Credit ratings agencies might end up paying for role in financial crisis
Filed under: Company News, Investing, Moody's Corp., Morgan Stanley , McGraw-Hill
A judge's refusal to dismiss a case against an investment bank and a few ratings agencies for their role in the structured investment vehicle collapse of 2007 raises the possibility that those defendants might actually be required to pay for wrapping toxic waste in golden paper. (SIVs are money market-like financial instruments.)
Abu Dhabi Commercial Bank and King County in Washington state sued Morgan Stanley (MS), Moody's (MCO), and Standard & Poor's, a subsidiary of McGraw-Hill (MHP). According to Bloomberg, "The case concerns notes issued by SIV, Cheyne Finance Plc, that collapsed in 2007. It 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."
The defendants argue that ratings are protected by the First Amendment right to freedom of speech. But the judge refused to dismiss the case, arguing that "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."
While the judiciary has not yet appointed blame in this case -- the judge has simply decided to let the case go forward -- I am confident that the rating process was severely compromised as the agencies were competing with each other for six-figure fees from the investment banks that were issuing the securities they were rating.The agencies competed to give the highest ratings to what amounted to financial toxic waste. Looking back, it seems that ratings agencies traded their long-term reputation for objective analysis for short-term profit wrapping toxic waste in golden ratings.
I would apportion the blame between the investment banks that underwrote the securities, the credit rating agencies and the investors who failed to conduct sufficient independent analysis of the SIVs. Ratings agencies' responsibility in the case of MBS is far more significant economically since the collapse of the MBS market contributed so heavily to the financial crisis.
The outcome of this case is up in the air, but in my view, the U.S. should conduct a thorough investigation -- along the lines of the 1930s' Pecora Commission -- to figure out who should pay, and how to make sure it never happens again.
Peter Cohan is a management consultant, Babson professor and author of eight books, including You Can't Order Change. Follow him on Twitter. He has no financial interest in the securities mentioned.
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Reader Comments (Page 1 of 1)
9-17-2009 @ 10:44AM
mbi said...
The three rating agencies are significantly implacted in the recent financial crisis. As the judge stated, investment banks could have not sold the securities without the agencies approval. The credit rating agencies bear a good deal of the blame.
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9-17-2009 @ 10:04AM
Dave D said...
These so called ratings agencies should be taken for what they really are then: advertising agencies! With their First Amendment arguement they are conceding to the fact that they are in the advertising business and not the ratings business.- "We're paid by the producer of the product, and our rating may not mean too much because it may not be based on any real hard research".
The court should make them all move to Madison Av.
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9-16-2009 @ 11:58PM
jjmartin said...
The rating agencies should be held accountable, along with the bankers, brokers, and other such Wall Street low-life thieves and liars. What they did can only be described as fraud, on a massive scale; misrepresenting financial instruments that they knew were not sound, selling them to unsuspecting investors who relied on the AAA ratings given by the rating agencies. In any other industry, such behavior would lead to arrests, fines, and imprisonment. But Wall Street doesn't have to live under the same laws as the rest of us, it seems.
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9-17-2009 @ 7:55AM
NOENERGYFUTURES said...
THE GAMES PLAYED ON WALL STREET ARE SLOWLY BEING EXPOSED...THE PLAYERS ARE RUNNING LIKE COCKROACHES AS THE FLOODLIGHTS OF THE REAL WORLD SHINE ON THEM....I CAN ONLY SIT BACK AND SMILE KNOWING THAT "WHAT GOES AROUND COMES AROUND".....
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