Structured By Cows


August 17, 2011

David Albrecht, Director, International Programs & Business Research

So, what if a ratings agency pulled the fire alarm and the engine company never arrived? What if the only result was a tinkling of broken glass and a momentarily alarming chorus of honking klaxons? And what if the reaction of the world at large was a rush to purchase the very debt that agency had warned was no longer worthy of its highest standards?

Well, now we know. Following Standard & Poor’s downgrade announcement on August 5, the working week of August 8-12 saw the kind of high g-force Coney Island market action that comes along only once in a great while. However, that was the week that was. Ten days post-pronouncement, by the morning of August 15, the market stood slightly above where it was when the downgrade announcement came out.

Whatever the short-term reactions to Standard & Poor’s downgrade, the longer-term backlash is only now getting under way. For starters, who could imagine that Lawrence O’Donnell and Donald Trump would ever agree on anything? The downgrade made it possible, with O’Donnell referring to S&P as a “confederacy of dunces” and Trump calling the firm “losers” and “disgraceful.” A more civilized take on the decision came from Faith Consolo, chairman of the retail leasing and sales division at Prudential Douglas Elliman in New York: “To put it mildly, S&P’s track record hasn’t been the best in recent years, and most sophisticated investors know this.”

Beyond the immediate market shockwave, complications continue to radiate from S&P’s decision – or rather, radiate back to S&P. On August 17 the Wall Street Journal reported that the city of Los Angeles announced that it will no longer use S&P to rate its investment portfolio, citing the U.S. debt downgrade as “irresponsible and just excessive.” And the Securities and Exchange Commission is working on two fronts.  One part of an ongoing investigation is concentrating on just what methodology S&P used to arrive at its conclusion that U.S. debt was now only AA+. A separate probe seeks to discover “whether certain market participants learned of the downgrade before its announcement.”

In the end, what it comes down to is this: after the stock market jello stops jiggling, and after all of the political puffing and blowing dies down, S&P has no credibility left when it comes to rating whether a company or a bond or a nation are a safe bet. Along with its compatriots in the ratings industry, S&P greased the skids for the housing bubble and subsequent financial collapse, handing out AAA ratings right and left for bundled high-risk mortgages as if they were just as credit-worthy as Treasury Bills.

In words that will live in financial infamy, two unnamed S&P executives spelled out exactly how things worked at their rating agency in an instant-message conversation on April 5, 2007.  The topic of discussion was yet another “AAA” bundled-mortgage instrument.

Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right…model def (definitely) does not capture half the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we would rate it.

So, here we are. We can worry about the credit ratings assigned by the Lords of Bovine Structured Finance and in doing so ignore their record of professional achievement over the last decade. We can stand horrified and immobilized by admittedly nasty short-term market conniptions. Or we can get on with what we do as a business community – digging up information, finding new customers, thinking of new ways to improve a service we provide or a product we create. Given the collective resilience, optimism, and inventiveness of the 300 million+ inhabitants of this amazing country, I know which of the three courses I’d choose.


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