until its failure, while Moody’s downgraded it to junk status four days earlier.

“MF Global is in its strongest position ever,” Steenkamp told S&P on Oct. 24, according to the letter to Representative Randy Neugebauer, a Texas Republican, from Craig Parmelee, a managing director at S&P in New York.

Who can understand the workings of an MF Global? Not me. Apparently they had a money vaporizing device, which in its final days was being manned by employees not wholly familiar with its proper operation, and which caused some unpleasantness when it was aimed at clients’ money. Still to a first approximation it seems reasonable to think that poor foolish-sounding Steenkamp was basically right. MF Global had some assets and some liabilities and its assets exceeded its liabilities. It had a short-term reasonably safe bet on some European government bonds that proved reasonably profitable, and that bet was funded with matched-maturity funding that was reasonably stable until it wasn’t. Then everything went south, that matched-maturity funding was pulled, MF Global needed to sell assets and post more collateral to remain in business, and in the confusion someone accidentally turned on the vaporizer. Read more »