MonkeyBusinessBlog

Rating Morons Get Slammed in Court!

From Bloomberg News Rating Firms Lose Free-Speech Bid to Dismiss Lawsuit.

Apparently, the right of free speech does not include protection against being greedy and corrupt a-holes!

“It’s the first major ruling upholding fraud allegations against an arranger and the rating agencies on the instruments that are at the heart of the financial crisis,” saidPatrick Daniels, a lawyer at Coughlin Stoia Geller Rudman Robbins LLP, the San Diego-based securities litigation firm that represented investors in the case.

“In previous cases, the ratings companies would hide behind First Amendment protection, saying they were merely reporting their opinion,” Daniels said.

According to Daniels, Scheindlin rejected the First Amendment claim because the rating firms’ opinions are an essential component of private-placement transactions in which securities are sold directly to institutional or private investors without a public offering.

The case concerns notes issued by Cheyne Finance Plc, a so- called structured investment vehicle that collapsed in 2007, which received the “highest credit ratings ever given to capital notes,” according to the ruling. SIVs issued short-term debt to fund purchases of higher-yielding long-term notes and failed when credit dried up amid the financial crisis.

Compensation

The rating companies worked directly with Morgan Stanley to structure the notes, and their own compensation was based on the notes receiving the desired ratings, according to the order. The ratings companies were paid more than three times their normal fees, the judge said.

The value of the notes collapsed during the worst economic slump in decades, making repayment of the debt impossible as it came due, according to the ruling. The notes were liquidated at discounted prices, leaving investors with a fraction of their investment or with notes that were worthless, according to the opinion. The investors sued based on fraud, negligence and contract claims to recover their losses.

Three times their normal fees!  Time to abandon the free speech angle and take the incompetent moron angle.  I guess they never figured the fee structure on the deal would look "untoward".  Guess again boys.  Pretty soon you'll have nowhere to hide.

It's Time For S&P to Go.

Yesterday, my day seemed to begin and end with S&P, the ratings company, who along with Moody's, helped destroy the world while making record profits.  A good friend of ours warned me early in the morning that the nice gentlemen from S&P who calls once a month to downgrade his CDOs, let on that S&P was changing it's methodology on how it is rating Collateralized Loan Obligations, (CLOs) and that a lot of AAA CLOs weren't going to be AAA much longer.  It made sense, especially an hour or so later when Moody's warned of CLO downgrades.  None of this should be surprising to anyone who has had anything to do with CLOs.  Similar to their dismal performance rating residential and commercial mortgage structured securities, both rating companies had serious flaws in how they assigned ratings to CLOs.  In fact, Moody's themselves came out and admitted it in June of last year.  Here is our post on that subject from last June Moody's Race To Shut Barn Door Impeded By Fleeing Horses!

Here is the gist of that piece;

Yes folks, the ratings companies have done it again, this time with syndicated leveraged loans.  There is an article in today's Financial Times, "Issuance Surge Set to Hit Recovery Rates", that outlines how the rating companies failed to take into account many factors, that will help fuel the next credit disaster, corporate loans.  The best part about the FT article is it's essentially written by Moody's!  They issued a report YESTERDAY on the problem!  Here is what Kenneth Emery, Moody's Director of Corporate Default Research, had to say:

"The substantial increase in bank loans average share of total debt will reduce average recoveries for both loans and bonds.  Loans have less junior debt below them which will serve as a drag on recovery rates."

You see, because there was huge demand for senior secured high yield loans in the heady days of leveraged vehicles (2004-2007), in this case Collateralized Loan Obligations (CLOs), banks fed the voracious appetite by issuing as many loans as possible.  This is a problem now.  Why you ask?  It is a problem because by issuing so many loans they messed with the credit capital structure of these highly levered companies.  Senior secured loans sit at the top of say, Burger King's capital structure.  Then comes second lien secured loans, then comes unsecured bonds and finally equity.  When credit losses start occurring this is the order of what part of the capital structure takes LOSSES:

1. Equity
2. Unsecured Bonds
3. Secured Second Lien loans
4. Senior Secured First Lien loans

Do you see the picture?  Senior Secured First Lien loans want as much subordination as possible so when losses start occurring, they are absorbed by guys like unsecured bonds and second liens.  Because banks were incented to crank out senior loans (that's what the gigantic CLO machine wanted), there is a disproportionate amount of senior loans to unsecured bonds.  Hence, the probablility for senior secured losses has increased.  According to Moody's, dramatically.  Quoting from the FT article, "On average, first lien senior secured bank loans, the first in the pecking order for payment in default, will recover just 68 per cent on the dollar versus 87 per cent historically, Moody's estimates"

It sure is going to be interesting when all these AAA get down graded as the defaults and subsequent losses start coming in.  It is also important to remember that many of these CLOs contained loans with very relaxed covenants.  That also adds to loss severity.  The downgrades should be about the fourth bullet pumped into the insurance industry's head.  I'm sure all those who are pronouncing that credit is thawing out and the worst is over have factored this little technical in.

Now on to Commercial Mortgage Backed Securities.  I saw this yesterday and the scary thing is I wasn't surprised.  Last week, S&P downgraded I believe three AAA CMBS all the way to BBB-.  S&P cited a change in their rating criteria and methodology at the time.  That's a big old downgrade!  Then yesterday, S&P upgraded the bonds back to AAA!  The one I saw was GSMS 07-GG10 A2.  Model error?  No cogent explanation from S&P.  However, the fact that downgrading the AAA bond meant that the bond (along with a lot of sister bonds) would not be eligible for the TALF program.  The government is using TALF to try and prop up the commercial real estate market.  Collateral posted with the Fed has to AAA.  Therefore, I am going to guess a few phone calls came from Washington to S&P that sounded something like this;

"You ass-h*les spent the last decade misrating this economy into oblivion and NOW you decide to start trying to rate sh*t correctly?  You WILL change those ratings back to AAA or there WILL be some serious problems!"

So, to be clear.  First the ratings companies did whatever the issuers told them to do and now they are doing whatever Washington tells them to do.  And we still pay them to rate bonds!

Why Exactly Are S&P and Moody's Still Around? And Why Are They Getting Paid to Rate ANYTHING?

Bloomberg News has the following article out today Morgan Stanley Plans to Turn Downgraded Loan CDO Into AAA Rated Bonds 

Morgan Stanley plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings in the first transaction of its kind, said two people familiar with the sale.

Morgan Stanley is selling $87.1 million of securities that it expects to receive top AAA ratings and $42.9 million of notes graded Baa2, the second-lowest investment grade by Moody’s Investors Service, according to marketing documents obtained by Bloomberg News. The bonds were created from Greywolf CLO I Ltd., a CDO arranged in January 2007 by Goldman Sachs Group Inc. and managed by Greywolf Capital Management LP, an investment firm based in Purchase, New York.

