Guest Post: The Rating Agency Scapegoating Catch 22

Submitted by Tyler Durden of Zero Hedge

It is no secret that the administration, and especially Barney Frank, has made public enemy number one out of the rating agencies (and particularly Moody’s), mostly in line with populist rhetoric and scapegoating. Of course, when the rating agencies satisfied a role that helped housing prices go higher, keep people happier and officials like Barney Frank in office longer, all was good. When things turn sour, the Franks of the world know to keep the attention away from Washington.

Well, Barney et al may want to be careful not to antagonize the RAs too much, as, in yet another twist of fate, the success of the New Economic Order plan hinges ironically on the rating agencies and their continued rating complacency, particularly with regard to that Plan Of All Plans, the TALF.

While recently perusing Moody’s Weekly Credit Outlook, I came across an interesting observation from the RA regarding the most recent TALF credit card securitization deals. Moody’s had this pretty standard language to say about the issuance:

Last Tuesday, two TALF-eligible credit card transactions were completed in the second round of TALF issuance. Credit card issuers Cabela’s and WFN issued $425 million and $560 million, respectively. As we had anticipated in our Special Comment of March 31,5 these early stage issuances under TALF are modest relative to the size of the market and to the TALF budget ($1 trillion). Meanwhile, however, these transactions are interesting for the information they provide on the early steps of the much-anticipated price discovery that we expect TALF to trigger.

Both credit card deals have three-year maturities and are priced comparatively wider than the Citibank TALF credit card transaction executed last month. As shown below, the estimated ROI for TALF investors ranged from a low of 14% for the Citibank transaction to a high of 24% for the WFN transaction.

So far so good – hedge funds have so much money on the side (allegedly) that they can throw it in any money pit they want, including credit card securitizations. Their problem. However, reading further down the Moody’s piece and a few scary things appear. First of all, while the kinks are being ironed out in allowing any piece of floating garbage to be eligible for the TALF, for now only AAA-rated credit card securitizations are eligible for the program. Moody’s acknowledges this as well “TALF requires triple-A ratings.” However, and here is the rub, Moody’s does not rate either Cabela’s or WFN’s other credit card debt AAA. Now this becomes a problem as allowing a non-AAA rating as part of the TALF structure would immediately render it ineligible. So what happens? In Moody’s own brief and cryptic words: “Moody’s rates WFN and Cabela’s other outstanding credit card ABS at less than Aaa. We were not asked to rate these TALF deals.

Yup, folks – turns out the survivorship bias of the AAA-rating is back in town. If the government wants a AAA rating to peddle it garbage to “private” investors and is aware it will not get it, it simply chooses to bypass that particular rating agency which disagrees with the government’s assessment on the pristineness of the collateral. Sure enough: the Cabela’s deal gets a AAA rating from the three other gov’t pets: S&P, Fitch and DBRS. No wonder Egan-Jones is nowhere to be included in this fray: their objectivity would royally screw with the purpose of picking the top three ratings out of the hat of four rating agencies eligible for pandering to Barney Frank and the PPIP.

Either way, this selective affirmative bias presents a new wrinkle in the rating agency conflict of interest: if there is advance information that a given RA will underrate and not provide the AAA seal of approval on any given TALF issue, the powers that be simply decide to bypass it entirely, relying on its more easily manipulated peers. Although this also means that Frank will have to be careful to focus the public anger on Moody’s as he has already started, and not stray far and blame S&P and Fitch for essentially the same transgressions, as if these last two bastions of “every collateral is fabulous” opinions decide to stop playing ball, the current version of TALF will simply evaporate, and the government will be forced to redraft TALF so that even C+ rated collateral can be packaged into it.

And just as the housing bubble ended the way it did with the rating agencies’ complacency, this new development will inevitably leave the naive private investors who are taking advantage of the government’s TALF “benevolence” in the same boat as Iceland, who was oh-so-keen to believe that non AAA-rated RMBS is “safe”.

