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Credit Ratings Agencies Are Pimps of Wall Street – It’s Time to Ban Them!

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By Marshall Auerback, a market analyst and commentator. Cross posted from Alternet.

Is Eric Holder’s “See No Evil, Hear No Evil” Department of Justice finally getting serious about investigating fraud on Wall Street? At first glance, it would seem so, given the news that the Department of Justice has filed civil fraud charges against the nation’s largest credit-ratings agency, Standard & Poor’s, accusing the firm of inflating the ratings of mortgage investments and setting them up for a crash when the financial crisis struck.

On the one hand, there is no question that without the credit rating agencies the Wall Street guys would not have been able to pull off this colossal heist against the American people, and the ratings agencies cannot be excused.  In fact, Standard & Poor’s employees openly joked about the company’s willingness to rate deals “structured by cows” and sang and danced to a mock song inspired by “Burning Down the House” before the 2008 global financial collapse, according to the DOJ lawsuit. On the other, the ratings agencies are simply the gift wrappers. DOJ has yet to go after the banksters who created these packages in the first place and who seem to be in the clear as a result of a series of unconscionably low settlements recently reached with the Justice Department.

I suppose we ought to be grateful for these baby steps in the right direction. The ratings agencies themselves have admitted to US government enquiries recently that they took money in return for ratings that were not based on any fundamental assessments other than the cash they were being paid. They have lied about the risk of default in many corporate cases and then marked down debt when the game was up further destabilizing the financial system. Hence, to say that their behavior was at the heart of the great crisis is absolutely correct.

Of course, that inevitably begets the obvious question: what took you so long and why leave it at S&P? As early as September 2004, the FBI warned that there was an “epidemic” of mortgage fraud and predicted that it would cause a financial crisis if it were not stopped. It was not contained. Everyone agrees that the mortgage fraud epidemic expanded massively after the FBI warning and still not one Wall Street figure of any note has gone to jail.

Under Treasury Secretary Geithner, and the Keystone Cops of the Department of Justice, led by Eric Holder and Lanny Breuer, we established a doctrine of “too big to jail” for the very institutions which perpetrated massive frauds on millions of Americans. Those who called for regulations that would take even that most minimal of steps necessary to reestablish the rule of law and restore our nation’s democracy and financial stability were essentially ignored. Geithner’s express rationale was that the financial system's extreme fragility made vigorous investigations of the elite frauds too dangerous, in effect giving the banksters a get-out-of-jail-free card and in effect enshrining crony capitalism and imperiling our economy, our democracy, and our national integrity.   

So what’s changed? Well, obviously one has to ask if the departure from Treasury of Mr. Geithner, along with the ignominious resignation of the odious Lanny Breuer at the DOJ heralds a new approach, or are there are other motives in mind? 

There is a school of thought which suggests that this lawsuit is an attempt by the US government to intimidate the ratings agencies against any further US debt downgrades. If so, it’s a pretty stupid shakedown. The truth is that sovereign governments like the US empower these agencies simply by listening to them, in the same way they listen to the IMF, and put the interests of these undemocratic and crooked agencies ahead of their own national interests.

In our economy, the Federal Reserve sets interest rates, not the bond markets, although the latter may impact on the prices and yields of longer-term investment assets.

But in general, the Bank of Japan showed in the period from the mid-1990s onward that they can keep interest rates very low (zero) and issue as much government debt as they wanted even in the face of consistent credit rating agency downgrades, by organizations of dubious ethics.

So when a government stands up to the agencies, the impact is likely to be minimal. Here's another idea: they can just outlaw them.  This may seem draconian, but consider that the FDIC puts criminally run banks out of business all of the time. It’s hard to see why the ratings agencies, as their enablers, should be treated any differently. The reality is that the so-called Big Three – S&P, Fitch and Moody’s — were all criminally incompetent. They prostituted themselves in a pay-to-play scheme in which they would give to garbage securities any rating sellers desired, so long as the assessed fees were sufficiently high.

