The Fundamentals Of Structured Finance Ratings

http://www2.standardandpoors.com/spf/pdf/media/082307_ian_op_ed_brt.pdf

For me if they have, rating will never work.

For what it’s worth, I noticed this was a particularly poorly written piece. Dunno if Summers got it in late, or the guy at FT who was editing him was the end-of-summer stand-in and afraid to mess with a big name.

The line you mentioned does go a bit overboard. However, from everything I can tell (and people like me don’t sit on trading desks), ABCP is just not being purchased. That doesn’t (necessarily) have to do with fear of losses, but that it’s value could go down due to everyone else repudiating it. Remember, a big chunk of buyers are subject to $1 NAV rules. They can’t take principal losses on their portfolios.

As for CDOs, I have seen comments that on some deals the losses couldget so large that they even impair the AAA tranche (see http://www2.blogger.com/posts.g?blogID=3782644139927778760&label=&searchType=ALL&txtKeywords=%22rating+agencies%22+default&numPosts=25) Fitch said privately with 1-2% price declines, “their models break down” and you’d see impairment extend into the AA and AAA tranches.

So the worries are legitimate…..

Anon of 1:40 AM and a at 7:08 AM

Note that Anon proposed a change in the payment mechanism, not a tax. However, that still might be unacceptable to Europeans.

Are we talking MBS, ,CDOs, or ABCP here? Is this true and, or, really the cause of the crisis? Elsewhere I have seen the comment that AAAs have not yet been impacted by losses.

Do not re-ratings happen thick and fast in corporates too?

In any case I think it’s far better to take the ratings agencies for what they are: capable of offering guidance based on historical statistics. That means ratings agencies are capable of providing ratings for plain vanilla products where historical statistics are present and relevant. For more complicated products they should not be allowed to provide ratings, or, if they do provide them, these ratings should be asterisked in some way so that they can be treated differently than the plain-vanilla products. After that, it is buyer beware. If this grinds the market for the exotic products to a halt, too bad for them; but if that were to happen, then it is clear these exotic products only have managed to exist because one a confusion as to what their ratings mean.

Thanks for the comment and good suggestion. It has the effect of treating the agencies like a public utility, which in many ways they are.

And no, I’m not now and never have been a rating agency analyst. But I’ve drafted many a CDO for a living, have been on many calls with the bankers and agency analysts, and offer the following observations:

– the agencies are overworked and underpaid,

– the so-called bankers handling the deals are typically late 20s, early 30s muscleheads in tight suits

– they have no care for the public effects of their dealmongering, caring only to close the deal;

– they connive routinely, sometimes with their lawyers but often behind the lawyers’ backs, to exploit loopholes or otherwise undermine the good-faith work of the agency analysts;

– they consider their dealmongering a matter of wrestling with the party on the other side of the trade — a kind of jockish jousting — and may the most devious man win, blind, one might think, to the public good and the existence of public consequences of their play.

A now-senior investment banker, overhearing literary chat in a conference room, asked “Is your novel fiction?” Followup chat revealed he had passed through high school, college and business school — fancy shops, too — without ever having encountered a novel.

To think that institutions operated by such people can be relied upon to conduct public affairs in accordance with the spirit of the securities laws is foolhardy.

Regulating these demi-beasts in tight suits will remain work of the agencies.

The most practical way to reform the agency system, given where we are, may be:

(i) instead of a bank paying an agency directly at the closing of a deal, funnel the money from the bank into a central kitty;

(ii) then pay the agencies monthly, say, from the kitty, based (as now) on the volume of their work.

The banks/issuers would still be paying the fee. But the direct pressure upon an agency to “perform” on a deal-by-deal basis would largely be relieved.

In other words: make the cost of failure high enough to be excruciatingly painful but not enough to bankrupt.

Call it the Prometheus solution. We’ll peck their innards out by day and let them regrow at night. Die they shall not.

One or two incidents would probably make the ratings agencies far more conservative. The cost of purchasing CDS’ on their structured products would skyrocket.

The fundamental problem is that the legitimate role of money – to coordinate and motivate human endeavor in productive ways – has been usurped and betrayed. What remains is a hopelessly labyrinthian maze of computational complexity resulting only in the enrichment of those who add nothing to the well being of the world.

I recently read that as of May 78% of financial assets were derivatives vs: 11% in the stocks and 1% in cash. What happens when 15% of those derivative holders panic and want value they can hold in the palm of their hand?

What a mess.

http://www.nakedcapitalism.com/2007/05/rating-agencies-weak-link.html

http://www.nakedcapitalism.com/2007/07/what-if-we-stop-believing-ratings.html

http://www.nakedcapitalism.com/2007/06/now-its-official-rating-agencies-hiding.html

If you have patience for only one, this one has some pretty damning stuff not widely reported elsewhere:

http://www.nakedcapitalism.com/2007/06/more-on-rating-agencies-and-risk-in.html