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:
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.