Calpers, the California state employees’ pension fund and one of the most powerful fund managers in the US, is suing the three main credit rating agencies, saying they were negligent when they gave gold-plated ratings to mortgage derivatives that have since turned toxic.
The lawsuit adds to the growing pressure on the agencies – Standard & Poor’s, Moody’s and Fitch – over their role in inflating the credit bubble that turned spectacularly to bust.
Calpers claims that it lost around $1bn on securities that the agencies had said were as safe as government bonds.
The computer models used by the rating agencies to judge the creditworthiness of mortgage derivatives were “seriously flawed in conception and incompetently applied”, the Calpers lawsuit alleges.The pension fund invested $1.3bn in bonds issued by three structured investment vehicles (SIVs), specially-created investment companies whose assets included mortgage derivatives and other repackaged loans.
All the bonds were given the gold-plated AAA credit rating, yet all three SIVs collapsed amid the market turmoil of 2007 and 2008.The agencies “gave the SIVs purchased by Calpers their highest credit ratings, and by doing so made negligent misrepresentation,” the fund’s lawsuit says.
“The credit ratings on the three SIVs ultimately proved to be wildly inaccurate and unreasonably high.”The SIVs in question include the finance industry’s oldest and largest such vehicle, Sigma Finance, which was set up by London-based hedge fund Gordian Knot. The founders of Gordian Knot, Stephen Partridge-Hicks and Nick Sossidis, had been pioneers of structured finance while at Citibank in the UK in the Eighties.
The other two named in the lawsuit are Stanfield Victoria Funding, run by a New York hedge fund, and Cheyne Finance, run by London-based Cheyne Capital Management.
Calpers is not alleging wrongdoing by the SIVs themselves, rather that the rating agencies were riddled with conflicts of interest because of their close involvement in the way the SIVs were structured. SIV managers designed their vehicles precisely so that the top tranche of bonds issued would get a AAA rating.”SIVs were opaque, and the rating agencies were the only entities other than those running the SIV with knowledge of what assets a SIV actually purchased,” Calpers said.
“The rating agencies were indispensable players in the structuring and issuance of SIV debt, which they subsequently rated for huge fees paid by the issuers – ‘rating their own work’, according to a recent Securities and Exchange Commission report.”Calpers, which manages $178bn of investments on behalf of 1.6 million public employees and their families, is the latest in a long line of investors to have launched lawsuits against the three main agencies.
Standard & Poor’s said yesterday that the suit was without merit and it would defend it vigorously.
The credit rating agencies – in common with many market participants – fatally misunderstood the effect of a housing market downturn on the many of trillions of dollars of derivatives whose value derived from the underlying mortgages.
Many of these were “sub-prime” loans to borrowers with poor or incomplete credit histories, which began defaulting in unexpectedly high numbers in 2007.
Policymakers are examining ways to reduce conflicts of interest in the credit rating industry, and to help investors to be less reliant on ratings when they choose which bonds to buy.
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Indeed. You've also got to wonder what a pension fund was doing even considering SIVs in the first place. They have long term liabilities, and their yield investments should be long term. Obviously they need liquidity as well, but that's what Treasuries are for. One of the things that's really surprised me about this crisis has been how most pension funds have only just woken up to the virtues of liability matched investment. These investors should be trying to maximise yield – they should be ensuring their ability to meet their liabilities. In other words, their strategy should be as cautious as practically possible. The reason SIVs were so popular with investors before the crisis was because of the yield, and there's always a reason why one security yields mroe than another of the same rating.
Oops, a typo there.
"These investors should not be trying to maximise yield."
Hasn't CalPERS heard of the phrase, "past performance does not guarantee future results?"
CALPERS: who peed in my pants????
@Ginger Yellow,
You are 100% correct. Higher yiled implies higher risk but pension funds were still stupid enough to invest in this toxic "AAA" debt.
Also, when you have to make a ridiculous 8.25% rate of return, you forget about liabilities and focus on chasing asset returns. This is why returns on pension funds are all about market beta.
Way too volatile.
In Canada, they started investing massively into private markets to "reduce" volatility. They are in for a nasty surprise.
cheers,
Leo
Ritholtz mentioned this yesterday. I'm not sure if it's just about the money. Hopefully this will force the ratings agencies into a corner. Basically they need to do one of two things:
A. Actually provide the intended service that estimates the risk of an investment and protects investors.
B. Stop existing.
Shouldn't this direct and open admission that the CALPERS board and management completely failed to do their jobs be grounds for removal, and perhaps legal action both board and senior management?
Yesterday's NYT article had a couple points that jump out at one:
" The security packages were so opaque that only the hedge funds that put them together — Sigma S.I.V. and Cheyne Capital Management in London, and Stanfield Capital Partners in New York — and the ratings agencies knew what the packages contained. Information about the securities in these packages was considered proprietary and not provided to the investors who bought them…."
Got that? We have a FIDUCIARY saying they bought stuff they didn't understand.
And weren't allowed to see.
"Hey Mister, I've got a magic box that will turn your dollar bills into C-notes!"
If Solar is so great why aren't people willing to spend the money to install it. Could it be even with gov. subsidies it takes 20 plus years for pay back? If you are a bottom line type person natural gas and nuclear are a much better deal.
" If you are a bottom line type person natural gas and nuclear are a much better deal."
Nuclear takes a lot longer than 20 years to pay back and requires massive government subsidies.
Chasing high yields in short time lines when your investment horizon is long (till death, do we depart).
Umm…Leo's countenance on reward/performance based Q/Q and Y/Y benchmarks, rings a bell in my head. The Easter Islanders ate them selves out of house and home just to erect the biggest Moi, for the title of Winner on that year. Then repeat the hole process over again until diminishment precluded such activity's, well they just modified the contest down wards really. Race to the bottom anyone?
Skippy…are pensioners the biggest liability to pension funds?
PS Get a longer stick on that carrot please.
Leo,
How can you set up an endeavor "Pension fund" ie: (sole responsibility is to act as care taker instead of extended family) in a dynamic economic environment.
When the leadership is rewarded for short term performance and, the leadership culture is so much about ones recuperation y/y, perceived length of manhood and professional legacy.
Sorry, but like most of mankind's activity's, personal enrichment precludes stated corporate policy objectives. Rewards must be in line with stated hell even legally mandated fiduciary duty's or risk diminished and in some cases long term jail. I bet that would thin the herd a bit eh.
Yes it's a dog eat dog world out there, but now it's time for men of responsibility (would you be one) to come forth and if needed shout down the rabble of "I" come first.
We are not playing a game of high school football where the winning team's strategy can be replicated by all too the same effect, there will be losers. Do we even get to choose teams in life, in most cases.
Skippy…ride Bulls and Bears long enough and one will be thrown upon their dung…befoulment in front of onlookers and peers…only a fortuitous dismount or astute maneuver will save face… so too whom do we bequeath that call.