Bernanke Says Downgrade Didn’t Help
In his speech given at Jackson Hole, Wyoming, Federal Reserve Bank Chairman Ben Bernanke complained that the recent downgrade of the U.S. debt by Standard & Poor’s and congressional budget battles were counterproductive to recovery.
First, he discussed how much had been done to address the root causes of the 2008 financial crisis that sparked the recession including a “substantial program of financial reforms” that had led to a significant improvement in the U.S. banking system and financial markets.
However he believes that “financial stress” continues to negatively impact the recovery, both in the U.S. and abroad. “Bouts of sharp volatility and risk aversion in markets have recently re-emerged in reaction to concerns about both European sovereign debts and developments related to the U.S. fiscal situation, including the recent downgrade of the U.S. long-term credit rating by one of the major rating agencies and the controversy concerning the raising of the U.S. federal debt ceiling.”
He admitted that the impact of these events can’t be judged exactly, however, “there seems little doubt that they have hurt household and business confidence and that they pose ongoing risks to growth.”
Former Moody’s Executive Attacks Ratings Agencies
William Harrington, a former senior president at Moody’s Investor’s Services, was sharply critical of how Moody’s and the other rating agencies conduct business. He claimed that the organization’s senior management would routinely interfere with analysts’ assessments.
Mr. Harrington, who resigned in 2010 after 11 years with Moody’s, said in a statement filed with the Security and Exchange Commission (SEC) that Moody’s had a culture of “intimidation and harassment” to ensure analysts awarded ratings that were wanted by clients. He said that the compliance department would “actively harasses analysts viewed as ‘troublesome.’”
He continued to explain that, “This salient conflict of interest permeates all levels of employment, from entry-level analyst to the chairman and chief executive officer of Moody’s corporation.”
In his 78-page filing, he also said, “The goal of management is to mold analysts into pliable corporate citizens who cast their committee votes in line with the unchanging corporate credo of maximizing earnings of the largely captive franchise.”
Mr. Harrington’s opinion must be taken in the context of a former employee.
Deven Sharma, Head of S&P, Stepping Down
The parent company of Standard & Poor’s (S&P), McGraw-Hill Cos., announced that Deven Sharma, president of S&P, will be replaced by Douglas Peterson. Mr. Peterson is currently the Chief Operating Officer of Citibank N.A. Prior to that position, Mr. Peterson was CEO of Citigroup Japan.
While with Citigroup, Mr. Peterson established a reputation as a leader who is able to handle government scrutiny, improve business standards, and repair damaged reputations.
Mr. Sharma will be staying with the company as an advisor until the end of the year. The reason given for the change is that Mr. Sharma, who joined the company in 2006, is “ready for new challenges.”
During his tenure, Mr. Sharma separated S&P’s data, pricing and analytics business from its rating business. No mention was made in the announcement about how S&P downgraded the U.S. debt under Mr. Sharma’s watch, a move that was stridently criticized by the administration and was not followed by the other two major ratings agencies. Nor was there any mention of the ongoing Justice Department’s investigation into whether S&P improperly rated mortgage-backed securities while Mr. Sharma was president.
U.S. Suing Banks over Mortgaged-Backed Securities
investments by the rating agencies and sold by some of the country’s largest banks, the U.S. government is intending to sue. The Federal Housing Finance Agency (FHFA) that oversees Fannie Mae and Freddie Mac, is hoping to be compensated for billions in losses.
The claim is that the banks misrepresented the quality of the securities. The FHFA issued 64 subpoenas last year to see the underlying documents for the mortgage-backed securities in which Fannie and Freddie had invested. The purpose given for the subpoena was to ascertain whether banks and other financial entities were liable for losses suffered by Fannie and Freddie, losses covered for by the U.S. Treasury.
Maybe we can also ask the buyers and managers of Fannie and Freddie what due diligence they did at time of purchase.
S&P Gives Sub Prime Mortgage Backed Securities a AAA Rating
Bloomberg News reports that Standard & Poor’s is prepared to give an upcoming bond issue by Springleaf Finance Corporation a AAA rating. Hoover’s describes Springleaf Finance Corporation as an originator and servicer of first and second real estate mortgages. Most of these “are categorized as subprime or nonprime loans.”
Bloomberg writes, “S&P is poised to provide AAA grades to 59 percent of Springleaf Mortgage Loan Trust 2011-1, a set of bonds tied to $497 million lent to homeowners with below-average credit scores and almost no equity in their properties.”
Subprime mortgage-backed securities that were rated AAA and then later failed spectacularly are considered by many to be a key contributing factor to the financial crisis in ’08 and the subsequent recession.
What is old is new again. However, what S&P rates and what investors buy is a private matter. Let’s go back to caveat emptor.
Elkin Urges Ratings Agencies to Stop Rating U.S. Debt
Larry Elkin, President of Palisades Hudson Financial Group, LLC, wrote on the company’s web site that the Security and Exchange Commission (SEC) is abusing its investigative power. He believes two SEC inquiries into Standard & Poor’s (S&P) to be retaliation for lowering the rating on U.S. debt. These SEC investigations deal with whether S&P had improperly rated mortgage-backed securities and if there was insider trading over the U.S. downgrade.
