Did Standard and Poor’s Break SEC Regulations in Disclosing Its Downgrade to Select Parties?

The Administration and its allies have gone after Standard and Poor’s for its downgrade of the US bond rating to AA+. They have attacked S&P’s general competence, its failure to reexamine its decision in the light of a $2 trillion math error (a Wall Street Journal story does not reflect well on S&P’s haste) and the subjective and political basis for its judgment. Even if these attacks have merit, however, they come off as being less than convincing by virtue of sounding like sour grapes.

There is a much more straightforward basis for questioning S&P’s conduct, and it has nothing to do with how S&P arrived at its rating. There is compelling evidence that the ratings agency made selective disclosure of its downgrade decision before it made it public last Friday evening. A reader told us certain hedge funds were informed Tuesday and traded successfully on the information. A separate source had told me certain banks were briefed on Thursday and were told of the US downgrade but assured their ratings would be unaffected. On Friday morning, Twitter was alight with the news.

Disclosing news of a ratings decision is required under SEC rules to be made publicly. All the discussion with favored parties is clear regulatory violation. Here is the germane section (boldface ours):

§ 240.17g-4 Prevention of misuse of material nonpublic information.

(a) The written policies and procedures a nationally recognized statistical rating organization establishes, maintains, and enforces to prevent the misuse of material, nonpublic information pursuant to section 15E(g)(1) of the Act (15 U.S.C. 78o–7(g)(1)) must include policies and procedures reasonably designed to prevent:

(1) The inappropriate dissemination within and outside the nationally recognized statistical rating organization of material nonpublic information obtained in connection with the performance of credit rating services;

(2) A person within the nationally recognized statistical rating organization from purchasing, selling, or otherwise benefiting from any transaction in securities or money market instruments when the person is aware of material nonpublic information obtained in connection with the performance of credit rating services that affects the securities or money market instruments; and

(3) The inappropriate dissemination within and outside the nationally recognized statistical rating organization of a pending credit rating action before issuing the credit rating on the Internet or through another readily accessible means.

(b) For the purposes of this section, the term person within a nationally recognized statistical rating organization means a nationally recognized statistical rating organization, its credit rating affiliates identified on Form NRSRO, and any partner, officer, director, branch manager, and employee of the nationally recognized statistical rating organization or its credit rating affiliates (or any person occupying a similar status or performing similar functions).

The language in Dodd Frank is more strict and specifies that a nationally recognized statistical ratings organization can have its registration revoked for misconduct (see page 1353).

The SEC is actually good at pursuing insider trading cases and even though this is not technically insider trading (as in the leakers presumably didn’t gain personally; this instead appears to be corporate favor seeking/trading) the type of investigation required would be virtually identical. It would be fun to see who S&P saw fit to enrich and how much ill-gotten gains they reaped.

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85 comments

  1. NYT

    Glad you raised this. Thats what I was thinking too because the markets dived on Friday with no explanation (other that the usual EU stuff).
    Then S&P send their initial downgrade justification to the Whitehouse. When the WH found the 2T error S&P acknowledged the mistake. But then they went ahead and changed their justification completely and went ahead with the downgrade.
    Which leads me to think they had to have a reason why the downgrade had to happen THIS weekend. Because what they did badly eroded S&Ps dwindling reputation for basic competence.

    The other reason might be that with Wall St bonuses looking to be down this year, Wall St might be looking for ways to ensure there is a QE3, so they ensure markets are all dragged down just as they were last year.

    1. psychohistorian

      Move on, nothing to see here.

      This is just a random walk of events and after all, these folks are doing Gawds work.

      Don’t you know that there are wars going on and much more important National Security issues at stake here. Why we just lost some our best trained killers and how are we going to subjugate more people if we can’t scare them into submission….with most serious apologies to the military that have recently lost their lives defending our country….I mean them absolutely no disrespect and mean it only for the global inherited rich that decided it is OK to turn my once wonderful country into an imperialistic aggressor around the world.

      What part of THOU SHALT NOT KILL have Americans been brainwashed into believing is somehow justified now? Our moral compass has been hijacked and is being held hostage to fear and faith based solutions to our problems.

      It is way past time to take back our secular Republic from the global inherited rich and their sociopathic minions.

    2. ScottS

      Well, whoever paid S&P to downgrade the US knew about it ahead of time. So there’s at least one company with insider information. Seems like a fruitful avenue of investigation.

      1. KnotRP

        So NOW we suddenly care about rule of law, eh?
        Live by the sword, die by the sword.

