Did the Rating Agencies Push the Monolines Into the Structured Finance Business?

A dirty little secret of the bond insurer mess is that the rating agencies not only aided and abetted their ill-fated entry into the structured finance business but apparently prodded them in that direction.

Although I had been given this tidbit before, I hadn’t gotten independent verification, but it now comes via a report in Bond Buyer of a speech by New York insurance superintendent Eric Dinallo.

First, the initial reports, which are hoisted from comments on February 3 post:

RK said…
There was an interesting interview today on CNBC with one of the principals of Egan Jones, the private ratings firm. Gasparino was on as well and made an interesting point. He said that S & P and Moodys were telling the municipal insurers for the last several years that they NEEDED to get into the structured finance business, to MAINTAIN their AAA rating, and that a prospective entrant into the business was told that to GET a AAA they would need to participate. While this is so far only heresay, Gasparino has done some good reporting in the past based on apparently good connections.

realty-based lawyer said…
Not hearsay – it happened in Oct/Nov 2005 or thereabouts. The prospective entrant was a financial guarantor being established by DEPFA, an Irish bank with German links that was recently acquired by Hypo Real Estate. CEO was Michael Freed.

Now for the independent sighting in Bond Buyer in its article, “New Regs for NY Insurers“:

Insurance regulators did not stop hte financial guarantors from expanding their busineses out of the muni market, a dynamic that one of the moderators suggested could nevertheless play out in future business cycles. In response, Dinallo said his understanding of the current crisis was the the bond insurers were encouraged to expand into the structured finance by the rating agencies, who asked them to expand their books of business.

“From what I have learned so far, the bond insurers were encouraged by the rating agencies to improve their returns on equity and seek diversification through doing this structured business,” Dinallo said.

The article notes that the Standard & Poor’s has denied suggesting that the monolines increase their structured finance business; Moody’s and Fitch so far are silent. It also begs the question of what sort of management would take strategic advice from experts in credit.

But again, one cynically has to wonder. Given how important and profitable the structured finance business was to the rating agencies at the time, they clearly (and naively) thought it was great business. And having the monolines involved no doubt facilitated getting deals done.

Of course, this doesn’t excuse either the companies themselves or the regulators. Nevertheless, given (as we have seen) that threat of the loss of their AAA rating is a sword of Damocles over the monolines’ heads, they’d have to think hard about ignoring a rating agency’s recommendation.

Print Friendly, PDF & Email


  1. Anonymous

    So the rating agencies pushed the bond insurers to get into structured finance because the rating agencies stood to make big profits on that kind of business.

    The threat of removing the AAA rating might be construed to be like extortion/blackmail.

    Is this grounds for a lawsuit against the agencies?

    Can the bond insurers sue the rating agencies?

    Or does the agencies’ teflon shield (“free speech”) still remain intact?

  2. insurance guy

    I think the rating agencies will be able to argue that they actually thought the diversification from structured finance would be a good idea.

    As Yves says, the Rating Agencies were naive in their view of the structured finance business. One can “cynically wonder” if they were influenced by the fees they were earning in that business. At this point though, all anyone is doing is wondering cynically. Its just as probable, if not more so, that the agencies were just naive.

  3. Ginger Yellow

    I can’t say whether the RAs pushed the existing monolines to diversify, but it’s certainly true they refused to give Depfa a AAA rating because it was focused on public/project finance. I’m quite curious to see if Depfa try to revive their plan. It would be difficult for the RAs to make the same argument again.

  4. Charlottesvillain

    I love the blog and read it daily. I don’t usually comment on posts but feel compelled in this instance.

    I have worked both in the structured finance side of a rating agency, and in strategy at a financial guaranty company (bond insurer). (All in the 90s, before all this nonsense began).

    I can certainly confirm that A) for a monoline, maintaining the AAA is the highest priority, and the threat of losing it trumps all other business considerations. B) The rating agencies certainly encouraged a diversified book of business, although in my experience they tended to view any new business with considerable skepticism, and needed considerable evidence that the insurer had the skills to assess different sorts of risk.

    Further more, I can also say that in my experience, there was little contact between the side of the rating agency providing ratings on monlines, and the side rating the structured financings. The insurance group would tell us how to calculate a capital charge as it related to insured pools of assets, but I think that suggestions of active collusion with the goal of generating more structured finance business is far fetched.

    Just my two cents, and worth about that much.

  5. Anonymous

    For anyone out there who is still confused:

    [1] At the request (i.e., lobbying) of the I-banks the government loosened the criteria for financing residential real estate.