Mr. Elkin agrees that the SEC’s mortgage-backed securities investigation predates the downgrade; nonetheless he questions whether these actions by the SEC had, “…nothing to do with the actual decision by S&P to cut Treasury’s rating. Administration officials and its SEC appointees would never dream of retaliating against a rating company for honestly expressing its constitutionally protected opinions. We know this because, though they will not say anything for attribution, they say so in all the stories reporting on their inquiries.”
Mr. Elkin says the SEC’s refusal to say anything for attribution is “baloney” and urges all the rating agencies to, “…withdraw its rating of U.S. government and agency debt. They should explain that government investigations render them unable to express an independent opinion. As a result, the government will end its tenure as a AAA-rated credit risk, not by having its ratings reduced (except for S&P), but by having them eliminated.”
Germany Begins to Suggest Greek Default
Philipp Roesler, Germany’s vice chancellor and economy minister, wrote in an op-ed piece that appeared in Die Welt that “To stabilize the euro in the short term there can’t be any taboos…That ultimately includes Greece’s orderly insolvency, if the necessary instruments are available.”
This is a significant break with German Chancellor Angela Merkel’s calls for patience in dealing with the ongoing Greek debt crisis. Other senior European and German officials also insisted a Greek default was not being considered as a viable alternative.
The credit-default swaps market project a greater than 90% probability that Greece will be unable to meet its obligations. And the Greek government estimates that they only have enough money to keep operating for approximately two weeks.
The speculation that the Germans and others in the European Union will not extend additional support to Greece has caused stock values for France’s three largest banks that are heavily invested in Greek bonds to fall dramatically. Likewise rumors that Greece will be forced to give up the euro has led to speculation that other countries in trouble like Spain, Portugal, Italy and others could also be pushed out. This has caused the value of the euro to fall precipitously.
Goldman Sachs Sued for Lying to Ratings Agencies
The Federal Housing Finance Agency (FHFA) has filed 10 causes of action against Goldman Sachs; of these, the more serious are for fraud. The agency is hoping to collect $11.1 billion plus interest for the lost securities and legal fees.
Courtney Comstock of Business Insider quotes a key passage from the lawsuit: “Because the information that Goldman provided or caused to be provided [to ratings agencies] was false, the rating were inflated…[and] also that Goldman Sachs knew, or was reckless in not knowing, that it was falsely representing the underlying process and riskiness of the mortgage loans…because Goldman’s longstanding relationships with the problematic originators, and its numerous roles in the securitization chain, made it uniquely positioned to know the originators had abandoned their underwriting guidelines…[and because] as a result, the GSEs paid Defendants inflated prices for purported AAA (or its equivalent) Certificates, unaware that those Certificates actually carried a severe risk of loss and inadequate credit enhancement.”
Because Goldman Sachs was not the originator of the mortgage loans, where the actual fraud took place, Ms. Comstock believes that Goldman Sachs has a strong defense. However the suit claims that Goldman Sachs was updated daily on the number of defaults but chose to securitize these failed loans anyway. Ms. Comstock also believes that Fannie and Freddie Mac were “sophisticated investors” who should have done their due diligence. To this the FHFA claims that the substandard loans were hidden; there is no way they could have known.
Good plan. Use the laws and rules that exist. If there is fraud, prosecute!
Taylor Criticizes Euro Zone’s 3-Day Warning Plan
Fitch Ratings President Paul Taylor addressed the feasibility of a three-day warning period before changing a country’s sovereign debt ratings. Among other issues, Mr. Taylor worried about insider trading. He told a panel of British lawmakers from Britain’s upper chamber of parliament, “One of the leakiest areas in our business is sovereign ratings…if you inform the Greeks of a rating decision you get phoned up by the French. Countries tend to talk to each other.”
Taylor also claimed that the ratings agencies’ power is overstated. Instead the lawmakers should focus on the business press. Reuters reports Taylor saying, “It’s overstated, the power we have in markets. A lot of that comes from the press. The financial press in particular loves the idea we wave our wand and magic things happen.”
Currently countries are given 12 hours to challenge any factual errors, however the Europeans are exploring the possibility of expanding that to three days. The politicians are looking for a longer grace period to avoid wild swings in bond prices while bailout packages are being negotiated.
This is pure folly. You can never regulate volatility.
Taylor Criticizes Euro Zone’s 3-Day Warning Plan
PFitch Ratings President Paul Taylor addressed the feasibility of a three-day warning period before changing a country’s sovereign debt ratings. Among other issues, Mr. Taylor worried about insider trading. He told a panel of British lawmakers from Britain’s upper chamber of parliament, “One of the leakiest areas in our business is sovereign ratings…if you inform the Greeks of a rating decision you get phoned up by the French. Countries tend to talk to each other.”
Taylor also claimed that the ratings agencies’ power is overstated. Instead the lawmakers should focus on the business press. Reuters reports Taylor saying, “It’s overstated, the power we have in markets. A lot of that comes from the press. The financial press in particular loves the idea we wave our wand and magic things happen.”
Currently countries are given 12 hours to challenge any factual errors, however the Europeans are exploring the possibility of expanding that to three days. The politicians are looking for a longer grace period to avoid wild swings in bond prices while bailout packages are being negotiated.
This is pure folly. You can never regulate volatility.