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  1. Gringcorp

    The ratings agencies are like the like super-bugs. They cannot be destroyed, and whatever we use on them just makes them stronger. Take Enron, probably their most public screw-up before the subprime fiasco. The agencies got hauled up to the hill for assigning high ratings to overleveraged power producers, Enron above them, and then reacting very slowly when their access to liquidity deteriorated. What was the result of this? After commercial banks pared back their exposure to the sector, in rushed investment banks and hedge funds to provide capital to the power producers. What did they need to reassure themselves about the sector? A rating. Business went through the roof.

  2. Nate

    Unbelievable. The biggest problem with rating agencies is how we’ve interwoven ratings into contracts and legislation. Though the agencies themselves state their ratings are only opinions, these opinions now determine matters as diverse as which securities are eligible for TALF to how much collateral AIG has to post for their CDS.

    Yes, there are other issues with the rating agencies, namely around incentives and conflicts of interest. They are the same sort of conflicts that Sarbanes Oxley tried to address with sell side equity research. Did sell side analysts mislead investors and cause them to lose money? Almost assuredly. But they never threatened the fabric of the financial system.

    When we allow opinions to have real world consequences, we create an environment where perception becomes reality. That’s where we are with the RAs and its discouraging to see that we haven’t learned our lesson.

  3. Joe In Morgantown

    Oh boy. Gotta add this one to the list:

    In the boom, thing were messed up.

    Banks and brokers gave residential mortgages for more than the value of the house with teaser rates which would reset to an impossible payment in a few years.

    Firms sold Derivatives and Credit Default Swaps for too little money, without putting up collateral.

    Banks kept many of their assets in off balance sheet instruments.

    Transparency in the financial sector was a big problem.

    Freddie and Fannie bought lots of unsound mortgages.

    There were private ponzi schemes by the likes ok Madoff and Sanford.

    Companies issuing bonds shopped for favorable bond ratings.

    In the crash almost everything was different.

    The government housing plan modified the mortgages. The value of the loan is more than the value of the house, but a nice teaser rate which will reset to an impossible payment in a few years. [1] The government then gave the banks loans with a balloon payment, so they could join in the fun.

    The Federal Reserve gave away Derivatives and Credit Default swaps for very little in return, without putting up collateral.[2]

    The government and the Federal Reserve kept many of their assets in off balance sheet instruments [3]

    Transparency in the governments financial programs is a big problem [4]

    Freddie and Fannie bought lots of unsound mortgages.

    There were public ponzi schemes.[5]

    The goverent shopped for favorable bond ratings for TALF recipients.

    We have learned a lot.

    [1] The Homeowner Stability Initiative provides modifications to five year teaser loans.
    [2] $301B of Citi assets are guaranteed— the Government’s exposure is $249B. The government has put up $5b via tarp. That’s just one of many.
    [3] The governments owns 79.9% of AIG; why not 80%? Because then it would go on their books. The Fed created the Maiden Lanes to accept junk it didn’t want on it balance sheet. Freddie and Fannie are also off balance sheet instruments of the government. Of course, the Fed itself is looking like a large off balance sheet investment.
    [4] Bloomberg and Fox need to sue the Fed and the government to find out what is going on.
    [5] Social Security, Medicaid. And, perhaps, the fiat currency itself.

  4. skippy

    Ministry of propaganda, industry rags, nothing more. Having worked in several industry’s in the states and over seas the same patterns present repetitively. Whether created in house with header changed or out sourced, individual company’s or collusion between industry members, the effect is the same to blind, obscure, redirect or other wise pull a fast one on buyers.

    Old saying goes_the industry sets the standard_,well in my 35 years experience the standard has gone constantly down. Now some would say the market demands such action to remain profitable (if some one drops their standard, we must follow suit or suffer share reduction, competitive structure).

