Calpers: Rating Agencies to Blame for Huge Losses

Way back when, I mentioned there was a surprise coming S&P’s way. Since it is now out there officially, I can discuss it publicly.

After the brouhaha with McGraw Hill began, I was contacted by numerous people — mostly readers emailing words of support. But a few West Coast lawyer types seemed to be asking lots of questions, and revealing little.

I poked around with some law firms in California, and started to pick up the rumor that California Public Employees’ Retirement System (CALPERS) was going to drop the bomb on S&P, Moody’s and Fitch. No one would say anything on the record, but it was clear that litigation was being considered as an option against the Ratings Agencies.

Here is the money quote:

The AAA ratings given by the agencies “proved to be wildly inaccurate and unreasonably high,” according to the suit, which also said that the methods used by the rating agencies to assess these packages of securities “were seriously flawed in conception and incompetently applied…”

“The ratings agencies no longer played a passive role but would help the arrangers structure their deals so that they could rate them as highly as possible,” according to the Calpers suit.

Now, here comes the fun part: Calpers doesn’t give a rat’s ass about the money. Sure, the financial instruments at hand (Cheyne Finance, Stanfield Victoria Funding and Sigma Finance) have  defaulted on their payment obligations. The losses to Calpers are ~!$1 billion.

But that’s not what’s going on here: These Left Coasters want their pound of flesh. They don’t care for the Ratings Agency folks, and consider them a blight on the investment landscape.

The goal of the litigation (as I see it) isn’t to make the rating agencies pay a financial penalty; rather, it is to publicly try them just as the regulatory rules are being rewritten. I also predict that CALPERS is going to attempt to not just win, but humiliate these agencies, call them out in the most embarrassing way possible, trash the senior executives, and make things very uncomfortable in general for these firms.

They don’t want them to merely suffer — they want to destroy their unique position as an Oligopoly, to remove them from having a special status under the SEC rules.

In these sorts of litigations, plaintiff can be very often bought off cheaply. In this case, that won’t happen. An offer a few million dollars — or a few 100 million — won’t tempt them into taking the money and going away. They have as much money as they need to finance this litigation to the long, drawn out, bitter end.

If I was a Rating Agency lawyer, I would be very, very nervous . . .

Some of the additional details:

– Conflicts of interest by the rating agencies are rife. They are paid by the companies issuing the securities — an arrangement that prevents the agencies from issuing negative ratings;

– Structured investment vehicles generated lucrative fees for rating agencies, above and beyond normal fees. They were paid as consultants who helped structure the deals — not as neutral 3rd parties. The fees ranged from $300,000 to $500,000 and up to $1 million for each deal;

-These fees were in addition to revenue generated by the agencies for their more traditional work of issuing credit ratings;

-By actively creating these instruments, CALPERS owed a different duty of care as an underwriter, not merely a 3rd party firm protected by  1st Amendment Free Speech;

-By then rating them AAA, what the Ratings Agencies did amounted to Fraud.


Originally published at The Big Picture and reproduced here with the author’s permission.

5 Responses to "Calpers: Rating Agencies to Blame for Huge Losses"

  1. Guest   July 15, 2009 at 5:10 pm

    This is the what started the whole collapse. This is the epicenter of the economy’s woes. All these ratings people, all their employees, and anybody that knew what they were doing (i.e. anybody that used there services) should be criminally prosecuted, not just publicly humiliated by Calpers. That entire system has to be scrapped. A complete prosecution of all these guys is the only thing that will restore trust by the american people.

  2. Guest   July 15, 2009 at 9:34 pm

    Financial chaos and pain. A creative opportunity. Beware when the legislators and bankers find an excuse to get together and write laws. It’s a very very bad thing. The laws that created the federal reserve in 1913 have brought us the present turmoil. It was baked in the cake then – coming out of the oven now.

  3. Anonymous   July 16, 2009 at 8:05 am

    Finally. From someone inside the mortgage industry. (Yes, I know but not a sub-prime lender). Lenders did not perpetrate this on unknowing borrowers. The borrowers wanted a loans. Fannie and Freddie would not approve them. These loans were what we used to call in the industry B, C and D paper. Sub-Prime did not mean stated income or “liar loans” to the media (which by the way are not the same as sub-prime, perform vastly better, and are needed as guidelines punish income from sources other than employment). Sub-Prime meant not good credit. It meant lending to persons who had ALREADY EXHIBITED POOR CREDIT RESPONSIBILITY. These loans were to people who were a much greater credit risk. HOW ON EARTH THEN CAN A LOAN TO A PERSON WITH POOR CREDIT BE RATED TRIPLE-A? And, at loan to values that would normally require mortgage insurance for “Prime” borrowers. Fannie and Freddie would not give a 100% loan and not have PMI. Everyone in mortgages knew that, how did the rating agencies and the Wall Street firms packaging these loan sales not know? How could they sell these loans to investors as low risk, driving up demand? ONLY BECAUSE OF THE TRIPLE A RATINGS. These were sub-“Prime,” meaning these borrowers would be denied by standard guidelines. How can that be a low risk loan (AAA) when sold to an investor? Poor credit, high risk and high loan to value with no extra mortgage insurance. The rating agencies are largely responsible because the vast liquidity available to offer these loans, and the prices that could be offered were directly related to the ratings. If the ratings were not triple-A investors would have wanted more. Investors would have demanded a higher rate or more down payment, or both and the amount of funds for theses loans and borrowers who could get them would have fallen off exponentially.

  4. Guest   July 16, 2009 at 2:04 pm

    As interesting as the prospects are, it will go nowhere. Litigation will become too costly and there is a general sentiment of “let’s get this behind us and move forward”.Stringing up a few high level “ratings nerds” won’t satiate the populists thirst for blood and will therefore be abandoned.

    • Guest   July 17, 2009 at 9:53 am

      For Guest @ 14:04:09Go back and read the article. This won’t go away or become too costly. Calpers is funded to the nines.These “ratings nerds” as you call them need to be brought down. Were it not for their fraudulous dealings we wouldn’t be in this mess.