At a very minimum one would have thought we could introduce reforms that would align incentives, with buyers of rated securities paying for assessment of risk. The ratings agencies like S&P never actually looked at any of the mortgages that collateralized the securities they rated (it was all too pedestrian for them). As we now know from internal emails, they neither checked the loan tapes (the data provided by borrowers), nor the expertise in rating mortgages (all of their experience was in rating corporate and government debt), nor took the time to assess credit risk. And they have never understood how to rate sovereign government debt, failing to consider that there is no default risk for a country that issues its own currency. And yet the ratings agencies have provided higher ratings to low-quality NINJA loans (short for No Income No Job No Assets) than to countries with riskless sovereign debt!

Sadly, Congress and the Obama administration, in their deliberations to “reform” our financial system via Dodd-Frank, did nothing then to reform the ratings agencies. They worried that somehow, by introducing widespread reforms to the ratings agencies, they would reduce business for the monopolies. Hence, the bill contains no significant changes required of ratings agencies, which are encouraged to continue pimping their ratings.

Perhaps this lawsuit signals a chance. In any case, it is time to wean the private financial markets off these agencies by eliminating their role as gatekeepers to the thousands of financial products on which they provide in their Papal-like declarations. It's time to leave it to individual institutions themselves to do their own credit analysis. We should go further and simply make them illegal, and mandate that all financial institutions with access to the Fed’s lending as well as any financial institution with Treasury guarantees on liabilities (such as FDIC insurance) would be prohibited from selling or buying any derivatives. All assets would be carried on bank books through maturity — with full exposure to interest rate, currency and default risk. That provides the correct incentives to protected lending institutions as opposed to relying on some flimsy rationale provided by a highly conflicted rating agency.

If our pension funds, and financial fiduciaries truly think they need an objective third-party agency to rate Wall Street paper, then at a minimum Congress and the President should be required to purchase ratings services from arms-length professionals, with the top three monopolists specifically excluded because they have demonstrated their inability to provide unbiased ratings. Furthermore, make ratings agencies liable for improper ratings, imposing a fiduciary responsibility to actually evaluate any instruments that are rated.

Better yet, prohibit banks and other government-protected institutions from buying this crap in the first place or prosecute them to the full extent of the law for using them to rip off millions of American consumers. If we’re going to go after the gift wrappers, we might as well after the original source of the fraud in the first place as well. In that regard, one can hope that yesterday’s lawsuit signals a fresh approach by the Holder Department of Justice, but don’t hold your breath waiting for it.

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26 comments

  1. Hugh

    Holder and Breuer were not Keystone Kops and the ratings agencies were not criminally incompetent. They were all extremely competent and extremely criminal.

    Ratings agencies are basically there to lower the costs of deals to sellers by supposedly realistically evaluating their risks to buyers. But for sellers and even for many institutional buyers, it all became about closing the deal and reaping bonuses. It was all IBG YBG. Agency ratings, like CDS and other devices, were just ways to grease the deal.

    Yes, ratings agencies should be banned. Fiduciary responsibility (and liability) should be put back where they belong, on those directly involved, on the buyers and the sellers. If a buyer can not assess the risks involved in a deal on their own, they have a fiduciary responsibility not to buy. Would this raise costs of dealmaking? Absolutely, but that’s the point. The buyable rubber stamps of the ratings agencies caused the costs of deals to be underpriced where risks were much higher than stated or where risks were significant but unknown.

  2. Laughing_Fascist

    Banning all ratings agencies is extreme and unwarranted and contrary to the first amendment. Not to mention that the gov is not even willing to mildly reform the agencies so clearly a ban will never be put on the table.

    Prosecution of agencies that commit fraud would quickly fix the problem. A few regs that would make such prosecutions easier would help. Instead all we get is retaliation against the few agencies that downgraded the gov.

    I would like to think the action against S & P will cause the industry to self reform. Instead, its simply a message to the major players to stick with the status quo and you’ll be fine, do something stupid and you will get the big stick treatment.

    1. Gerard Pierce

      As I recall, there is already precident that protects the agencies – based on the 1st Amendment. The theory is that what is offered is only an opinion. You can’t shut them up, and you can’t hold them responsible for an opinion.

      1. Yalt

        But you can hold them responsible for selling their opinion under false pretenses.

        The first amendment is not a defense against charges of fraud.

        1. Larry Barber

          But the only people who would have standing to sue would be their customers who they sold their opinion to, the Wall Street Banks. It’s unlikely that the banks would sue their accomplices.