        Where were all these compliants when all that crap was marked AAA and stuffed onto middle class pension balance sheets? Where were all these people during the happy fun ball days of looting?

        Right.

        1. KnotRP

          The ONLY reason anyone is going after S&P,
          is because the defected (game theory)….not
          because they may have broke the law (leaks
          for profit and future employment prospects).

  2. attempter

    Obama keeps looking worse and worse from any point of view. He created this criminological environment, so that all people who are capable of looking at the evidence know he encourages actions like this one from S&P. (And if, as his whining now indicates, he’s actually unhappy about this particular kleptocratic move, all that means is that he’s not only malevolent but doesn’t even have any control whatsoever over the monsters he’s unleashed.)

    Meanwhile the idiots who still want to believe in his ineffable goodness are left scratching their heads at how cowardly and incompetent he looks (from their pov), since S&P telegraphed this move long before they did it, and any POTUS with a modicum of willpower could easily have forestalled it.

    There is a much more straightforward basis for questioning S&P’s conduct, and it has nothing to do with how S&P arrived at its rating.

    I don’t think this kind of pseudo-legalism which we know will go nowhere is the most straightforward analysis.

    Since this is a purely political war, the most straightforward analysis is the analysis of kleptocracy and the development of a political strategy to fight it.

    Even legalistically, the most straightforward route would be RICO and anti-terrorism laws, not technical SEC regulations.

    1. K Ackermann

      But going through the SEC may be viable whereby the routes you mention, as appealing as they are, are not realistically viable.

      Let’s face it: Washington should have an air traffic controller coordinating drone attacks on the capitol if they really wanted to put a dent in terrorism, but it ain’t gonna happen.

      1. attempter

        I didn’t say RICO was viable. I said that if legalism were viable at all, that would be a more straightforward route.

        Meanwhile, can you provide any evidence that going the SEC route, something already discussed ad nauseum for years now with zero effect, will ever be viable?

        The evidence indicates the contrary.

    2. Yves Smith Post author

      Even though the SEC will not act unless subjected to a lot of pressure, this is a much cleaner shot at S&P, whose conduct sucked, than other routes. McGraw Hill’s chairman is head of the Business Roundtable, which is pro austerity. The downgrade was an enforcement action by the rentiers, and the fact that they were arrogant enough to leak to their cronies on top of that deserves to be called out.

      If the Senate includes this in its investigation, the SEC may be forced to act.

      1. Just Tired

        So S&P downgrades the U.S. and the U.S. responds by launching an SEC investigation which leads to a….punishment of sorts. This sends a really good message to anyone who relies on the ratings. Try to see if the U.S. government’s lips are moving when ratings agencies give future ratings. Sure the SEC is “technically” investigating a “technicality” but it sure looks to me like what Wall Streeters like to call “bad optics”.

        1. Yves Smith Post author

          This isn’t a “technicality”. People I know who worked at rating agencies when rating agencies were respected (pre the housing bubble) say this is a very serious violation.

          1. Just Tired

            I didn’t mean to trivialize the violation. I agree that it was an unprofessional and outrageous thing to do. But my point is that I believe the issue from the SEC standpoint is one of trading on inside information. Not many people believe the SEC makes a truly serious effort to prosecute those who trade on insider information. Here they going after the leaker (is that a word?). Common sense says that the SEC would have to have a theory as to how S&P’s lapse led to harm to the markets via insider trading. My point is that “optics” requires that the government respond without making it appear that it is merely retaliatory for the ratings downgrade. Whether one agrees or not, the law recognizes the concept of “so what”? S&P broke the law. A law generally recognized as serious. But other than the possible damage to the U.S.’s credit(which would happen whether leaked or not), how has the public been harmed SOLELY BY THE LEAK. If the SEC fails to answer that question, many will believe a prosecution is purely out of spite.

          2. hermanas

            God bless you,Yves and the stamina He gives you.
            I’m trying to hang on to this wild ride.

    3. fajensen

      Even legalistically, the most straightforward route would be RICO and anti-terrorism laws, not technical SEC regulations.

      Bringing RICO online – which is IMO precisely what should have happened immediately following the collapse of AIG/Fannie/Freddie to “restore confidence”; or at the very latest within the first weeks of Obama taking office – will now, after the new administration has been colluding with the fraudsters for years, be pretty much like tapdancing on the border between North and South Korea!

      If wishes were granted, I would like to see “Team Change” do just that. Literally! I am so fed up with those clowns I can taste it!!

  3. Typing Monkey

    If you don’t mind my asking, how do you know that Treasury didn’t leak it to the IBs–perhaps, for example, to ask what would happen once the downgrade went ahead?