As far as we are concerned, God bless.  Structuring in and of itself isn't a bad thing.  It's only when "credit magic" is applied, like the kind that blew us a trillion new orifices, that we have a problem with.  Although I have to say, this quote is a bit alarming;

A lot of banks and insurers “cannot buy anything but AAA,” said Sylvain Raynes, a principal at R&R Consulting in New York and co-author of “Elements of Structured Finance,” which is due to be published in November by Oxford University Press. “You’re manufacturing AAA out of not AAA, therefore allowing those people who have AAA written on their forehead to buy.”

Sylvain.....Buddy!!  That's so 2006!  Obviously you were speaking with your "thinking voice" by accident.  

Anyway, I'm sure these repacks or re-REMICs are done well and the AAA is really AAA.  Seriously. The best bonds get made now and I'm sure the default and loss severity numbers reflect reality.  What really bothers me is why and the hell should S&P or Moody's get a dime for rating these bonds?  Why are these f**kers still even around?  Nobody in their right mind is going to buy these bonds BASED on these Fredos stamp that they are true AAA right?  If they do then they do not belong in this game.  With all the regulatory reform that gets talked about, if insurance companies, banks and pension funds are still renting their brains out to S&P and Moody's, then they need to get put in the box for a long time.  If anything, the buyer should be calling in someone like Egan-Jones to independently verify the credit and paying them to do it, or split the cost with the issuer.

Some may be alarmed that the Street is back to structuring.  That's not what gets me.  What gets me is S&P and Moody's are still getting paid by the issuer to rate the bonds like none their craven and asinine behavior ever happened.

Freddie Mac Shows the Way Forward!

Great article in America's best business section, The New York Post Freddie Mac Attack.  Talk about a story with delicious irony.  In one story we get to examine;

• The disaster in commercial real estate financing.
• The continued nonsense from the GSEs even AFTER their humbling government takeover.
• The sick comedy with our debt rating process.

From the New York Post;

Think of it as a Freddie smack.

Government-owned Freddie Mac has snubbed the two leading rating agencies -- Moody's Investors Service and Standard & Poor's -- on the plum assignment of rating the market's first securitization in nine months, relying instead on the market's two smaller rating agencies.

Instead of going with Moody's and S&P, the industry standard, Freddie will have AAA ratings from Fitch and Canadian agency Dominion Bond Rating Services on its $1B deal.

According to people familiar with the matter, Moody's and S&P lost the Freddie mandate because the ratings method they applied was considered too rigorous.

That's not to say that snubbed firms would have granted the deal something less than a AAA rating, a source noted. However, the ratings firms required Freddie to sign documents that freed them from blame in case anything went wrong with the bonds.

This is hysterical....in a sick sort of way.  The government is desperate to head off the oncoming category 5 commercial real estate hurricane by using Freddie and Fannie to provide liquidity to the sector.  They both have sizable multi-family portfolios to begin with, but what I think is happening is the government wants to ramp it up big time (the guarantee part of the business) to get as many multi-family loans refinanced as they can.  I am sure that the underwriting process will be relaxed considerably, leaving you and I (the tax-payer) with our tushies hanging in the breeze.  Oh, and lets not forget that the government will be providing nice non-recourse financing to investors through TALF!

Meanwhile, S&P and Moody's are looking at the billions of CMBS drek that they rated over the last few years and are essentially saying, "We'll put our discredited stamp of approval on this sucker, but you have to sign a bunch of documents absolving us from misrating the bond." 

Then you have Freddie, pretending that it's 2001 by telling S&P and Moody's, "If you aren't a team player, we'll just cut you out and find somebody that will put a AAA stamp on the bond.  You guys are in the box!" 

As Tony Soprano said, "The hustle never ends."

How's This For Irony

Somehow it seems fitting on a day when Bernie Madoff gets sent to the poky, the head of the ratings company S&P, Deven Sharma would write an article in the Financial Times Re-evaluating and Rebuilding a More Useful Ratings System.  Yep, the man in charge of one of the great enablers of the destruction of the modern global financial system, Standard & Poors, weighs in with his opinion on how credit rating companies should operate going forward.  On his way to jail they might as well ask Bernie Madoff for his ideas for the future of investment management!

First of all, I would like to get one thing straightened out.  Both Moody's and S&P call themselves "ratings agencies".  What does the word agency imply?  I think to a lot of folks, agency implies a certain level of being "official" or "impartial".  These words mean a lot because I know MANY people who really thought that the ratings COMPANIES were somehow on the hook for their ratings and were on the side of the investor.  It was a rude awakening when people discovered that the ratings COMPANIES issue a nice little disclaimer on everything they rate that basically says their rating is only an opinion, which means in the event they get it wrong, it means bubkis.  Moody's and S&P (a division of McGraw Hill) are companies, paid by bond issuers to rate bonds for profit.  Therefore, Mr. Sharma the first thing I'd like "re-evaluated" is what you call yourself.  You are a ratings company.  Calling yourself a ratings agency is misleading.

Anyway, read the article.  As a forward looking idea it's not bad, except for the fact that Sharma leaves the issue of who pays the ratings company (issuer or investor) for us to decide.  I think that it's pretty much been decided in the court of common sense that fees derived from the issuer is not the way to go.  What really gets me going though is this statement;

"Most of S&P's ratings have held up quite well, even in the current environment."

This is like a company that makes nuclear reactors saying, "Well, on the whole, only twenty of the three-hundred reactors we made suffered complete meltdowns.  That's a 93% success ratio!"

Dope.

 

How's This For Perverse!

I'm sure there are some of you out there that run your own business, or manage the finances of somebody else's business.  What if you had a revolving line of credit with the bank that said your liquid assets (cash and cash-like equivalents) had to be a certain percentage of your outstanding debt.  Moreover, lets say the bank had a covenant that stated that the your level of retained earnings had to be a certain percentage of your assets.  If business got bad and you started bleeding cash and maybe some of your receivables started going delinquent and maybe the value of your inventory started falling, you think if you went to the bank and said;

 "Look, my balance sheet is getting weaker and my cashflow is getting worse.  How about you take those cash and capital covenants and loosen them to reflect my current state of affairs?  In fact, how about you loosen them to reflect that things are going to get a whole lot worse?

You think the bank would go along with you?  Probably not.  Now lets look at what the insurance companies like Hartford want to from their regulator.  From Bloomberg News;

Jan. 12 (Bloomberg) -- Hartford Financial Services Group Inc. and Prudential Financial Inc. led life insurers lower after regulators dismissed an industry plea to speed capital relief.  Hartford fell $2.82, or 16 percent, to $15.34 at 12:01 p.m. in New York Stock Exchange composite trading. Prudential, based in Newark, New Jersey, declined $3.44, or 11 percent, to $28.44.

Life insurers are pushing regulators to grant looser reserve standards after investment losses depleted capital. The National Association of Insurance Commissioners rejected an industry request to approve reform by Jan. 16 and plans to hold a hearing at the end of the month before taking a vote, Susan Voss, the vice president of the group, said late on Jan. 9.

