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.
BOE’S Tucker Seeks Less Regulatory Dependence on Rating Agencies
Paul Tucker, Deputy Governor Financial Stability at the Bank of England, expressed the opinion that it is a “great mistake” for regulators to require rating agency assessments in their rules.
Speaking in London to the International Council of Securities Associations iMarketNews.com reports him saying, “Pervasive mechanistic reliance on ratings is by no means mainly the fault of the rating agencies themselves or of financial firms, although many of the latter have acted — and probably continue to act — foolishly. The extent to which ratings have been bolted into regulatory regimes — by securities regulators and prudential supervisors — has plainly been a great mistake.”
He continued to say, “Yes, we do have asset managers (and banks) who might not be able to evaluate some securities on their own if they were not permitted, by official regimes, to rely on CRA ratings. But what on earth are we doing not only tolerating but effectively encouraging a financial system in which asset managers and banks can’t always understand their portfolios?”
Hoory. Leave it to the Brits to say it straight. If you can’t figure out what a security is worth (with or without a rating), you shouldn’t be in the investment business.
SEC Proposes Broad New Rules for Rating Agencies
In a recent public meeting Mary Shapiro, chairwoman of the Security and Exchange Commission (SEC), announced what she called a “massive proposal” designed to “help investors and other users of credit ratings better understand and assess the ratings” provided by rating agencies.
Included in the proposal, which is open to public comment for 60 days, are rules requiring periodic analyst performance exams, provisions that force the separation between analysts and rating agency marketers, and restrictions on ratings agency analysts taking jobs at firms seeking ratings.
Some believe the proposed rules changes do not go far enough. Specifically, the “issuer-pays” model that has allegedly led to conflicts of interest has not been eliminated. On the other hand, the rating agencies are opposed to the proposed rules. They challenge the SEC saying that the new “transparency” that is being forced upon them will lead, in practice, to assessments that are “opaque” or “formulistic.”
Market Forces Begin To Challenge Rating Agencies’ Conflicts of Interest
While the Dodd-Frank bill was being drafted, a proposal was made to remove the stigma of rating agencies’ conflict of interest by essentially assigning an arbitrary agency to evaluate each deal. The issuer could hire others to rate the offering, but would be forced to accept the arbitrary analysis. The idea died in committee, but there is evidence that market forces are leading to unsolicited ratings that may correct the conflict of interest.
The Wall Street Journal reported recently that both Moody’s Investors Services and Standard & Poor’s presented unsolicited appraisals of a mortgage-backed security that challenges Fitch’s Triple-A rating.
Daniel Indiviglio, writing for The Atlantic, believes this is good for two reasons. First it demonstrates that agencies are serious about creating a diversity of assumptions, and second it places greater burden of analysis on investors where he believes it belongs.
Mr. Indiviglio concludes, “This debate is very health [sic] for the market. It might make the process of selling certain securities a little harder, but the process should have been harder.”
Rating Agencies Attempt To Calm Fears About Japan’s Sovereign Debt
The Financial News reports that Moody’s Investors Services senior vice president Thomas Byrne wrote, “the shock from Friday’s earthquake does not make a fiscal crisis in Japan imminent. The country’s deep and liquid government debt market will likely continue to fund government deficits, even a larger deficit as a result of the earthquake, at an exceptionally low cost.”
Mr. Byrne also mentioned that The Bank of Japan had provided Y55bn ($670m) of emergency liquidity to 13 banks.
Similarly Standard and Poor’s assured that although the country had suffered “significant” fiscal and economic shock, Japan’s AA- sovereign rating was not at risk. However the Financial News quoted Standard and Poor’s as cautioning that the problems with the nuclear reactors were troubling, “Whether the macroeconomic damage is short-term or more prolonged depends on the outcome of the situation with the nuclear reactors, an event that is still unfolding, and time needed to recover the output of electricity sufficient to cover demand.
The global head of sovereign ratings at Fitch Rating Fitch, David Riley, was reported to have emailed that, “It’s too early to estimate the economic impact of these tragic events.”
Massachusetts AG Challenges SEC
The attorney general of Massachusetts, Martha Coakley, has sent a letter to the chairwoman of the Security and Exchange Commission (SEC), Mary Schapiro, asking why the commission is refusing to enforce ratings agencies’ liability requirements. When Dodd-Frank became law, ratings agencies were subject to expert liability from that moment on. This opened the agencies to lawsuits from investors.
The New York Times quotes Ms Coakley as saying in an interview that, “We wanted to make clear that we see this as a problem and important enough that we would like an answer… “They [the SEC] are either going to enforce this or say why they are not. As a state regulator, we don’t enforce Dodd-Frank, but we certainly deal with the fallout when it is not enforced.”
The New York Times also quoted Meredith Cross, director of the SEC’s division of corporation finance. She explained the agency’s decision to not enforce the regulation by saying, “If we didn’t provide the no-action relief to issuers, then they would do their transactions in the unregistered market…You would impede investor protection. We thought, notwithstanding the grief we would take, that it would be better to have these securities done in the registered market.”
Greece’s Credit Ratings Continue to Plummet
Moody’s has downgraded Greece’s sovereign debt by three notches and Standard & Poor’s has warned that Greece could again be downgraded if the outcome of an upcoming European leaders’ summit to determine the key features of the European Stability Mechanism – which is due to replace the current European Financial Stability Facility, doesn’t instill confidence.
Currently Moody’s has Greece rated B1 and “highly speculative” and Standard & Poor’s has the country rated BB+. It is unlikely that another downgrade by Standard & Poor’s would be more than two notches. However, should this be the case it would have little additional negative impact since Greece’s debt is already junk status.
A 110 billion euro bailout from its partners in the EU and the International Monetary Fund has given Greece some flexibility before again it needs to tap bond markets for more cash. And Greece needs to see its borrowing costs fall before they can again turn to the investment community.
Yield on Greece’s ten-year bond spiked to over twelve percent and took the spread with benchmark German bunds to over nine points. There is uncertainty about how and at what point private creditors might be forced to take losses on Greece’s debt.
FINRA Investigating Bond Underwriters
Unnamed agencies and underwriters are being investigated by the Financial Industry Regulatory Authority (FINRA) to see whether the firms had been entertaining rating agency executives lavishly in an attempt to influence security ratings.
Reuters quotes FINRA Chief Executive Richard Ketchum from the annual FINRA fixed-income conference in New York as saying, “We have seen examples of excessive expenses for the entertainment of issuer officials and rating agency officials, which are then charged to the municipalities’ cost of issuance, thereby reimbursing the firm out of bond proceeds.”
Mr. Ketchum explained that this is part of an ongoing effort by Wall Street to self-police and ensure new issue pricing practices and fees are fair.
Reuters reports that the FINRA investigation has also discovered payments to political action committees as a line-item in new bond underwriting expenses. False representations of payments made to dealers and others for services never performed were also uncovered.
“These issues raise serious noncompliance issues and a breach of ethics that we are continuing to investigate,” Ketchum said.