    In any case, somebody saw this coming a couple of weeks ago:

    http://etfdailynews com/2011/07/25/investors-the-1-billion-armageddon-trade-placed-against-the-united-states/

    1. Yves Smith Post author

      Treasury did not think this was gonna happen. The various reports make it clear they were gobsmacked that S&P pulled the trigger. S&P did not talk to them until the PM, when it was all over Twitter by then.

      In addition, the two reports I got from different sources were specific: that S&P leaked to certain hedgies on Tuesday and it briefed certain banks on Thursday.

      1. Typing Monkey

        Thanks.

        One follow up, though: is it possible to go after S&P and not the banks who may have traded on the news? I can see SEC going after some hedgies, but they’ve been pretty acquiescent (negligent, actually) towards the large banks.

          1. attempter

            Since self-pity is a basic element of Obama’s “character”, he must be relying on it more and more these days.

            But whether or not he’s re-“elected” will depend completely on whether the Reps put up a real candidate or not. So far they seem uninclined to.

        1. Yves Smith Post author

          In insider trading, both the tipper (who is always part of the scheme, I can’t think of a case where they weren’t cut in) are liable.

          This is not insider trading, so I am reasonably sure the tipees are not liable, but I have pinged some lawyers on this one (unless there was a specific quid pro quo to S&P but I’d be surprised if there was anything that explicit).

          1. Patrick

            Bob Moffatt, the senior IBM executive, was arrested for passing on information to a femme fatale in a very recent insider information prosecution. He accepted a plea bargain and went to jail. So, if he’s liable then so are S&P and their executives who provided the insider information.

            Moffatt’s misfortune was that he wasn’t a banker and therefore would have had the ‘get out of jail card’ entitlement beloved of that species.

  4. Jason

    But this is just another technical distraction about why the downgrade might be bogus.

    The proper response would be to attack and destroy the S&P. Any leader that would allow a nation to be blackmailed is no leader at all. The S&P has the gall to tell the government what to do and if they don’t do it they’ll ‘downgrade’ them and cause further hardship. What balls! Too bad our President hasn’t any.

    Since the US government has no technical limitation of meeting its commitments, especially regarding Treasury payments, the S&P’s actions amount to libel, maybe treason. Don’t play around with these people. Don’t pull a Gordon Brown and surrender the economy to the ‘market’.

    1. Jim Haygood

      ‘S&P’s actions amount to libel, maybe treason.’

      Not a lawyer, I see! The crime you’re invoking is lèse majesté. ‘Off with their heads!’ screams Jason’s Red Queen.

      Gov, like God, is immune from criticism. It’s a stake-burning offence in the liberal theocracy, which is sort of like North Korea with Starbucks.

      You need Ayatollah Michael Moore on your presidential ticket.

      1. Jason

        Wrong. This has nothing to do with criticising the government. And it is libel in that it is defamatory and misrepresents the true position of the US Government’s debt obligations.

        Don’t be so rude.

          1. Jason

            Okay Jim, you’re just being assumptive then.

            I never said anything about the S&P being charged with libel: I said they were being libelous which is not solely a ‘legal’ term. I could have written the word ‘defamatory’ if that would make you happy. I also said they might be traitors, but I wouldn’t expect them to be tried as such. I was merely characterizing their actions.

            But back to the substance: S&P has taken actions that are not based on any reality and for the government to sit back and roll over while an entity in the ‘free market’ manipulates the nation is outrageous. I wouldn’t expect any government complaint against the S&P to hold up in court, but I would expect S&P to get the message.

      2. aet

        There are important moral differences between sopeaking truth, and speaking lies.

        There is no chance that the USA will not pay its due debts.

        That the object of critique is the Government does not change that, no matter how inconvenient it is to Strauss and his neo-con followers.

        1. Just Tired

          People argue that there is absolutely no chance that the U.S. will not “pay its debts”. I say that misses the point. The ratings deal with “default”. Given the nature of the question, what precisely is a default, even a delay of one day of payment could result in a technical default. We have seen this issue discussed ad nauseum in connection with the Greek debt crisis. There was no shortage of speculation on what debts Obama would chose to pay should the debt limit not be timely increased. No one could argue that it was totally outside the realm of possibility that the U.S. would delay payment of any specific type of debt for a day, week or month.

  5. LeeAnne

    Using S&P to slam the market followed up by PPT manipulation of the averages (with the demonstrated power to target precisely the number of points for the most effective psychological result) is consistent with the Paulson 2008 finance coup d’etat 700 pt drop in the market technique.