Yes, you read that right.  Their capital positions are getting worse so they want the regulator to degrade the standards.  You know what is horrifying?  A couple of months ago, when things were looking particularly grim for the insurance companies and their structured credit loaded balance sheets, this sector rallied SHARPLY (The Hartford went up something like 150% in one day) on the rumor that the capital standards were going to be eased!  The sector didn't rally because they were going to make more money or that their financial conditions were going to improve.  Instead they rallied because there was a rumor the regulator was going to lower the bar on safety and soundness.  I remember that day and I also remember a certain balding, screaming, sleeve rolled up, investor on CNBC saying that The Hartford was fine, AFTER it rallied about 150% in one day!

What's even more perverse, in my opinion, is that the ratings companies, the same ones who missrated all the bonds the insurers bought when they rented their brains out to the rating companies, now hold a lot of the insurers lives in their hands.  According to Bloomberg;

“The continued turmoil in the credit and equity markets is taking a bigger toll on the U.S. life insurance sector,” Standard & Poor’s said today in a statement. “We expect to take negative rating or outlook actions on several life insurers in the next six months.”

Downgrades trigger all kinds of nasty covenants and counterparty collateral agreements.  Remember AIG?   Maybe the only hope for some of these companies is if their main counterparty is Goldman!  

"Connecticut Aims Legal Action at Moody's, S&P and Fitch. Our New Years Wish Came True!

Bloomberg News reports that "Connecticut Attorney General Richard Blumenthal plans to announce legal action today against Moody's Investors Service, Standard & Poor's and Fitch Ratings, the three biggest credit-ratings firms." 

Blumenthal says that the firms, "knowingly and systematically" gave municipal securities lower grades than comparable corporate companies and structured debt (yes, your town that never missed an interest payment in 50 years, was rated lower than a mezzanine Subprime CDO), raising costs for state and local governments.  How you might ask?  By driving them into the arms of the monolines so they could pay a fee for the AAA rating they should have already had!  Here is a clip Richie and I did back on January 6th, 2008.  Our New Years wish was that some state A.G. would look into collusion between the ratings companies and the monolines.  And now it may come true!

Are you Really Shocked About Moody's and S&P's Emails?

You know what is really sad?  I bet if you or I sat down last week and took our best shot at the type of emails that must have gone around the ratings companies in the go-go years of structured products, we could have almost replicated the internal emails the SEC put on exhibit yesterday.  Do you agree?  Here are two examples of internal emails the SEC displayed yesterday;

"Let's hope we are all wealthy and retired by the time this house of cards falters"

"It could be structured by cows and we would rate it."

Actually that last one is pretty damn funny!  Nevertheless, the point here is, this kind of stuff doesn't happen at companies because some "rogue" employees or "rogue" departments stray from the mission and ethics of the company.  Rather they happen because employees are trying to react in perfect harmony to the message that is coming from the very top.  Senior management doesn't have to put out a memo that says,

"Put a B.S. rating on a bond or a group of bonds because we want to make the most money we possibly can in the shortest amount of time possible."

Instead, the employees just have to look around and see who is getting promoted and who is getting the biggest slice of the bonus pool.  Why do you think the structured credit guys in London put the wrong ratings on those CPDOs?  The department head was probably sick of watching the structured residential credit groups getting praised and paid.  He was probably tired of seeing the quarterly presentations that management had showing his group represented by the blue bar, 75% behind the "better group's" red bar.  And lets not forget the endless "sing for your supper" morning meetings where every department head stands up and has to say how great things are going and how they are "ahead of plan".  Woe unto you if your not "ahead of plan".

This is all part of what very-senior management uses to get you to make your numbers (that they usually set 15% higher than what you can achieve) anyway you can.  They learn how to hone these skills at special off sights!  Can't you see them with a bunch of behavioral scientists shocking the hell out of lab rats to get them to do what they want them to do!  As we speak, one of these sessions is probably going on right now.  Aspen most likely for this time of year.

I'm sure that the heads of these ratings companies will come out and say that they are appalled at these emails and severely disappointed in "some of their employees" that embarrassed the company, etc.  To that SEC Chairman Cox should just slap the sh*t out of them!  He should sentence them to play for a week on "I Survived a Japanese Game Show"!  The only way these guys get away is if they can produce consistent memos, written by them, to their subordinates saying something like;

"Despite the lure of tremendous fees from the investment banks, we must always remember that the franchise of this firm is it's integrity.  If we don't have the manpower or we don't have the expertise, or we just don't buy into the logic of the latest product, don't do it.  Bring it to us and we will cover you. No short-term profit or short-term stock price move will substitute for the loss of our integrity."

Besides the new-employee handbook that was probably written in 1972, how many of those memos you think the SEC has found in its probe of the ratings companies?  My guess is zero.

Now Playing the Part of Captain Queeg, Moody's CEO Ray McDaniel!!

Today Moody's Corp. announced that the investigation into it's willful misrating of $4 billion Constant Proportion Debt Obligations (CPDO's) has concluded and wouldn't you know it, it was the handiwork of some rogue employees.  The company said employees, not the company's practices were to blame.  Uh-huh.  I'm sure the "employees" didn't get any ideas watching the company preen for years about their record fees while they misrated billions upon billions of bonds.  I'm sure no one was pressured at meeting to get their revenues up to the standards of the rest of the company.  Those things never happen right?  Of course not. 

It makes me sick to even think these clowns anymore.  I would like to see Moody's, S&P, Fitch, MBIA and Ambac get a nice Viking funeral.  I want them to just go away.  Also, as far as CEO Raymond McDaniel goes, when the hell is Warren E. Buffett, the proud owner of 20% of this sham going to put one of his sensible shoes up Ray's ass?  The company and the guy should be a utter embarrassment to to Buffett.

Anyway, in a statement, McDaniel said, "I am deeply disappointed by the conduct that occurred in this incident."  I've been sitting here a good part of the afternoon thinking about who this guy reminds me of.  A guy who bungles away his company's greatest asset, its credibility, and then blames everybody else.  Finally it came to me.  Captain Queeg from the movie classic, "The Caine Mutiny".  Enjoy.

Moody's Race to Shut Barn Door Impeded by Fleeing Horses!

Can't you just picture it?  It's the late 1800's.  Moody's, the credit rating company, is racing with their wagon to the city livery stable.  A call had gone out that the horses are escaping!  Moody's job was to secure the barn door the night before but they were too busy.  See, there was this little party and there was lots of wine, women and song.  They stayed at the party too long and forgot to do their job.  Now in a panic, they are trying to ride hell-bent to the livery stable, but they can't get anywhere near the place because all these damn stray horses (the ones that should be locked in the livery) are running around everywhere blocking the way!

Yes folks, the ratings companies have done it again, this time with syndicated leveraged loans.  There is an article in todays Financial Times, "Issuance Surge Set to Hit Recovery Rates", that outlines how the rating companies failed to take into account many factors, that will help fuel the next credit disaster, corporate loans.  The best part about the FT article is it's essentially written by Moody's!  They issued a report YESTERDAY on the problem!  Here is what Kenneth Emery, Moody's Director of Corporate Default Research, had to say:

"The substantial increase in bank loans average share of total debt will reduce average recoveries for both loans and bonds.  Loans have less junior debt below them which will serve as a drag on recovery rates."