    A simple case in point would be the rating standard of wood products to build homes, A, B, C etc, sort of AAA/AA and so forth used by rating agencies. Now in the building boom here in Australia I watched as manufactures dropped standards of say a A grade door to a B or even C grade, but still charge for A grade. In one case I had to threaten a Plant Mgr, to take a defective door to their showroom to compare the received A grade door with the one on display (Two weeks of rope a dope, countless phone calls, pain and for what). you have to fight this kind of garbage tooth and nail every day.

    In ending the standards of personal conduct in business are at a new low, rating agencies are just a reflection of a broader trend, urged on by their sources of capital, money before all else. If the end game is gross wealth then those with out are screwed, consigned to slavery, scraps from the masters table.

    Skippy…can we start a rating agency who’s job mission is the rating of personal and corporate behaver.

  5. Terry Maynard

    Thanks for this excellent research into the TALF and the RA ratings game.

    Just one thing: I don’t think (OK, maybe it’s just a prayer) there are anymore “naive private investors”, but then I’ve been wrong before.

    …often, way too often!

  6. Lionel

    Thanks to knowing a very attractive young woman, I got to know an older fellow who owns one of the largest REITS in the world. He claimed that moving the ratings up was no great feat – said that the raters were lonely, pathetic people and easy to sway with trips and others “amenities”. In fact he said he was stunned at how easy it was.

  7. Doc Holiday

    I saw this yesterday and it kinda fits in as additional fluff here:

    > TALF's Strengths and Weaknesses

    The potential and incentive for TALF participant collusion and the “gaming of the system” is high, and incentivized by the implicit put options that are the high leverage and the non-recourse nature of the loans
    The plan specifically provides for the exclusion of SIVs (off balance sheet Structured Investment Vehicles of banks) from investing in the bank's legacy assets through PPIP by excluding affiliates of banks participating in distressed assets. So technically a bank cannot set up an SIV with a more than 10% stake and overbid for those assets.
    However there is no such mechanism as such to prevent private investors to engage in collusion and overbid for securities, risking taxpayers' money since both the parties stand to gain in such an event (out of this three party affair).

  8. Richard Kline

    This ‘ratings’ connivance _by the government_ is direct evidence that there will be NO meaningful reform while the present crowd in Washington remains in power. There is zero intent here to clean up industry practices, only to calm the public and pump more vapor credit back into the balloon.

    One thing that history shows is that sometimes public authorities rise to a crisis, but other times they flop abysmally. We Americans don’t think that we do big time historical failure because we have generally muddled through in the past. Anyone with a nose can smell the flopsweat oozing from inside the Beltway, as our failed intervention stacks criminality atop folly leavened with inanity. Miserable, miserable performance by our ‘leaders’ and their ‘advisors’ in DC.

  9. RPB

    Start watching the tape on what the FED is purchasing through QE. There are some real shenanigans afoot. Watch as certain issuances are being bought by large players, far overpricing them, then watch as the CUSIPs are announced as part of a QE repurchase. This has occurred far too many times to be coincidental. These notes are far too overpriced to be rationally bought. It is a sham.

    More slight of hand by our FED as they stuff the banks with cash.

    Is no one watching?

  10. Brick

    When decision makers say they are only investing in top quality paper and there will be an upside for the Tax payer, you know by the clumsy handling such as this that they are being less than honest. If even Moody’s will not rate it as AAA then it must be some way short of being prime investment material. It is not that they bought the stuff that bothers me or that they will loose tax payers money, it is the constant need to paint things better than they really are.
    It is these not outright lies but deliberate manipulations of the truth that are undermining the confidence of the economy. Everyone knows this stuff is not prime and we are forced to take the most pessimistic view as decision makers assume we are stupid. So much is being swept under the carpet that it becomes obvious when heads are bump the ceiling.
    At least if they used Egan and Jones we might have some faith that they know what they are buying.

  11. JonHendry

    I can’t take Durden seriously ever since he gave credence to a post by a racist anti-semitic nutbar. Is he a regular fan of Hal Turner or something?

    I really question Durden’s judgement and ability to determine the quality of sources and arguments.

Comments are closed.