    And, don’t forget the Supreme Court role that gave the CRAs a get-our-jail card in spite of their massive fraud. Failure to prosecute them has given them massive incentive for more fraud; clerical workers traditionally, they’ve learned to play big with the big little people on top.

    The PPT has been supporting market averages for decades. It has only to step aside for prices to fall without that support. It looks like they ended Monday with a little upside -only to save something for another day. Why tank the market, when you want to instill fear in a population, mostly amateur passive investors, with 1,000 points in one day, when you have the power to spread it out to 2 or more?

    Of all the propaganda techniques in play these last couple of decades, manipulating the appearance of stability in the stock market and the Dow as front page news has been the most effective; key for keeping the middle class become shareholder class in line even as their own are tossed out of jobs and economic opportunity by the millions -and they live in fear of same. Like living in a prison camp where people are taken out regularly, disappeared, and you never know who’s next.

    The more fear massive the fear produced, the more pain inflicted, the more money and power goes to the top. Hopefully, the more mistakes they’ll make.

    Great system.

    1. Jason Rines

      Very astute LeeAnne. I am beginning to feel more and more that supply-side economic systems and fear are synonymous. After all, Eve didn’t ram the appple into Adam’s mouth but he sure would have gotten lonely if he hadn’t eaten it…

    2. Crazy Horse

      Spot on analysis LeeAnne. If you want to see clear tracks of PPT manipulation in action, look at the tape for the Russel 2000 futures last Thursday. Counter trend price action into the close at a rate of change over 30 seconds that made gold look like the Queen Mary on a calm sea. Today’s 430 point Dow outburst looks similar, but may only have been triggered by the PPT team and then became a short covering rally. In any case, the signs of market manipulation by TBF institutions with open troughs to the Treasury are everywhere.

    3. fajensen

      It is not neccessary for someoen to (be) ” … manipulating the appearance of stability in the stock market …”

      It is just a system thing: When more money becomes available for investment, the “gain” of the financial system increases in proportion.

      The system gain is now so high that mere words from proven incompetents trips “circuit breakers” across the planet. The human response is, naturally, to do more of whatever it is that did not work before. In this case even more money is printed – which will again produce even more instability.

      The unwinding will be painful: Trade restrictions, Limits on capital flows and all manner of similar “anti-globalisation” measures will be brought in eventually to compartementualize the world economy.

      The re-introduction of Interfaces, basically. Every working complex system by neccessity has interfaces proscribing the allowed behaviour.

      The “Advanced” economies set about removing them in the name of Globalisation and “Efficiency”, allowing everything to stomp over everything else, the “Advanced++” economies will bring them back – at a huge cost.

  6. LeeAnne

    Playbook: S&P supports Obama’s austerity plans, and 12 appointed wise men will decide. Jokey stuff.

  7. vlade

    IIRC, this would be insider trading under FSA rules. FSA rules specify that you don’t have to profit personaly, just that you have to communicate material information not publicly available that allows someone to trade on it (and they don’t even have to profit, strictly speaking).

    1. vlade

      Which leads me to another thought – how about getting FSA (which I believe a less captured regulator than FED) on this? If you could show that someone in S&P leaked this to an FSA regulated entity…

    1. aet

      It looks that way from here.

      The stock market is cheap – the many companies are hoarding cash. And that’s why stimulus don’t work – the banks and corps swallow it all, let it sit in their accopunts, and use it to buy undervalued assets – everybody’s a “financier” now, as production alone does not seem to make enough profit to satisfy desire.

      Desire for what?

    2. seabos84

      what else are they going to do? pump & dump dot.bomb stocks? Triple A the CDO-LBO-MBS-WTF du jour?

      Aside from having to listen to local Seattle Democrats run around with their hair on fire in terror of backmann-palin-perry next year, I’ll have Maria Cant-Do-Shit running for her U.S. Senate seat in 2012. ugh.

      she won a congressional seat in ’92, got swept away in ’94 by Rich White Boy, made a gazillion by getting in early at Real Networks, and eeeked out a win in 2000. She’s a poster child for the DLC-Third Way branch of compromising bipartisan sell outs. I’ll be writing in “Medicare ForALL” at the top of my ballot, for many offices.

      rmm.

  8. Maju

    So who is going to downgrade S&P’s ratings now? With S&P and Moody’s specially it seems quite clear that they are anything but honest and strict, as would correspond to such prestigious and influential… clown troupes.

    Hmm, really, sincerely, how trustworthy are these peoples’ ratings if anything at all? Chinese rating agencies already had the USA downgraded a year ago and nobody blinked, only Beijing maybe. In July 2010 the USA was just AA (without plus and with a “negative outlook” remark) according to Dagong Global Credit rating.