    [2] The I-banks gradually became overwhelmed by the amount of MBS, CMBS, etc. that they were able to securitize and send into outer space (read: pension funds, insurance companies, non-US banks), and thus needed a way to get a broaden the investor base for this garbage. This huge unexpected increase in volume is directly the result of Greenspunk keeping rates too low for too long — but again, this was at the request of the I-banks.

    [3] The I-banks approached the rating agencies and coluded with them to force the monolines to “wrap this crap.” The I-banks needed a “ultimate bagholder” for the residual risk should this crap start to blow-up (note: this is where we are now).

    [4] The rating agencies then put the hammer to the monolines who were eventually all too happy to comply given the increase in seemingly risk free revenue and profits.

    But like all ponzi finance schemes the jig is up once there are no new patsies to be had…once the subprime begin to implode, that was the end of this financial circle jerk.

  6. Anonymous

    In addition to this search for market share cash, I read in snip someplace that Moody’s rushed into rating CDOs and all the fun derivatives, even though they didnt understand how to rate them, i.e, they did not have models to really understand the nature of the risk or the accounting of the risk transfer. However there was a race for market share and organizations like SIFMA and various derivatives peddlers were very anxious to get these ratings going so they could start buying AAA ratings so that underwriters could start mass producing packages of AAA rated synthetic junk and connect it all as if it was collateral to back various CDO, SIV, VIE, SPE/subprime trash.

    This type of un-regulated collusion did provide the perfect storm and one can only hope that just as in the Perfect Storm movie, these derivative fisherman that stuffed their boats beyond capacity, hit the tsunami waves of reality and sink to the deepest depths of the dark sea from whince they came! And if God is out there, ake along the Bush conspirators in the hull and all the politicians that bought tickets in this un-sinkable voyage to chaos! A pox on them all!

  7. Anonymous

    We would not have any of this mess if there would have been legal regulation and enforcement to keep financial gurus from turning wall street into a mafia run casino. This is disgusting that we have a government that instead of enforcing rules and regulations, promotes and thus enables illegal activity and the abuse of discretionary powers!

  8. Anonymous

    OT, kinda, but it is funny how these shadow systems that enjoy darkness want things to be unregulated and to be un-enforced, un-ethical, un-accountable, un-real:

    Blueprint For Reform
    NFA, the futures industry’s self-regulatory organization, emphasized the historical and cultural differences between the CFTC and the SEC. The CFTC’s primary mission is to protect the price discovery and risk management functions of the markets, NFA said. Futures markets have mostly institutional participants, and the CFTC’s philosophy and internal culture encourage innovation and competition. In contrast, the SEC’s primary mission is to protect investors, and its internal culture tends to be more risk adverse. One telling example of the differences in their outlook is in their views regarding short sales, NFA said. “To the SEC, ‘short sales’ must be restricted, while to the CFTC they are the very life blood that ensures [that] futures prices mirror prices in the cash markets. To the SEC, ‘speculation’ has a negative connotation, while to the CFTC it provides the liquidity that makes futures markets run.” Given the differences in their histories, philosophies, and markets, the two agencies are simply “incompatible,” NFA concluded.

  9. Anonymous

    As economist Ludwig von Mises said: “There is no means of avoiding the final collapse of a boom brought on by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

  10. Anonymous

    Trivia: Under Skilling, Enron adopted mark to market accounting, in which anticipated future profits from any deal were tabulated as if real today. Thus, Enron could record gains from what over time might turn out losses, as the company’s fiscal health became secondary to manipulating its stock price on Wall Street during the Tech boom. But when a company’s success is measured by agreeable financial statements emerging from a black box, a term Skilling himself admitted, actual balance sheets prove inconvenient. Indeed, Enron’s unscrupulous actions were often gambles to keep the deception going and so push up the stock price, which was posted daily in the company elevator. An advancing number meant a continued infusion of investor capital on which debt-ridden Enron in large part subsisted. Its fall would collapse the house of cards. Under pressure to maintain the illusion, Skilling verbally attacked Wall Street Analyst Richard Grubman[3], who questioned Enron’s unusual accounting practice during a recorded conference call. When Grubman complained that Enron was the only company that could not release a balance sheet along with its earnings statements, Skilling replied “Well, thank you very much, we appreciate that . . . asshole.” Though the comment was met with dismay and astonishment by press and public, it became an inside joke among many Enron employees, mocking Grubman for his perceived meddling rather than Skilling’s lack of tact.

    Skilling wants outta the slammer now and is suspected to not call the regulating judge an asshole, but this is probably just a matter of paying the right person to look the other way and call Enron shareholder assholes?? Pardon me for my French… Sorta fits the MO of rating agencies though and the lack of integrity that these top notch snake oil crooks live by!

Comments are closed.