The retired policemen of Louisiana are going to get themselves some justice…
They are funding the pursuit and destruction of corruption…
The Louisiana Municipal Police Employees Retirement System is suing Moody’s and here is what they say… from WSJ.com
~~~~ “As a result of defendants’ misconduct, trillions of dollars of highly risky securities were sold to investors that should never have seen the light of day,” the lawsuit said.
“Beginning in late 2007, Moody’s was forced to ‘come clean’ and downgrade most of these securities. The rest went into default. All of these events have had a hugely magnified effect on the rest of the U.S. financial system.”
The complaint alleges Moody’s reputation has been damaged and its stock price has suffered as a result.
“Thus, besides burning Moody’s reputation to the ground, defendants have helped ignite the greatest financial wildfire this nation has seen since the Great Depression,” the lawsuit said.” ~~~~
It pretty cool that it’s the cops who have authorized this litigation…
The SEC has said that it will be announcing new rules for the oversight of raters in the next few weeks…
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The Security Rating Game
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1287363
First, the securities’ credit ratings provided a downward biased view of their actual default risks, since they were based on the credit ratings agencies’ naïve extrapolation of the favorable economic conditions. Second, the yields failed to account for the extreme exposure of structured products to declines in aggregate economic conditions (i.e. systematic risk). The spuriously low yields on senior claims, in turn, allowed the holders of remaining claims to be overcompensated, incentivizing market participants to hold the “toxic” junior tranches. As a result of this mispricing, demand for structured claims of all seniorities grew explosively. The banks were eager to play along, collecting handsome fees for origination and structuring. Ultimately, the growing demand for the underlying collateral assets lead to an unprecedented reduction in the borrowing costs for homeowners and corporations alike, fueling the real estate bubble…
In March 2007, First Pacific Advisors discovered that Fitch used a model that assumed constantly appreciating home prices, ignoring the possibility that they could fall.
The authors then quote a transcript of a phone conversation between First Pacific and Fitch that makes the latter (one of the credit rating agencies) appear to be idiots. The authors continue,
It certainly appears that rating agencies did not fully appreciate the fragility of their estimates or the possible effects of modest errors in assumptions about default correlations and probabilities in their credit ratings. But this lack of understanding was apparently shared by the regulators that tied bank capital requirements to ratings, as well as by the investors who outsourced their due diligence to rating agencies without sufficient consideration of whether credit ratings meant the same thing for structured finance as they had for single-name securities.
[emphasis added]
So we have the suits vs. geeks divided, and the problem of regulatory capital requirements, both of which I have been emphasizing.
http://econlog.econlib.org/archives/2008/10/the_security_ra.html
Corporate Securities Info : Stretchable credit ratings
By Raul J. Palabrica
Philippine Daily Inquirer
Posted date: October 31, 2008
Amid the present world financial crisis, the credibility of three major credit rating companies—Standard & Poor’s, Moody’s and Fitch—is at its lowest in years.
They are being criticized for complicity in the sale of trillions of dollars worth of securities which used as underlying assets mortgages held by subprime borrowers, or people with doubtful paying capacity.
The high credit rating the raters gave these securities encouraged banks and other financial institutions to invest in them, with disastrous results.
The investors assumed the rating companies conducted the appropriate due-diligence review of the securities before they stamped an “AAA” rating (meaning, highly recommended for investment) on them.
These companies have been described as modern day alchemists: They converted worthless mortgages into investment-grade financial instruments.
Based on the investigations conducted by US regulatory authorities, greed appears to be the reason behind the action of these well-known appraisers of credit worthiness.
Since their fees depended on the goodwill of the issuer of securities, they gave whatever ratings the latter asked for even if they did not completely understand the mechanics of the securities or were not sure of their merit.
Conflict of interest
The more complex the financial instruments the companies were asked to rate, the higher the fees they charged for issuing their “good housekeeping seal.”
It was a classic “You scratch my back, I’ll scratch yours” arrangement that translated to mutually beneficial profits to both parties.
The “check and balance” principle that was supposed to guide and govern their relationship was thrown out of the window of their posh Wall Street offices.
With yearend bonuses at stake, conflict of interest was the least of their concerns. They became conscious, or gave the impression they were, of that mantra only when the true value of the securities unraveled.
From their press releases, the credit raters are shedding crocodile tears about the financial meltdown. But no way are they admitting, even indirectly, that they bear some responsibility for the mess.
This is not surprising because any statement that may be interpreted as an acknowledgement of their involvement, no matter how slight, in the sale of worthless securities could be used as basis for their prosecution for fraud or misrepresentation.
In case the US authorities decide to run after them, these companies are expected to seek refuge under the “no warranty” clause of their credit assessment reports.
No liability
Here are excerpts of those Pontius Pilate-like provisions:
“No warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such rating … is given or made … in any form or manner whatsoever.
“Credit ratings issued by … are solely statements of opinion and not statements of fact or recommendations to purchase, hold or sell any securities or make any other investment decisions.
“The assignment of a rating to any issuer or any security should not be viewed as a guarantee of the accuracy, completeness or timeliness of the information relied on in connection with the rating or the results obtained from the use of such information.
The essence of these disclaimers is, don’t take our word for the ratings. If the assessment turns out to be wrong, don’t look at us. It’s not our fault you relied on our recommendation.