    Maybe it’s the fox warding the chickens but not sure in which sense, as it was obvious from some time ago that the USA was de facto bankrupt, though unclear in which term this category applied because of its unusual role as imperial hegemon.

  9. LeeAnne

    Its amazing that anyone watching this stuff unfold, with any feel for markets, would think anything other than that S&P is taking their orders from TPTB.

    And, the US Supreme Court has to be included in TPTB. Without them these things wouldn’t be happening. SCOTUS are responsible for CRAs free from adult responsibility, on and on …

    At this point, it is fair to say, the right wing justices of the US Supreme Court are owned.

    We have to have an alternative to their absolute authority; the ability to immediately challenge their decisions whenever a certain threshold is reached in public interest and an end to their lifetime appointments.

    The Bush 2000 coup has come home to roost. Bush, once appointed, enabled by the Supreme Court, was able to complete the rout of liberal democracy with his Supreme Court appointments.

    They have proven they can’t be trusted with the absolute authority they hold.

    They’re treated like a SACRED COW, when they are the essential factor in enabling all of this stuff.

    There is no way little old S&P took the lead on this. The whole thing has been coordinated, and continues to be coordinated.

    No coincidence that the big 12 came into being prior.

    Criminals are in charge, not only behind the scenes, but right before our eyes. It has been a takeover in a straight line by international banking/drugs and the CIA.

    Here’s your Republican nominee. Because among politicians its so hopeless. Indeed. General Patreaus, straight from the military -now head of CIA? for president anyone? If not, then how about, dictator? Titular dictator, of course.

    1. aet

      Yeah, that’s what Fidel Castro said when GWBush got elected

      That GWBush’s Florida transport during his fight to takw the presidency from Gore was provided courtesy of Enron Corp was for me the “tell” – the people of the USA seem to be under an attack from their own Government.

      How many “Democrats” who have signed up since the 1980s were Republican “undercover” operatives?ves?

      The theoreticians of the Right claim deception as fair ball in politics – so why wouldn’t they use such tactics?

      1. liberal

        There was a very funny Tom Tomorrow cartoon where Bush, Cheney and others were secret Dem plants from decades ago, and Obama et al. were secret Republican plants.

    2. Doug Terpstra

      “There is no way little old S&P took the lead on this. The whole thing has been coordinated, and continues to be coordinated . . . Criminals are in charge, not only behind the scenes, but right before our eyes. It has been a takeover in a straight line by international banking/drugs and the CIA.”

      And how! It is robbery in broad daylight, Shock Doctrine so audacious (by the author of audacity) that, by design, people suffer hysterical blindness: “this can’t be happening, therefore it’s not. Obama can’t really be evil; he must be a cowardly idiot.”

      I said as much yesterday, but a couple of commenters thought it too conspiratorial.

      “That the president, who owns the SEC [and] sock-puppet Eric Holder and wields the Dodd-Frank club, holds a live national address to give these discredited felons any credibility at all is baffling.”

      Baffling, that is, until you consider the sole thrust of his message (repeated by crony pundits since) the destruction of the safety net, and until you consider collusion and conspiracy with the S&P as minion not driver. Yves post on S&P’s illegal selective disclosures and the all-but-guaranteed lack of action by the SEC in response essentially make conspiracy at a certain level self-evident.

      It need not be an overt conspiracy of detailed orchestration either, but rather a wink-nod collaborative consensus among cognitively-captured elites—that certain deceptions, nudge-nudge, are necessary in order to serve the greater good (concentration of wealth and power in a worthy aristocracy). As Mark Twain said, “A conspiracy is nothing but a secret agreement of a number of men for the pursuance of policies which they dare not admit in public.” Clearly, that fits Obama and his immediate henchmen, but it is surely much wider than that.

  10. Two kind words

    Love to know which hedge funds and which markets they ended up in….. Can potentially see their activities on Tuesday…..

  11. Peripheral Visionary

    The ratings agencies have been telegraphing this move well in advance. They made it perfectly clear that the U.S. sovereign was on downgrade watch whether or not the debt limit got raised. It still is possible that they had made a firm decision in advance and leaked it to select parties, but I think it is more likely that the people trading ahead of this were simply making a bet.

    At any rate, the attacks on S&P are simply shooting the messenger. Does anybody in their right state of mind think that U.S. Treasurys are “money good” in the way they would have been a generation ago?