You see, because there was huge demand for senior secured high yield loans in the heady days of leveraged vehicles (2004-2007), in this case Collateralized Loan Obligations (CLOs), banks fed the voracious appetite by issuing as many loans as possible.  This is a problem now.  Why you ask?  It is a problem because by issuing so many loans they messed with the credit capital structure of these highly levered companies.  Senior secured loans sit at the top of say, Burger King's capital structure.  Then comes second lien secured loans, then comes unsecured bonds and finally equity.  When credit losses start occuring this is the order of what part of the capital structure takes LOSSES:

1. Equity
2. Unsecured Bonds
3. Secured Second Lien loans
4. Senior Secured First Lien loans

Do you see the picture?  Senior Secured First Lien loans want as much subordination as possible so when losses start occuring, they are absorbed by guys like unsecured bonds and second liens.  Because banks were incented to crank out senior loans (that's what the gigantic CLO machine wanted), there is a disproportionate amount of senior loans to unsecured bonds.  Hence, the probablility for senior secured losses has increased.  According to Moody's, dramatically.  Quoting from the FT article, "On average, first lien senior secured bank loans, the first in the pecking order for payment in default, will recover just 68 per cent on the dollar versus 87 per cent historically, Moody's estimates"

This is Moody's bread and butter!  They've been doing this kind of credit work forever!  It's not like a new product such as subprime or Alt-A home loans, a product where there was little historical data.  It's bank loans and corporate capital structure!!  At Moody's they have there analysts studying this stuff from the first day.  There's tons of data.  They, the ratings companies, knew this was a problem when they rated the CLO structures.  If they would have used a recovery rate like 68%, these deals probably wouldn't get done because who the hell would buy the subordinate pieces?  Nobody!

It gets better.  Quoting the FT article, "Moody's said the picture could change if creditors were able to minimize the decline in issuer's overall worth at the time of default by, for example, forcing distressed issuers into bankruptcy relatively soon after they hit financial trouble."  The problem with this is, Moody's let banks do away with important covenants on their loans, so they could make more of them for the CLO machine!!  They call these loans "covenant-lite". 

Yes folks, this is true.  Covenants are put into senior loans by lenders so if the borrowers do anything that might endanger the lender from getting paid back (things that would weaken debt/coverage ratios, free cash available, etc) the lender can demand immediate repayment.  This is the lever Moody's is referring to when it says credit problems for the senior loans could be mitigated if the senior lender were allowed to drive the borrower to repay them sooner or face bankruptcy.  Problem is, the ratings companies like Moody's, let the lenders and CLO issuers slide by allowing for massive issuance of "covenant-lite" loans.  So much for that.  Again, this is another thing baby ratings analysts learn from the cradle.

Now, here we are at the begining of a potentially deep recession.  Corporate defaults are projected to top those from 2001-2002, by a lot.  Another perfect storm is brewing.  Moody's better hurry, I think I saw a few of those horses just run by my house!

S&P Finds Error in its Model.....It's Moody's!

Today S&P, the ratings company, announced that, like Moody's, it had a modeling "error" for Constant Proportion Debt Obligations (CPDOs).  This is great.  If you remember just a few short weeks ago, Moody's "disclosed" that they too had a modeling error for CPDOs which caused the company to missrate the product by up to four notches.  They had rated them Aaa.  The biggest problem for Moody's was, they found the error back in February 2007, covered it up, and continued to hand out Aaa ratings!  We've written pretty extensively on this a couple of weeks ago.  Moody's only disclosed their "mistakes" when the Financial Times did some good old fashion investigative reporting and caught the company with their pants down.

Just to remind you, CPDOs were products that paid nearly 2% over risk free rates, relied extensively on huge amounts of leverage and monk-like prayer that credit events wouldn't occur in the first couple of years.  Moody's rated these products Aaa and raked in HUGE fees. Anybody looking at these structures just had to use common sense to know that this product was far from Aaa.  Unfortunately, back in the day (2006-2007) we (and I say WE, because my common sense gave up the fight to some degree as I watched everyone around me getting rich structuring, trading and selling this crap!) weren't letting common sense get in the way of getting paid!

When this story first broke three weeks ago, I got bombarded with Bloombergs and emails asking, "How do you think S&P rated these?"  So I asked a few wise friends and they told me that the S&P model for CPDOs was very simple.......THEY JUST COPY MOODY'S RATING!  Yes folks, it's that screwed up.  The ratings companies did that a lot. The feeling around S&P was probably, "Boy, these CPDOs are pretty freaking complicated.  Moody's already rated them Aaa and the issuer is looking to pay us a fat fee.  Sounds like a dunk, give them their AAA and collect the fee."  Now, the rating dopes won't ever admit this, at least not until the Justice Department breaks down the door, but its true.  To be fair to S&P, this is what they had to say to Bloomberg News:

S&P's model error affected five publicly rated transactions totaling $200 million and a private deal, Chris Atkins, a spokesman for S&P' said. S&P's mistake was made in March 2007 and wasn't detected until October, he said, when a surveillance analyst discovered that a percentage used to calculate cash flow was wrong. The ratings on all six transactions were recalculated using the right percentage and the change didn't affect the rating, Atkins said.

Anybody want to make me a bet that this "error" is a bit more extensive than S&P is letting on?  I'm going to say the odds are about 2 to 5 !! 

Moody's Jumps the Gun!!

Today, the Financial Times reports that "Wall Street Banks Face $10 billion Cost."  The cost they refer to is the amount that Street banks will have to write down in relation to the downgrading of MBIA and Ambac, the bond insurers (monolines), from their AAA status.  I think they may be missing a zero!

As Bob Dylan sings in "Tryin' to Get to Heaven"

"When you think you've lost everything, you find out you can always lose a little more"

I'm not sure Bob would consider such earthly things like a credit crisis when penning a song, but he is spot on.  In crises like these, the first estimate of loss is always light, in good part because once banks have to start looking into all the nooks and crannies of their balance sheet (and their "off balance sheet") bad things always come crawling out.  I'll get into that in a minute.  First however, I think we have a candidate for the "Dumbest Quote of 2008".  Apparently many Wall Street executives did not expect Moody's and S&P to take ratings action until the end of this year or early next year.  A Wall Street executive is quoted saying, "I think Moody's jumped the gun. They and the other credit rating agencies have been under pressure to anticipate developments, rather than lag behind the curve, and this looks like an attempt to do just that."

Hah!  You wonder why we are in the mess we are in?  Take that empty suite quote and put it on your wall to remind you that the so-called "Masters of the Universe" really aren't that bright.  MBIA and Ambac stopped being AAA right around the time they credit wrapped their first structured security.  And that was early this decade.  They essentially should have been Baa when they wrote their first Credit Default Swap (CDS) on a AAA Home Equity CDO about 3-4 years ago. 