The credit raters are in an enviable situation. In case the securities they rated as “investment or near investment grade” do well, they can crow about their ability to predict winners.
If things turn out differently, the disclaimer shields them from possible liability for giving the wrong advice. But either way it goes, they get paid for their services.
Objectivity
Before credit raters issue their rating on financial instruments, it is standard practice to discuss it first with the issuer or investment bank handling the transaction.
Unless the rating is really bad and beyond repair, the rating is open to negotiation by the parties.
If the result of the assessment is a few points shy of the desired satisfactory or investment grade, subtle “pressure” can be applied on the raters to convince them to change their mind.
This is where personal ties and professional networking play a significant role.
In the rarefied world of international finance, where practically the same people buy and sell securities, bonds and equities among themselves, a little tweaking of the rules or stretching of discretionary authority can bring in the desired results.
Reminding favors given in the past (and a promise to return favors in the future) have strong persuasive effect in an industry that holds sacred the principle that the ends justify the means.
That’s why, every time I see the credit rating given to a financial instrument, bank or country, I try to figure out whether it is a product of an objective assessment or backroom negotiations.
http://business.inquirer.net/money/columns/view/20081031-169410/Stretchable-credit-ratings
Credit-rating crisis triggers suits by cities
The $2.6 trillion municipal bond market has been brought to its knees by the loss of triple-A credit ratings on the bond insurance sold to cities, rendering the policies worthless and prompting a wave of lawsuits by California cities against their bond insurers.
The litigation is almost certain to mushroom nationally, given the number of municipalities, utility districts and others hit by the public bond rating crisis, according to the attorney who has filed the California actions, Nanci Nishimura of Cotchett, Pitre & McCarthy in Burlingame, Calif.
In addition, Connecticut Attorney General Richard Blumenthal weighed in earlier this year with the first suit in the country against the nation’s three largest credit rating agencies, accusing them of low-balling credit ratings on municipal bonds, creating a demand to purchase bond insurance. Connecticut v. McGraw-Hill Cos. Inc., No. HHD-cv-08-4038927-S (Hartford, Conn., Super. Ct.).
‘Wall Street tax’
He said the rating agencies employ a double standard by weighing municipal and corporate bonds with different scales, which gives companies higher ratings despite their higher default rate.
“In effect, they imposed a Wall Street tax on Main Street,” said Blumenthal. “Our cities have been compelled to pay higher insurance rates or premiums, based on ratings that were lower than they deserved,” he said.
The rating agencies, Moody’s Corp., Fitch Inc. and Standard & Poor’s, owned by McGraw-Hill Cos., have called the Connecticut lawsuit meritless. McGraw-Hill spokesman Frank Briamonte in a statement said the company would “defend against it vigorously.”
On Oct. 9, San Francisco became the latest city to file suit against five bond insurers, alleging fraud, negligence, misrepresentation and antitrust violations. San Francisco v. AMBAC Financial Group Inc., No. CGC 08-480708 (San Francisco Co., Calif., Super. Ct.).
The problems stem from the cities’ need to purchase bond insurance so that they can use the triple-A credit rating enjoyed by the insurers and thus entitle the city to a lower interest charge on variable-rate bonds.
But the insurers also backed subprime mortgage pools at the center of the current credit crisis. This forced a downgrade of the insurers’ own ratings in February below triple-A. Suddenly, the cities no longer had the insurer’s elite rating guarantee paid for in the premiums.
Their bond interest rates spiked, and banks that provided the liquidity for city bond projects exercised the right to force early bond repayment at higher interest rates, further squeezing cities.
“That is the key to this case, bond insurers scoured America selling the insurance and saying they were sound, but they failed to disclose they were investing in risky subprime mortgages and credit derivatives,” said Nishimura.
The five bond insurers named were AMBAC Financial Group Inc., MBIA Inc., XL Capital Assurance Inc., Financial Guaranty Insurance Co. and CIFG Assurance North America Inc.
AMBAC spokeswoman Vandana Sharma, MBIA spokesman Kevin Brown and CIFG spokesman Steve Pachella all declined to comment on the litigation. XL Capital and Financial Guaranty did not return calls seeking comment.
But MBIA’s Brown said, “What we’re seeing is a number of insurers studying ways to reactivate dormant subsidiaries and get back into public finance securities.”
The borrowed money, used to build roads, schools and sewer systems, became much more expensive, interest rates and insurance premiums rose, and new money has become far tougher to obtain.
“We’ve paid increased interest on the airport construction,” said Dennis Herrera, San Francisco’s city attorney. He said the city suffered tens of millions of dollars in damages when bond insurers lost their credit ratings.
On July 24, Stockton, Calif., at the epicenter of the housing foreclosure crisis, and Los Angeles, the second-largest U.S. city, sued their bond insurers, followed by Oakland and San Mateo County, both in California. San Diego is reportedly considering similar litigation, and transit agencies that must borrow to fund expensive equipment purchases or leases may follow.
It is no accident the litigation began in California.
The state, the largest municipal bond issuer in the United States, has roughly $44 billion in general obligation debt outstanding. The state sold $12 billion in bonds during 2007, according to State Treasurer Bill Lockyer.
– Pamela A. MacLean
http://www.lalegalpad.com/2008/11/credit-rating-c.html
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