    2. Hugh

      What you can do is write into the law that an agency rating does not in any sense fulfill or discharge the fiduciary responsibility of the buyer and that it can not be used as a defense to reduce liability of the seller.

      As for extreme and unwarranted, who are you kidding? Ratings agencies are the modern form of snakeoil salesmen. A few prosecutions would not fix the problem because the essence of selling snakeoil, and ratings, is fraud. Ratings agencies can’t assess risk in the same way that the federal government can’t project revenues and outlays with any accuracy much beyond one to two years, if it is lucky. Ratings agencies either knowingly misprice risk as during the housing bubble or more commonly have no real way of assessing it at all. So at a minimum any agency rating should be forced to carry the following disclaimer: “This rating is an opinion. It has no force in law and makes no claim to accurately, objectively, or realistically assess risk of any kind. It should not be used for this or any substantial purpose.”

      Ratings should be treated in the law in much the same way as sports forecasters, you know, all the ones who predicted that the 49ers would make hash out of the Ravens. If you are stupid enough to risk your own money on their say-so, that is your affair, but you are legally liable if you use their “opinion” to risk anyone else’s.

    3. nonclassical

      laugh at yourself fascist-you don’t know the history of S & P, who owns, who they were raised with, got contract for NCLB from-for…

      when you foliow the $$$$ you will see reason they are being singled out by bushbama, who won’t go after almost anyone…

  3. Lafayette

    WE, THE SHEEPLE

    {Is Eric Holder’s “See No Evil, Hear No Evil” Department of Justice finally getting serious about investigating fraud on Wall Street?}

    I must agree with this remark’s insinuation. However, and this is no excuse, let’s not forget how America’s democracy is warped by BigMoney. It is unfortunate that this should be, but donations do affect electoral outcomes.

    We, as a nation, are not sufficiently mature (apparently) to elect our representatives based upon substance. The dreariness of electioneering advertising is mind-boggling. Candidates are shown how they “wash whiter than white” and are sold like they were soap-powder.

    Hey, it works! The Pavlovian Reflex to TV-advertising seems to influence sufficiently opinion amongst the dimwits – enough to shift votes meaningfully. We, the sheeple, are not, I repeat, a politically mature nation of voters.

    Were we so, perhaps we’d expect more depth to the political debate. More focus on issues and less on superficiality? More meat and less bread with dressing and fried potatoes and … ala BigMac political-packaging of candidates.

    So, if we are not impressed with politics in LaLaLand on the Potomac, let’s not forget who put them there. We, the sheeple, did.

    MY POINT?

    Frankly, I don’t mind if Obama put a muzzle on Holder during his first tenure of office. Obama knew that in order to get reelected he would need Wall Street money to do so.

    For as long as we allow “the-sky’s-the-limit” funding in the Bilious Belief that it serves “freedom of speech”, then we are obliged to suffer the blizzard of mindless media mediocrity at election time.

    Not to mention the sad consequence of our elected representatives who feel beholden to the plutocrats who provided them the moolah.

  4. dan boxer

    Interesting, but I think you have it backwards on the pimp analogy, metaphor or whatever.
    The rating agency is the whore, not the pimp. The pimp makes the serious money and that went to the financial institutions who sold the “rated” products. The buyers of the crappy CDO’s are the johns.

  5. Brooklin Bridge

    It seems to me this article starts out with the wrong question.

    Is Eric Holder’s “See No Evil, Hear No Evil” Department of Justice finally getting serious about investigating fraud on Wall Street?

    Seriously? One would even ask that question? Given the extraordinarily obvious Vichy sellout that epitomized the bank settlement fiasco and illegally dispossessed thousands if not millions of their homes?

    A more interesting question would be to delve into why they are even bothering with this. Would anyone buy for a minute that this suit would exonerate the DOJ for turning the legal definition of ownership on it’s head?

    Ownership, by recent precedent at least, now means the rich can turn you upside down at any time and extract everything you “legally own” by executive intimidation of our judicial system. “Just get it done you two bit Judges and stop worring about whether or not the banks have any right to disposess these fu*king retards. And as to you dead beats – and your children, go suck on eggs, on the curb if you please. But don’t worry, we’ll come down hard on the risk rators.