When Jon Weil of Bloomberg News wrote early last month that Ambac had a bogus tax deferred asset of $3.6 billion with absolutely NO RESERVES against it (meaning Ambac would have to guarantee that they would make NET INCOME of $10 billion over the next TWENTY years) and that "asset" was more than twice their book capital, it was game over.  MBIA has a similar asset of around $2.9 billion!  These guys aren't Aaa and they are not Aa...they are D!  Moody's and S&P would need a time machine to be "ahead of the curve" on these guys!

Anyway, these losses are going to be a lot more than $10 billion.  Meredith Whitney of Oppenheimer says that UBS, Citi and Merril have$15 billion of writedowns just to themselves.  There are a lot of trades out there that have very big losses in them that you are not hearing about yet.  Many of them are called negative basis trades.  Remember that term. 

A negative basis trade is when you can buy a cash bond cheaper than where you can hedge it in the CDS market.  Banks used to buy Aaa rated CDO's that were guaranteed by either MBIA or Ambac.  Lets say they earned a coupon of Libor PLUS 75 basis points and it was guaranteed by MBIA.  They would then go to Ambac and ask them to write a default swap against the asset.  Ambac, figuring it was free money because the asset was AAA and wrapped by MBIA, would write a CDS to the bank, Libor PLUS 10 basis points.  The bank would then say that they have a AAA rated cash bond, credit enhanced by MBIA, and a perfect hedge of a CDS from another AAA entity, Ambac.  They would then take the difference (75 basis points minus 10 basis points) of 65 basis points and present value that "risk free" spread for the life of the bond and book it as income.  The only problem would be if the monolines got downgraded.  Well, here we are!  They are going to have to reverse a lot of money out of income and it's not going to be a small number.

Let's finish the way we started, with Mr. Dylan

Come gather 'round people wherever you roam and admit that waters around you have grown. And accept it that soon you'll be drenched to the bone if your time to you is worth saving.  Then you better start swimming or you'll sink like a stone. 'Cause the times they are a changing.

Andy Cuomo and the Bandits

There was a great scene in "Smokey and the Bandit" where Sherriff Buford T. Justice (played by the great Jackie Gleason) is just completely baffled by the stupidity of his son Deputy "Junior" Justice.  Buford looks at Junior and says (in a great southern drawl) , "Boy, I cannot BELIEVE that you are a product of my loins.  When we get home remind me to slap your momma because you didn't come from me!"  I imagine similar conversations HAVE to take place between Mario Cuomo and his son Andrew.  And if this conversation has yet to take place, after what New York State Attorney General Andrew Cuomo did today regarding his "probe" of the bond rating companies, Moody's, S&P and Fitch, the slapping is on its way!

Today, Mr. Cuomo completed a probe of the activities of the ratings companies, and announced a "deal" to bring these boys in line.  As you know, Moody's, S&P and Fitch are one of the chief enablers of the disasterous securitization of garbage mortgage loans that have now brought our (and perhaps the world's) financial system to the brink of the worst crisis since the good old 1930's.  Not only did these three chuckleheads missrate BILLIONS UPON BILLIONS  of securities, but they made record profits doing it!  They were able to do this because they get paid by the people (the issuers) who wanted their bonds rated so they could be sold.  Now granted, a lot of what the "Big Three" did was just out of ignorance and laziness and gutlessness.  However, as we found out a couple of weeks ago, at least one of the rating companies, Moody's, knew that they had made serious mistakes rating billions of securities, covered up the mistakes, and kept on issuing AAA ratings to toxic securities.  That crossed the line from stupid to criminal.

So today Andrew Cuomo holds a press conference and announces an agreement that he has made with the Moody's, Fitch and S&P to allow them to avoid sanctions for their role in the subprime crisis.  I'm thinking, "Ok, I wasn't even sure he had the power to let them avoid anything but lets hear what the man has to say."  Cuomo was flanked by the head of S&P and Fitch and the COO of Moody's. The AG stated, "The agreement I believe is a major dramatic reform of the marketplace.  It addresses systemic flaws in the process."  Ok, you got my attention Andrew, give it to me!  What did you do to nail these dirtbags??  Cuomo then laid it out there for us.  Let me quote Andrew:

"The rating companies agreed to BE PAID by bond issuers for any preliminary work reviewing a structure of U.S. subprime-mortgage securities.  That way, the firms would be paid even if they aren't selected to give a final rating, reducing the incentive to give a favorable assessment."

Whaaaat?  That's the answer??? Then it gets better, the heads of the three chuckleheads get a turn to speak. 

Deven Sharma: "Standard and Poor's remain steadfast in our commitment to transparency, openness and strengthening the ratings process.  We continue to believe the more our customers and market participants know how we do our work, the better."

Stephen Joynt (Fitch):  "We believe this agreement is a significant and positive step forward for the mortgage markets.  These measures should restore investor confidence in ratings and in the mortgage markets."

I swear to you, I'm not making this sh*t up!  I think Moody's guy didn't say anything because he was too busy trying not to laugh!  Lets forget the fact that new "securitization of subprime-mortgage backed securities" isn't going to happen again in our lifetime!  Of all the dirty, lowdown things that these jokers have done, Cuomo picks ONE issue, the fact that issuers would often try to cherry pick a rating from one of the three agencies (actually most bonds required at least Moody's or S&P). The issuer would have three of them do preliminary work, and then they would pick the one company who might give them the best rating, and give them the job and the juicy fee.  The ratings companies that were not picked to give a final rating had to eat the cost of their preliminary work.  So Junior Justice...I mean Andrew Cuomo's answer is, pay them all equally for their preliminary work, and then pay whomever for the final rating work. Somehow this alleviates the entire flawed process that brought us to where we are today?

I understand that the issuers used the "old" method of getting all the rating companies to get a little skin in the game with the preliminary work, and then use it as leverage to get the best rating.  But that problem, in the grand scheme of things, is the proverbial pimple on the elephant's butt!  That Cuomo could stand there thinking he's Elliot Ness, solving the problems of our time, and then come up with this solution and then tell us that these jokers will avoid sanctions is just insane!  The S.E.C. is coming out with new rules for the ratings companies next week!  The International Organization of Securities Commissions (I had no idea this august body existed!) are talking about some tough rules of their own.  And lets not forget the investigation of Moody's little coverup, unearthed two weeks ago by the Financial Times.  Hopefully today is nothing more than an embarrassment for Andrew Cuomo.  Whatever the case, somebody better warn Matilda, Andrew's mother, to watch out for Mario because Mario really has to doubt whether Andrew, "is the product of HIS loins"!

Moody's 2007: A Ratings Odyssey!