    Yes, the U.S. can always make payments on its debt, but it is looking increasingly likely that it will have to resort to creating money to do so, which means that it will not be making repayment at full purchasing power, but will be repaying in a degraded currency with much weaker purchasing power. It would be a repayment in the letter of the law but not the spirit of it. That does not qualify as the highest quality of debt in my view. That is entirely a creation of U.S. debt and money policy, and the ratings agencies have nothing to do it.

    1. Foppe

      hich means that it will not be making repayment at full purchasing power, but will be repaying in a degraded currency with much weaker purchasing power

      Sorry, but this is nonsense. There is no such thing as “full purchasing power”. Have you heard of inflation, among other things?

      1. Peripheral Visionary

        Yes, I have heard of inflation, among other things. And for a sovereign, who has full control over the currency, deliberately inflating the currency by allowing it to depreciate, or worse by outright printing vast quantities of it, is a default, in my view.

        To see this clearly, consider yourself the holder of Zimbabwe sovereign debt. The Zimbabwean government announces that it will make good on all debt (as well as all civil servant salaries, as well as all pensions, as well as the purchase of vast amounts of privately held land) with newly minted money. Considering that they will be making full payment on your debt, would you consider that debt to be AAA quality or C quality, or outright defaulted? And if prices in the international market – that is, in foreign currencies with steady purchasing power – are an indication, would that debt qualify as high grade, speculative grade, or defaulted?

        1. john newman

          Of course, I see how the US is much more like Zimbabwe, confiscating the agricultural base of our industry and handing it to incompetent urban poor people, than it is like Japan who has over twice our “debt”, has had it for twenty years and continues to flirt more with deflation than inflation. Yes, yes, hyperinflation is just around the corner, where it has been for the last thirty years.

        2. Yves Smith Post author

          We’ve debunked the hyperinflation meme repeatedly. You need to destroy a great deal of productive capacity to get hyperinflation. US debt was not downgraded during the inflation of the 1970s, which was moderately high inflation.

          And austerity is deflationary. Get your bugaboos straight.

          1. Peripheral Visionary

            Yves, the problem is that you treat “hyperinflation” as if it were some sort of physical phenomenon, that requires the right conditions in order to occur. It is nothing of the sort. The value of the currency is as perceived by the people. Inflation is nothing more or less than the outward manifestation, as reflect in prices, of people coming to believe that it is worth less than what they had previously thought it was worth. That can happen overnight. In the past, such rapid changes in sentiment have been triggered by policy changes, but they can certainly be triggered by other events. It can be caused by the increase in the money supply, but, because it is a human response, it can also be caused by an expectation of the increase in the money supply.

            “US debt was not downgraded during the inflation of the 1970s, which was moderately high inflation. “

            It should have been. Anybody holding Treasuries through that period got robbed blind. If ratings are to mean anything, they should reflect the real return, not the paper return, of securities, as balanced with risk – and in those terms, U.S Treasuries through the 1970s would qualify as junk.

            Overall, I am coming to think that fixed income, but particularly sovereigns and above all municipals, are a fool’s game. They rarely cover inflation, and virtually never survive national crises that occur on a routine basis. Much better to hold equity in corporations with monopoly pricing power that can consistently pass on price increases and that have the ability to adjust for inflation.

          2. Yves Smith Post author

            Go look at Japan, or the 1930s. High quality cash and bonds did well. Stocks were terrible unless you traded well, classic bear market volatility. They didn’t come back to 1929 level until 1954.

            Imposing your moral values on markets does not make for a successful investing strategy.

        3. Yearning to Learn

          Peripheral visionary:

          I see your point, however I think there are a few major flaws.

          1) normally “shoot the messenger” means that you are shooting an innocent person who just happens to be the one delivering a message. this is not the case here. S&P is more than a messenger in this case, and far from innocent. As many people have noted, they have severe conflicts of interests vis a vis the US debt rating. is it “shooting the messenger” if you kill a mobster who comes to tell you that your son swims with the fish?

          2) also: S&P has demonstrated that they are NOT QUALIFIED to make this assessment. (so says Trillions of $$$ of “AAA” MBS/CDO securities) You may agree with their assessment, but that does not make S&P qualified to give an opinion.

          3) You bring up good points about future possible inflation/currency destruction (however, we are clearly in deleveraging right now, and despite what S&P says the long bonds certainly don’t share your inflationary view).
          That said: is that what AAA signifies??? I’ll need someone more technical to answer this… but I was unaware that the AAA captured future inflationary risk… (remember, the ratings companies are often very clear about what an AAA means and what it does not mean… my understanding, VERY POSSIBLY WRONG, was that a sovereign AAA rating did not encapsulate future inflationary/interest rate risk, and only encapsulated repayment risk).