    Pffui… But it does raise the question of why they are actually doing this, bothering with it that is, and why at this particular time. Who are they trying to impress? Is it some sort of internal thing where Holder or Obama got pissed at someone?

  6. briansays

    maybe they are doing this because obama does not need to run for reelection and it gives them something to trot out and wave in front of the base in 2014 congressional elections

  7. EVmarc

    hell no
    Obama and holder are in the protection racket
    Obama has nominated penny Pritzker for commerence the sub prime queen whith with ernest & Yound designed sub prime finiance securtization. One of the biggest criminals
    the crime that pays is the crime that stays
    listen Tim Anderson Flashpionts 2-7-13
    http://www.kpfa.org/archive/id/88746

    1. Mr. Jack Mehoff

      “The crime that pays is the crime that stays”

      exactly….

      Everytime that wool gets pulled over the sheeps eyes, he says, ‘oh my, this time, things really are going to be different, and justice is coming to reign.’

      Pretty pathetic, but thats exactly whats going on. Just some more wool being pulled over the populaces eyes. When you see orange jump suits on Wall Street Executives, then assume things might change, but not until that day. Oh, I wouldn’t recomend holding your breath while you wait.

  8. mark

    “ . . . Standard & Poor’s employees openly joked about the company’s willingness to rate deals “structured by cows” and sang and danced to a mock song inspired by “Burning Down the House” before the 2008 global financial collapse, according to the DOJ lawsuit.”

    At last the world is beginning to comprehend that this was financial arson committed on a grand scale by the mortgage-banking cartel. Until some credible government institution follows the money connected with the trillions of dollars of credit default swaps that insured the RMBS securities, we will never know just how grand the heist is. And until there are meaningful criminal prosecutions, the heist will continue.

    And by the way let’s not forget that during the decade leading up to the 2008 financial collapse, the cartel was represented by Covington & Burling’s white-collar criminal defense duo Holder & Breurer.

    Mark

    1. Ms G

      But, but … weren’t Covington & Burling just zealously representing their clients? The law does not demand morality from them!

      (Note. This is sarc’)

    2. Ms G

      But, but … weren’t Covington & Burling just zealously representing their clients? The law does not demand morality from them!

      (sarc’)

  9. gc_wall

    If only government officials admitted to the fact that they were and remain terrible money managers. Their incompetent management of the economy should not be rewarded by allowing their deceit to lead our blindness. There is more than enough collateral and revenue to back the radical blind when conservatives have the executive branch, but they suddenly dry up and disappear when a moderate republican like President Obama is in the White House.

  10. harry

    This is not the first time ratings agencies have put out dubious ratings. Back in the 80′s several insurance companies went bankrupt, most of whom had A or A+ ratings from ‘a highly respected rating agency’. An annuity that I had purchased from a large full-service brokerage firm went through three of those bankrupt companies.

    A few years later a newspaper article quoted a financial advisor, “To those in the know, ratings from that agency aren’t worth the paper they are written on”.

    One ratings agency make correct calls on all the companies that went bankrupt. The difference in that company was that they were not paid by the companies being rated.

  11. Schofield

    Hugh says:
    February 8, 2013 at 1:29 pm

    “What you can do is write into the law that an agency rating does not in any sense fulfill or discharge the fiduciary responsibility of the buyer and that it can not be used as a defense to reduce liability of the seller.”

    Excellent in theory but “Revolving Door Politics” would quickly get rid of it even if it managed to get enacted in the first instance. When you’re rigging markets it helps the bottom line to “badge up” that you’re not!

    1. Ms G

      Another problem with disallowing the use of “ratings” by the sellers of financial “products” is that the sellers (or their employees) would have to do the due diligence themselves. Can you imagine anybody working at an i-Bank being either competent (or willing) to do the herculean work of real due diligence on “MBS portfolios”? I don’t think there is one individual anywhere in that sector who would do it. They’d have to be as intelligent and thorough as the guy in the Big Short.

  12. Shutter

    My god, some people -never- learn.

    The 1% are not your friends, they never were, they never will be. They are reaching for a true Ownership society, where THEY own everything and YOU own nothing — not even your right to life.

    I enjoy reading this blog but for every ten thousand words there’s maybe a half dozen that cut to the chase. The rest is otherwise intelligent people blathering on even while the whip comes down.

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