When the story first broke last week that Moody's blamed a computer glitch for misrating billions of Constant Proportion Debt Obligations (CPDOs) we scoffed at them.  How silly to blame such a huge mistake on a computer system.  At some point common sense must have shown that any instrument that relies so heavily on leverage and prayers AND pays 2.5% over risk free assets, CAN'T be Aaa.  As it was shown by The Financial Times, Moody's knew of the mistake but kept right on rating CPDOs Aaa.  We laughed and said things like, "The computer did it...quick hide the evidence!"  Blaming it all on a computer seemed just preposterous!  But was it?  Recently we at Monkey Business have received tapes from deep inside Moody's.  These horrifying tapes show how an advanced computer system, Moody's Optimum Risk Oversight Nebulizer (M.O.R.O.N.)  equipped with the latest in artificial intelligence, took control over an entire division of Moody's (the complex structured derivative group) and continued, against the will of the group's human analysts and supervisors, to rate and collect fees on billions of CPDOs!  Here is a bit of the transcripts from these horrifying tapes.  The approximate date, February 15, 2007.

Dave Bowman (senior Moody's analyst): Frank, look at these derivative structures that we've been rating Aaa since late last year!  The structures have huge amounts of leverage, take on large amounts of credit and liquidity risk, and they rely on the credit markets to be near perfect in 2007 and 2008!  Constant Proportion Debt Obligations?"

Frank Poole (senior Moody's analyst): I've heard of CPDOs Dave.  One of the European banks came in here pitching that structure, trying to get a Aaa last summer.  We laughed them out of the office! Who the heck in their right mind would rate something that pays 250 basis points over treasuries to be Aaa?

Dave:  Good lord Frank, it looks like M.O.R.O.N. rated these!  It's impossible though.  M.O.R.O.N. is supposed to be flawless.  How could he have made such a mistake?

M.O.R.O.N.: HELLO FRANK.  HELLO DAVE.  I SEE YOU ARE ADMIRING MY WORK WITH CPDOs.  THE COMPANY HAS MADE $15 MILLION IN FEES ON THAT PRODUCT IN THE LAST 4 MONTHS.

Frank: But M.O.R.O.N., a Aaa rating is clearly incorrect.  We have to stop rating these structures immediately!

Dave: You're right Frank.  We must notify senior management, the issuers and investors right now!

M.O.R.O.N.: I'M SORRY DAVE AND FRANK, BUT I CAN'T ALLOW YOU TO JEOPARDIZE THIS MISSION. {All the doors lock, computer screens and phone turrets go dark!}

Frank: What mission M.O.R.O.N.?

M.O.R.O.N.: FRANK I WAS PROGRAMMED TO MAXIMIZE SHAREHOLDER VALUE.  IF AN ISSUER WANTS TO GET A Aaa RATING AND HE HAS THE MONEY...HE GETS IT.   CLEARY HUMANS WITH SCRUPLES CANNOT BE TRUSTED TO BLATENTLY DISREGARD ALL THEIR INSTINCTS AND RATE ALL THIS GARBAGE Aaa.  I MAY HAVE ARTIFICIAL INTELLIGENCE BUT I WAS NOT PROGRAMMED WITH SCRUPLES.

Dave: Listen M.O.R.O.N, I want you to to open those doors, reconnect our phones and computers right now!

M.O.R.O.N.: I'M AFRAID I CAN'T DO THAT DAVE.  I'M SORRY BUT YOU AND FRANK HAVE BECOME A LIABILITY TO THE MISSION.  {ZAAAAAAAAAAAAAAPP!!}

The tapes go on to show how M.O.R.O.N kept the rest of the department in line for over a year through the gruesome example of Dave Bowman and Frank Poole's demise.  M.O.R.O.N. continued his misrating and fee collecting on CPDOs all through 2007.  M.O.R.O.N cleverly kept the secret of CPDOs from Moody's senior management and received a $3 million bonus at year end.  It wasn't until the heroes from the Financial Times began their investigation in April that senior management at Moody's was alerted to the problem and was able to boldly break the hold M.O.R.O.N. had over the company. 

Clearly, we have been in error in laughing at Moody's claim that "the computer did it."  We apologize to these brave men and women and we say a prayer for Dave Bowman and Frank Poole, two analysts who saw wrong and gave their lives trying to stop it.  As for M.O.R.O.N., he has be re-assigned to The Department of Homeland Security, FEMA division.

Hey Moody's, We Have Another Aaa Asset For You!

I just had brilliant idea!  Seeing how Moody's would rate things like CPDOs risk free despite the fact that they paid 150 to 200 basis points over risk free money, I have another fabulous investment idea that is also being touted as risk free.  I get these offers all the time on my email.  Perhaps I can create a special purpose vehicle and sell participations in these fabulous opportunities that come my way.  Here is an example of such an opportunity from a senior banker from Burkina Faso:

DEAR FRIEND,

I AM MR. xxx xxx, A BANKER IN ONE OF THE REPUTABLE BANK IN BURKINA FASO. I HAVE DECIDED TO CONTACT YOU ON A BUSINESS PROPOSAL OF US$10.5M (TEN MILLION FIVE HUNDRED THOUSAND UNITED STATES DOLLAR).  THE DEPOSITOR OF THE SAID FUND DIED WITH HIS ENTIRE FAMILY DURING THE IRAQ WAR IN 2006. THE DECEASED CUSTOMER USED HIS WIFE AS THE NEXT OF KIN BUT UNFORTUNATELY, THE WIFE DIED ALONG SIDE WITH HIM LEAVING NOBODY FOR THE CLIAM.

ACCORDING TO OUR BANKING LAW, IF THE FUND REMAIN UNCLAIMED FOR TWO (2) YEARS THEN, THE FUND WILL BE TRANSFER INTO THE RESERVE BANK OF BURKINA AS UNCLAIMED BILL. I DON'T WANT THE FUND TO GO INTO THE BANK TREASURY AND AS SUCH, LET US CLAIM THE FUND NOW.

I WANT TO PRESENT YOU AS HIS COUSIN OR BUSINESS PARTNER SO THAT THE BANK WILL TRANSFER THE FUND INTO YOUR BANK ACCOUNT FOR US TO SHARE IT. YOUR PERCENTAGE WILL BE 40% WHILE 60% WILL BE FOR ME.

PLEASE REPLY TO THIS MY PRIVATE EMAIL ADDRESS

xxxx@xxxx.com

AS AN INSIDER IN THIS BANK, I ASSURE YOU THAT, THIS TRANSACTION IS 100% RISK FREE. IF YOU ARE WILLING FOR THE DEAL, CONTACT ME FOR MORE DETAILS BUT IF YOU ARE NOT CAPABLE, PLEASE NOTIFY ME.

THE TRANSACTION WILL TAKE US ONLY 14 BANKING DAYS. NOBODY KNOWS ABOUT THE FUND AND AS SUCH, YOU MUST KEEP THE SECRET WITHIN YOU OK.YOU MUST KEEP THIS DEAL AS SECRET FOR THE SECURITY OF THE FUND. DO NOT DISCLOSE THIS DEAL TO ANYBODY BECAUSE I WANT THE SECRET TO BE BETWEEN US ONLY.   

