Michael Lipper: seven reasons why S&P lawsuit is misguided
The veteran investor and blogger outlines why the US Attorney General should hold off on legal recourse for the rating of sub-prime mortgage debt.
by Michael Lipper on Feb 11, 2013 at 09:25
Last week the expected outgoing US Attorney General began a lawsuit against McGraw-Hill (Standard & Poor’s) for failing to see the future.
S&P is in the somewhat distinguished company of various presidents, members of congress, government agencies and departments; e.g., Treasury, Federal Reserve, SEC, as well as a number of government sponsored mortgage-related companies (GSCs).
The private sector has an equally long list of participants which did not see the end of the rising house price trend.
These errors of human judgment are also found in betting that various streaks will continue.
The mortgage mess
The DOJ alleges that the ratings of a small number of credit ratings issued on subprime-related, structured underwritings by S&P were faulty. (Focusing on only the specific issues in question, based on selected internal emails, the fees earned by S&P were on the order of $13 million.)
Disclosure: I have personally owned shares in McGraw-Hill for many years and my fund has a long position in Moody’s. The high price on Moody’s last week was $55.39, and the low $40.67, with a close of $43.37.
US vs. McGraw-Hill
The case against McGraw-Hill has generated much news media coverage, which is ironic as the media itself should be considered a contributing factor in this debacle.
As Wall Street Journal columnist Holman W. Jenkins, Jr. pointed out on Saturday, 'S&P was not responsible for the destruction of underlying housing collateral (caused) by politicians who made it nearly impossible to foreclose on delinquent homeowners.'
Jenkins also reminds us of the Fed chairman’s illuminating quote: 'You know, the stock market goes up and down every day more than the entire value of the subprime mortgages in the country.'
Seven reasons why I believe the suit is misguided
- Within any sizeable organization that deals with opinions such as credit ratings, there is likely to be differing opinions, particularly from those on the lower and middle rungs of the power ladder.
- We know that the Federal Reserve Board was not too concerned about housing and subprime loans during the period in question.
- There is significant legal risk if a credit rater is early in downgrading ratings without firm facts that seriously contradict past history.
- In my work over the years, I generally felt that credit ratings were a lot like performance statistics; i.e., a backward-looking device with not much predictive value if things change.
- While the SEC has been mandated to reduce the power of the credit rating agencies, it has not been able to do so yet, and the SEC has not joined in the suits.
- I suspect the states who have joined the suit are trying to aid in the defense of their own pension plans who did not do their own credit research.
- In most cases of the so-called AAA paper, it was only the top tranche that had that highest rating, and the lower tranches had lower ratings. It was the lower tranches with higher (leveraged) yields that investors bought, ignoring the lessons of the market that higher yields often show a market judgment of potential risk of loss of capital.
There are no innocents
There are no innocents in this train of unwise and intellectually challenged decisions.
The list includes both Congress and the administration, the Fed and the SEC, the builders and real estate agents, the public who lied either to themselves or to the mortgage companies, the investment and commercial banks who couldn't get rid of the paper off their own books quickly enough, insurance companies and pension funds who let their insatiable need for yield override their own sense of fiduciary controls, the media that stoked the desirableness of owning ones' own home and the ease of getting a mortgage and of course the credit raters who relied completely on history and not a fundamental understanding of supply and demand and the dangers of leverage.
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