My attention was caught by a throwaway line on Bloomberg:
Democratic presidential nominee Barack Obama said regulation of Wall Street needs to “catch up” with changes in financial markets, and investors can’t expect taxpayers to bail them out in bad times.
Obama said the role of ratings services must be examined as part of any revamping of the way markets are monitored and regulated, and he suggested that he doesn’t favor having the government stepping in to rescue failing firms.
The role of ratings services?
So I looked at his Economic Platform:
Improve Transparency in the Market
Investigate Potential Conflict of Interest between Credit Rating Agencies and Financial Institutions: Credit agencies are paid by the issuers of securities, not by the buyers of securities, which creates a potential conflict of interest in favor of issuing strong securities ratings. This problem was illustrated in the subprime market crisis in which credit rating agencies strongly rated subprime mortgage securities even as there were significant indications of large numbers of foreclosures and a weakening housing market. Barack Obama supports an immediate investigation into the ratings agencies and their relationships to securities’ issuers, similar to the investigation the EU has recently announced.
The European Union Kangaroo Court has been previously discussed on PrefBlog.
We can only hope that – in both the Obama campaign and the EU – that these public utterances are made merely for populist appeal and signify nothing. But it’s not a good sign.
I was actually more offended by another line from the Obama Economic Platform (emphasis added):
Obama’s STOP FRAUD Act provides the first federal definition of mortgage fraud, increases funding for federal and state law enforcement programs, creates new criminal penalties for mortgage professionals found guilty of fraud, and requires industry insiders to report suspicious activity.
Yay! Even more Informers and Secret Policemen! The west’s moral fibre is going to hell. But when I start ranting about this stuff, people usually just treat me kindly, so I’ll shut up now.
Yabbut – you have to wonder where the ratings people were and what they were thinking when all this bundled (good and bad in the same bundle) stuff was being passed around with triple A ratings. If they had no idea it included ninja mortgages, credit card debt etc. then they didn’t do their due diligence, if they knew what was in the package and rated it triple A anyway – you tell me. I find it more than disheartening that banks and ratings co. can no longer be trusted. One may not have liked their bank manager but he/she could always be depended on to tell you the unvarnished (financial) truth. If your bank thought you could afford it: you probably could – if they thought you couldn’t – well you probably couldn’t. Those days are gone, though they may come back.
Credit rating agencies and their role have been discussed extensively on PrefBlog.
They knew very well which instruments included ninja mortgages, credit card debt, etc. They examined the structure of the paper and – in the case of paper eventually rated triple A – saw that it included tranching; the rebundling of paper so that the AAA tranches were given a degree of seniority over the mezzanine and equity tranches.
In their view at the time, the degree of seniority in these structures was sufficient that the instrument would not default, even under high-stress conditions.
It has not yet been shown that they were grossly incorrect. While the market price of these things has been hammered, the number of actual defaults of original-AAA tranches has not (yet!) been significant.
If they were incorrect, due to insufficiently pessimistic forecasts of the worst financial crisis in 100 years or more, what of it? I’m not perfect either. I do not pretend to be. Neither do the credit rating agencies.
I find it more than disheartening that the credit rating agencies are taking suffering such attacks, while investors and their portfolio managers are getting off scot-free. The agencies only give advice. It’s the PMs who actually pull the trigger.
One may not have liked their bank manager but he/she could always be depended on to tell you the unvarnished (financial) truth.
Is this why so many old-folks wind up leveraged to the nuts to buy equity funds? Bank branded equity funds, of course, so you know it’s good.
Mr. Hymas, love reading your blog but hardly think “investors are getting off scot-free” – quite the contrary as I’m sure WaMu, Lehman, Bear Stearns etc. etc. etc. shareholders will attest and any bank that puts old age pensioners into equity funds without the obligatory (yes, I know, and highly questionable) “know your client” info sheet, can and should go directly to jail without collecting $200 (or is it $400 now?) and should get their money “cheerfully refunded”, as they say. Old folks, don’t usually take the big risks preferring to go easy by easy.
“know your client” information is necessary, but hardly sufficient to do a good job investing. The other part of the equation is “know your markets”.
The banks are excellent at ticking off all the boxes on the regulatory forms; by and large they are somewhat less excellent at investment management.
You misunderstand my point about “scot-free”.
Let us assume you have put a big chunk of your life savings into a particular bond fund. This bond fund invests solely in AAA paper. Unfortunately, the AAA paper has now proven to be sub-prime CDO-squared and you have suffered a very large capital loss on your position.
Why are you – and everybody else – blaming the Credit Rating Agency? It’s the bond fund’s portfolio manager who made the decision, based on advice from his research department, the credit rating agencies and his shoe-shine boy, amongst others.
Added Later: Or, if you were the investor and you put your money into this sub-prime CDO-squared yourself … why did you do that? Simply because the credit rating agency told you “it’s good”? An investor who puts blind faith in advice he doesn’t understand has nobody to blame for the consequences but himself.
As stated by Mark Zelmer of the BoC: you can delegate tasks, but not accountability.
The regulators, who delegated the task of risk-weighting corporate debt, and investors, who delegated the task of understanding their investments are simply attempting to evade their own responsibility.