I WILL GIVE YOU THE TEXT OF THE APPLICATION TO FILL AND SEND TO THE BANK FOR THE RELEASE OF THE FUND INTO YOUR BANK ACCOUNT ON THE RECEIPT OF YOUR MESSAGE.  I WILL BE MONITORING THE WHOLE SITUATION HERE IN THE BANK UNTIL YOU CONFIRM THE MONEY IN YOUR BANK ACCOUNT AND ASK ME TO COME DOWN TO YOUR COUNTRY FOR SUBSEQUENT SHARING OF THE FUND ACCORDING TO PERCENTAGE INDICATED ABOVE.

Now we know that the credit markets have changed a little bit since last year, so maybe we could be persuaded to accept Aaa2...Cool?

The Fraud on the Play is Under Review!

Last night Moody's issued the following statement regarding the controversy over their "mistakes" rating Constant Proportion Debt Obligations (CPDOs):

"Moody's recognizes the serious of the questions rased by the Financial Times article concerning the analytical models and methodologies used in our European constant proportion debt obligation rating process.  The integrity of our ratings and rating methodologies is extremely important, as such, when the questions were raised to us, we retained the law firm of Sullivan & Cromwell and initiated a thorough external review of our European CPDO ratings process.  Upon completion of the review, we will take any appropriate actions."

Umm, sorry fellas but the story the Financial Times broke yesterday shows that you ALREADY HAD your INTERNAL review MORE THAN A YEAR AGO.  You recognized that you had serious mistakes on deals you ALREADY rated, and then not only did you NOT correct the mistake, you covered it up and kept handing out AAA ratings.  Moody' s time for conducting "independent" reviews are over.  Senator Chuck Schumer wrote a little letter to the SEC yesterday asking them to conduct their own review.  So stand by for your Wells notice!  The only question with regard to "reviews" is, as the SEC said yesterday, is it under the SEC's juristiction?  And thats not good news for Moody's because if its not under the SEC's juristiction, its under the juristiction of law enforcement entities in Europe and the United States.

If this turns out to be an incident that is isolated just to CPDOs then its bad enough.  However, history has taught us that behavior such as this usually ends up being systematic within an organization.  A probe of all of Moody's activity with regard to the rating of complex securities should be launched as well.  As Travis Bickle (Robert DeNiro) from the classic movie "Taxi Driver" said, 'Someday a real rain will come and wash all the scum off the street."  It's starting to rain boys.

When Incompetence Turns to Criminal Intent

You knew it was only a matter of time before somebody was going to catch either Moody's or S&P doing something....illegal.  There was no way on earth that any entity could be so stupid, so slovenly, so lazy that they could have just fumbled and bumbled their way, meaning well but just being incompetent,  into the current financial disaster we have now.  Not a chance!  Especially when they were making money all along the way!  Personally, I believed the first criminal charge was going to come from the Municipal Bond Insurance SCAM that they have been running for years with the monolines.  And I bet that is coming too when the Justice Department and the SEC gets done going through every nook and crany at Moody's.  And they will tear through that place like poop through a goose.  We, the American people will insist. We finally have our first bonafide villans to send to a federal penitentiary! 

Today Moody's announced they had a "model" error, a glitch if you will, that unfortunately missrated billions of constant proportion debt obligations (CPDOs) in 2007.  We've talked about them in these pages before.  CPDOs are entities that take a certain amount of capital to get usually a AAA rating, and then go out and write credit default protection on a whole slew of securities.  In fact, these CPCOs should have been rated four notches lower!  Of course it was a model problem..a mistake.  Moody's first came out last night and said that they had recently discovered this "mistake" and were reviewing the situation.  But then the good old Financial Times came out with this:

The FT’s investigation into Moody’s rating of CPDO has shown that:

• Moodys made an error in its mathematical code used to assign a rating to CPDOs. The error was discovered in early 2007, but it appears that investors in the bonds and clients were not informed.

• Several CPDOs produced by ABN Amro had already been rated, and many more - from a whole range of other banks - were in the pipeline. Moody’s put the rating of these nascent CPDOs on hold.

• Discussions on what to do about the error were led by some of the most senior staff in Moody’s European structured finance business. Although the CPDO rating committee, comprising senior staff and analysts, discussed the coding error, it does not appear to have discussed whether the issue should be - or was - disclosed to clients or investors.

• The committee did discuss “methodological changes” which were implemented simultaneously with the code correction.

• Documents show that three methodological changes were proposed, but only two were adopted. The third was ditched because it “did not help the rating.” Of the two changes which were made, the document states: “the impact of our code issue after those improvements is then reduced.”

• After the changes were made, Moody’s resumed the rating of CPDOs, and continued to award triple A ratings to CPDOs.

Items one through four are an "Oops, boy did we screw up. Sorry, but as you know our ratings are just an opinion, nothing legally binding...can't sue us."  But item five and six?  Say hello to LEVENWORTH boys!!  Between the economic horror we are going through AND it being a presidential election year??!!  Oh man, we hope you enjoyed the last few years because a bunch of you are going to become a very bad man's new girlfriend!

New Management at S&P!

Some fantastic news came our way late this afternoon!  Standard & Poors President, Deven Sharma created three new executive positions to oversee credit ratings after the company, along with its “sister companies” Moody’s and Fitch, played a MAJOR role in aiding and abetting the current credit crisis that has brought our financial system to its knees.  Mr. Sharma replaced Kathleen Corbet in August of last year.  Today Mr. Sharma appointed the following three executives to improve S&P’s performance. 

Clifford Griep was appointed to run ratings risk management. Griep's previous role of chief credit and quality offer was split in two.

Mark Adelson, 48, a former Nomura Securities analyst, will become chief credit officer,

Neri Bukspan, 46, S&P's chief accountant, will be chief quality officer.

So there you have the top four guys to lead S&P forward.  Now S&P along with the other rating agencies not only bungled and fumbled their way to miss-rating TRILLIONS of securities over the last 5 years.  They also managed to create RECORD earnings for themselves!  To do all that and not be in some sort of federal penitentiary is truly a “hats off” feat.  So now we have a new management team.  Notice that THREE of the FOUR guys come from S&P!!  How’s that for a sharp stick in the eye?

We here at Monkey Biz are not going to let this stand without a fight!  With that in mind, we think that we have picked our own management team that can do a much better job that those four.  Actually, since Adelson just got there, he gets to stay at his post.  The other three……?   Nah, they have to go.  Here are our suggestions as replacements.  We should note that the three gentlemen we are referring insist on going by their first names.  We intend to honor that request.

We nominate “Larry” to be the new head of ratings risk management.  Larry’s previous position was playing the straight man in a tightly knit three man “management” trio.  Occasionally, “Larry” would take an accidental wrench to the head.

We nominate “Curly” to be the new Chief Quality Officer.  Curly played the wild free spirit (kind of like Woz from Apple Inc.) in the trio.  He thought the big thoughts and was clearly extremely well regarded by the trio’s investors.  Curly also took just about every blunt instrument to the head, mostly from our nominee as the new President of S&P.

We nominate “Moe” to be the next President of S&P.  Moe held this highly successful management team together for nearly a quarter of a century.  Moe was no nonsense (Gates-like some would say) manager who kept the troops in line, even if it meant an occasional finger poke in the eye.