          1. Yves Smith Post author

            Yes, any bond investor will tell you credit and inflation are separate investment parameters. S&P is not in the inflation rating game, or not supposed to be.

          2. fajensen

            It is worth considering that “The Market” does not pay ratings agencies for being qualified, instead “The Market” pays to get the highest rating at the lowest possible price with the minimum of fuss.

            I.O.W: From the customers perspective, a monkey with an ‘AAA’ rubber stamp is indeed all the qulifications asked for!

            Probably why there are laws dictating the use of credit ratings. It is such a useless product that nobody pays for it voluntarily.

    2. LeeAnne

      the timing says everything. after the 12 wise men system was put in place without a hitch -now its safe to instruct S&P to bring it on.

  12. thelonegunman

    ‘There is compelling evidence that the ratings agency made selective disclosure of its downgrade decision before it made it public last Friday evening. A reader told us certain hedge funds were informed Tuesday and traded successfully on the information. A separate source had told me certain banks were briefed on Thursday and were told of the US downgrade but assured their ratings would be unaffected. On Friday morning, Twitter was alight with the news.’

    whawhawha??? do you mean to say S&P is in bed and beholden to hedge funds (as they were during creation of the mortgage ‘crisis’)???

    i’m shocked… shocked!!!

  13. thelonegunman

    ‘It would be fun to see who S&P saw fit to enrich and how much ill-gotten gains they reaped.’

    hmmm how about:

    Magnetar
    Paulson
    Goldman…

    1. Fat cat

      If the Tuesday pre announcement to hedges is correct, would be interesting to see if they were in aud ois

      Look at how the spread to physicals recently. May just be a factor of illiquidity, or shorts getting caught post Rba statement, or it could be a nice conspiracy theory..

  14. Snidely Poster

    Like this matters? The analogy is that your house is on fire with the smell of natural gas in the air, and you’re going after the kid next door whose dog pooped in your yard. Go get ’em tiger.

  15. Jean

    A possible Moody’s downgrade was reported in a local blog last Thursday.

    “US debt situation could impact Prairie Village through credit rating”
    Posted by PVPoster on Thursday, August 4, 2011 at 11:29 am.
    “The wrangling on Wall Street over the United States’ mounting debt situation may have impacts reaching all the way to Prairie Village city hall.
    “Prairie Village finance director Lisa Santa Maria told the City Council earlier this week that Moody’s was considering downgrading the country’s AAA bond rating – and that such a downgrade may affect both Prairie Village’s rating and the payments the city makes on debt. Moody’s is one of Prairie Village’s credit rating agencies and currently rates the city AAA.
    “It’s very hard to know exactly how this situation will impact things at our level,” she said. “But there is a chance we could see something happen.”

    “The credit rating situation is of particular interest as the city pursues the refinancing of its debt. The City Council approved a measure in its 2012 budget that reworks the city’s 2009 bond issue so as to provide cash flow next year that can be used to pay for road improvements.”

    http://pvpost.com/page/2/

  16. xrayd

    So after S&P was informed about the $2 Trillion “error” in their budget computation, they did not want to be sued by anyone they might have improperly informed?

  17. Lee

    Since there is no doubt that S&P selectively leaked this, the most interesting question for me is what was S&P’s motive? Surely both the downgrade itsel and the selective leaking were extremely risky (both from a legal and political point perspective). I have a hard time believing this is simply another run of the mill corrupt act by S&) (though with a company this shady one can never rule it out). What did S&P get in return from the tipees?

    1. LeeAnne

      to ask ‘what is their motive?’ is to assume they master the situation when they are slaves. Its international bankers who depended on the CRA’s fraudulent AAAs for junk.

  18. Chris

    The rating agencies no longer have any credibility after failing to forwarn investors of the underlying risks of CDOs, Lehman Brothers etc.

    What a great business model – pay us and we will rate you. Oh and by the way, if our ratings turn out to be crap, you can’t sue us because we put in this great little disclaimer that you should not rely solely on our advice.

    I hope this company is broken…

  19. Andrew

    Yves, thanks for posting this story. Would you mind elaborating on the penalties that McGraw-Hill might face if it did come to light that they leaked the story early? Also, is there any chance at all that the person leaking the story didn’t fully appreciate that they were violating SEC rules. It seems pretty obvious when you reference the appropriate sections of the code, but not having any involvement with the ratings agencies or their clients, I don’t know how they think about things and how many people internally had knowledge.