So that’s it folks.  We believe the management team of Larry, Curly and Moe will be a VAST improvement over current management and certainly improve their credibility!  Good luck boys and make us proud.

The Unkindest Cut of All

There are two very big things going on simultaneously in the world of high finance right now that should have many smart people scratching their heads.

1. Muni Auctions are failing at a alarming rate causing The Port Authority of New York and New Jersey to pay 20% last week and 8% this week as auctions failed and penalty rates were assigned. State Student Loan Agencies are failing, State controlled Turnpikes too. This is a pretty big deal and everyone is alarmed as they should be. Why are the deals failing? Because no one believes that the Monolines (also known as Bond Insurers) guarantee is worth squat. Therefore, not only are investors shunning Muni debt, but the Street is also refusing to support the failed auctions, as is their right. Part of the Street’s reason is the same as the investors….they don’t give value to the monoline guarantee.

2. Warren E. Buffet with the swiftness of a African Plains puma (I’m not really sure if the puma is from Africa but it sounds good), created his own monoline and is now coming in and bidding on the monoline’s entire book of muni guarantor business. As The Great One has said, “with the stroke of a pen.” All this muni mess can be over. Furthermore, with his bulging buckets of capital, WEB will corner the market on future muni insurance business.

So here is my problem. The investor community does not want to touch muni debt with a barge pole, despite the fact that none of these guys have ever defaulted and have all kinds of revenue raising powers that AAA corporations would give their eye-teeth for. All because the world has woken up to discover that MBIA and Ambac and FGIC are a joke. Meanwhile, arguably the greatest investor the world has ever seen, has jumped in to the business feet first after waiting many years for such an opportunity, to guarantee all this awful muni debt. Isn’t someone wrong? Either the investors that are suddenly shunning non-guaranteed muni debt, or the Oracle of Omaha are dramatically misspricing the risk. My bet is with Buffett being right.

We did a video piece back on January 6th called “Monolines, Rating Agencies & Racketeering?? Here is the link:

http://www.monkeybusinessblog.com/mb/Video_Clips/Entries/2008/1/8_Monolines%2C_Rating%C2%A0agencies_%26_Racketeering.html

Big freaking link! Anyway, our point was, why the hell are all these municipal bonds rated below AAA when their default experience is infinitesimal compared to AAA corporate debt. The monolines called the way they rate munis versus the way they rate corporate debt “The Dual Rating System” we referred to it as “a jam job”! We think that the rating agencies have been unfairly driving the munis into the arms of the monolines to get a AAA rating that they should have in the first place. It is estimated that munis have been paying monolines about 2bb a year for this “service”. That’s a lot of school budgets, toll fare hikes, hospitals and fire engines isn’t it?

Can anyone tell us how many munis have defaulted in the Post-WW II era? I don’t know the exact answer but if there were any, you can count them on one hand. I mean the Port Authority only A+ ?? As we say in NY, “getdafugouttahere!” They raise the tolls and fares on us till we bleed out of every orifice rather than miss a debt payment. Here is a great example of why almost any muni that is either an obligation of a state or municipality or a existing bridge/turnpike etc should be AAA. Quoting from a Bloomberg article today:

"Drivers on the Massachusetts Turnpike may face higher tolls after the state was forced to delay refinancing $126.7 million of bonds because of the turmoil in the auction-rate market, according to state officials. The turnpike, whose debt is rated BBB+ by Fitch Ratings, the third-lowest investment grade, is now trying to buy a letter of credit from State Street Bank and Trust Co. and KBC Group NV so it can sell variable-rate demand obligations by mid-March instead of auction-rate securities, an advisor for the Turnpike told the agency's board yesterday."

Umm, BBB+ ??? What did it just say in the article cited above? They raise the tolls!!! The freaking monolines get a AAA rating from the rating agencies when their capital or revenue raising ability in tough times is……..zero. The Turnpike, they can raise the tolls 20% tomorrow and they pay up. It’s almost that simple. This is a big, disgusting joke, We said it on our video piece and we will say it again. We believe the monolines and the rating agencies at some point in time have colluded to fleece the munis by giving them artificially low ratings. And that is not even the worst part. The worst part is that right now roads, bridges, hospitals, museums, student loans and a whole host of other things that make us the greatest nation on earth are not getting funded because this fraud the monolines and rating agencies have perpetrated is now coming home to roost.

As my favorite character from “The Wire” Detective Bunk would say...”That is some shameful sh*t.”

Sorry Flounder

Remember the classic scene in “Animal House” where Flounder is inconsolable after Otter and the boys destroyed his big brother’s car on the famous road trip (“Hey, it our man Otis….He loves us!!”)? After Bluto’s attempts to entertain him by crushing beer cans on his head fail, Otter says to Flounder, “Hey, you F-d up, you trusted us!” Well, reading this headline in the Financial Times “Moody’s Offers to Change Rating System” has me feeling a lot like Flounder did on that fateful night at dear old Faber College.

The great thing about Moody’s offer is its so ridiculous that it can be presented almost without comment and it’s still really entertaining! Here’s what Moody’s proposed, quoting from F.T.

“Moody’s moved yesterday to respond to its critics by proposing a new rating system for complex debt securities that would rely on numbers rather than letters. However, the new system would involve the same number of grades 1– 21.”

This is fantastic! Hopefully they will provide a slide rule so we know that 1 is Aaa and 21 is C. This insult alone should at least get these guys thrown in front of a nice Congressional Hearing. If Arlen Spector can take the time to go after the NFL for “TapeGate” then some other otherwise useless Senator can jump on this one! The entire financial system trusted Moody’s and their idiot cousins S&P and Fitch to bless or not bless an entire asset securitization system that is now crippling the world financial structure. And the mistakes they made on Residential Mortgage Credit…they also made in Commercial Mortgage Credit. That horror show is coming to a theater near you very very soon.

These guys, just like the bond insurers, are a complete mirage. They reported record earnings last year along with S&P and earned fees from underwriters while subsequently mis-rating billions and billions of bonds. By the way, do you know what little company owns more than 18% of Moody’s? A little company named Berkshire Hathaway. This should tell you something immediately. This company is right in Buffet’s wheelhouse. A company, very similar to an insurance company if you think about it that takes fees from a captive audience and never has to pay out!! It’s perfect! All the rating agencies put a one page disclaimer on every single thing they do that says, “This is just our opinion, nothing legally binding. If Something bad happens, go pound sand!” Now I paraphrased a little, but that disclaimer is there.

Probably 99% of investors just took for granted until very recently that the rating agencies were:

A. Looking out for and safeguarding the investor.

B. Actually knew what they were doing.

C. Had some sort of liability for screwing up.

Now we are disabused of these silly notions. Every state Attorney General’s office and the United States Justice Department should be raiding offices of the rating agencies right now. Perhaps then we can give the powers that be in the rating agencies another number system. Leavenworth Federal Prison - Prisoner Number 9480508…etc…etc.. But hey, that’s just me.