    One other point. An academic point made by some is that insider trading benefits the market by making stocks more quickly reflect the “true value” of the company and insuring that those that transact in the stock trade at a price that is more reflective of this “true value”. In this case however, there were untold numbers of traders, including fiduciaries (pension funds, etc.) that increased equity exposure last week due to the sharply lower prices on “no news” or what appeared to be “good news”. Some probably sustained major losses, and others probably made significant adjustments to their portfolios (not necessarily voluntarily) which they wouldn’t have had this been a one day event. Whatever the excuse de jour for the markets gyrations last week by the financial press may have been given undue importance For example, how much of last Tuesday’s drop was due to events in Europe vs. the leak, and would the ECB’s actions been different if they knew that the markets were responding to S&P vs. Italian bond problems). I don’t know the answers, but this wasn’t simply a case of some well connected hedge funds making some money; there were real victims here. Aside from its affect on policy decisions, the fact that the downgrade was made public after a horrible week may have resulted in sustained damage to the world’s economy, further lack of trust in the integrity of our markets and overall public pessimism.

    1. Deus-DJ

      “An academic point made by some is that insider trading benefits the market by making stocks more quickly reflect the “true value” of the company and insuring that those that transact in the stock trade at a price that is more reflective of this “true value”. ”

      Where are you going with this? Pointless talk.

      Anyway Yves, great timing on this, I was thinking about this as a way to strip S&P of their license…which would effectively destroy the company(and man would I LOVE to be one of the people shorting them). Thanks for pointing out Dodd-Frank.

      1. Andrew

        economically, I am saysing that there is real damage to insider trading in that to the extent it moves price levels,it induces market participants to trade. Insider trading (and leaks by S&P are not victimless crimes).

    2. David

      If I rob a bank and steal a bunch of money, it doesn’t help my defense even if I can show I didn’t know that robbing banks was illegal.

      We seem to be getting cornered into sort of technical arguments about things that should be obvious, and to read what some judges write, I think that to them they are obvious. We do have some good judges in the system, who call a spade a spade and do the obvious thing.

      But getting that far is a challenge, if Holder won’t even prosecute. Holder is busy enforcing social engineering and I doubt he has time for stuff like this. :/

  20. David

    I’m stunned. We all agree S&P tipped off some people, and it isn’t obvious that the justice system will string ’em up.

    I agree it isn’t obvious, in fact they probably won’t. That means our justice system doesn’t work any more.

    1. beowulf

      18 USC 371. Conspiracy to commit offense or to defraud United States
      “If two or more persons conspire either to commit any offense against the United States, or to defraud the United States, or any agency thereof in any manner or for any purpose, and one or more of such persons do any act to effect the object of the conspiracy, each shall be fined under this title or imprisoned not more than five years…”

      Chief Justice Taft breaks it down for you:
      To conspire to defraud the United States means primarily to cheat the Government out of property or money, but it also means to interfere with or obstruct one of its lawful governmental functions by deceit, craft or trickery, or at least by means that are dishonest…
      http://www.justice.gov/usao/eousa/foia_reading_room/usam/title9/crm00923.htm

      Meanwhile, New York Attorney General Eric Schneiderman could use the Martin Act to pursue civil or criminal charges,
      “The purpose of the Martin Act is to arm the New York attorney general to combat financial fraud. It empowers him to subpoena any document he wants from anyone doing business in the state; to keep an investigation totally secret or to make it totally public; and to choose between filing civil or criminal charges whenever he wants. People called in for questioning during Martin Act investigations do not have a right to counsel or a right against self-incrimination. Combined, the act’s powers exceed those given any regulator in any other state”.
      http://www.legalaffairs.org/issues/May-June-2004/feature_thompson_mayjun04.msp

  21. advisor519

    Not a surprise the market volatility can easily depict that.
    Now that those INSTITUTIONS had a jump start and traded ahead of the release All the investors should be entitled to the 10% head start they all got!!!. Those market moves greatly impacted the market as there was a mad rush for the door, and I believe that this correction lies primarily on the S&P irresponsibility of leaking THE INFO!
    WE THE INVESTOR WILL ALWAYS BE AT THE SHORT END OF THE STICK!!! Those institutions should be forced to buy back all those shares they sold on insider info, as well as the shorts and vix they purchased!!!

  22. Jumbo Alt-A

    I remember hearing one of the S&P people in an interview on Bloomberg saying essentially that “we talked with a lot of people about when to do it so that it would pose the least disruption to the markets”. Anyone with half a brain would know that it was about to happen. This is selective disclosure, plain and simple. S&P almost admitted to this in their interviews!

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