When Do These Guys Pay A Price?

Via memeorandum, a story about the newspaper industry:

Newspaper and newspaper groups are likely to default on their debt and go out of business next year — leaving “several cities” with no daily newspaper at all, Fitch Ratings says in a report on media released Wednesday.

“Fitch believes more newspapers and newspaper groups will default, be shut down and be liquidated in 2009 and several cities could go without a daily print newspaper by 2010,” the Chicago-based credit ratings firm said in a report on the outlook for U.S. media and entertainment.

That is all well and good, and I am sure people who run good newspapers will thrive and survive, but this story reminded me of something I have been meaning to ask for a long time- when are the credit ratings folks going to pay a price for their hand in the current financial mess?

Seriously? Lots of people have lost their collective asses, lots of business and banks have gone under, the federal government (you and me) is spending trillions to shore up this sector of the economy to avert total collapse, corporate CEO’s are being bashed every day in the media and on blogs, everyone hates Wall Street, but as far as I can tell, one group of people has gotten away with their perfidy- the credit ratings companies. Why is Moody’s still in business? Fitch? Standard & Poor? Why are any of them? Aren’t they the ones who greenlighted everything at the end of the day with their triple AAA raitings on these crappy mortgages repackaged as shiny new bonds? Why are they not paying a price for their incompetence and malfeasance? Didn’t they look at a bunch of shit sandwiches, proclaim them to be steak, suck up a bunch of fees, and then look the other way? After Enron, Arthur Andersen and others took it in the shorts, but the credit ratings industry seems to have gotten away completely unscathed.

I don’t want to unfairly tar and feather here, so if I am wrong, tell me, but aren’t these guys partially to blame? And if so, why is no one talking about that? Why have we not seen any new regulations or a new regulatory framework? Is everyone going to walk away from this without paying a price? Everyone, of course, except for the taxpayer?






46 replies
  1. 1
    blogenfreude says:

    Remember this S&P classic?

    In a hearing today before the House Oversight Committee, the credit rating agencies are being portrayed as profit-hungry institutions that would give any deal their blessing for the right price.
    ____________________________________________________

    Case in point: this instant message exchange between two unidentified Standard & Poor’s officials about a mortgage-backed security deal on 4/5/2007:

    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.

  2. 2
    Xenos says:

    Someone has already filed a class action suit against Moody’s. Where can I sign up? Surely those mooks have a few trillion in reserve to pay damages, right?

  3. 3
    TenguPhule says:

    I don’t want to unfairly tar and feather here, so if I am wrong, tell me, but aren’t these guys partially to blame? And if so, why is no one talking about that?

    You’re not wrong.

    The problem is they have everybody else by the short and curlies.

    Because everyone relies on them and they rely on everyone.

  4. 4
    Doctor Gonzo says:

    You are 100% right. And unless there are significant changes to how the ratings agencies work, this will happen again.

    @blogenfreude captures it. There is an inherent conflict of interest here: the ratings agencies are paid by the financial companies to rate things. Gee, I wonder why all of a sudden the ratings are all spectacular? What are they supposed to say? "Gee, Goldman, I think your CDO sucks and I’m going to rate it junk. But I hope that this doesn’t harm our business relationship, and I really hope you won’t take your ratings business elsewhere. Okay?"

    It’s a joke. Nationalize the ratings agencies, have them rate instruments by lot and get paid by a surcharge on the industry as a whole, I don’t care what we do. But we need to do something.

  5. 5
    Jeff says:

    I am not sure why, but according to this, only 56% of 5 year corporate bonds originally rated Aaa by Moody’s stay at that rating since 1970.

  6. 6
    El Cruzado says:

    The obvious fix would be to forbid anyone to buy his own rating.

    If someone wants to know the rating of ScumWorks bonds they can go and buy it, but ScumWorks can’t give a penny to those guys.

    It’s not a perfect fix (I can think of ways around it and places where there would still be one) but it would go a long way to making these agencies be what they are supposed to be.

  7. 7
    Leo says:

    As I understand the business model, its just a bunch of people and computers looking at paperwork on a fee-for-service basis. That means they probably don’t have much of any debt, so they won’t collapse quickly like the banks have.

    I also don’t think they have any legal liability for their mistakes.

    Which means that they probably will shrink in size as demand for their services goes down, but probably won’t disappear altogether.

  8. 8
    Quaker in a Basement says:

    Is everyone going to walk away from this without paying a price? Everyone, of course, except for the taxpayer?

    If you have to ask, then you’re forgetting the first rule of shit sandwiches: The more bread you have…

  9. 9
    blogenfreude says:

    @Doctor Gonzo: I’ve seen emails in other cases where financial institutions will drop their membership in a particular agency if they’re not satisfied w/ their ratings. An approach-avoidance conflict for the agency if there ever was one.

  10. 10
    TheAssInTheHatOnMyCat(Formerly Comrade Tax Analyst) says:

    Yes, I agree. I’ve been wondering when the Ratings agencies were going to be asked just WTF they were doing. If their ratings are just pay-for-play BS then WhoTF needs them? Apparently they have no liability (and someone please correct me if I’m wrong here), nor apparently any basic ethical standards. Well, shit…hang me a shingle and call me a "Ratings Agency", you know?

    Doctor Gonzo correctly describes the incestuous relationship between these agencies and the financial companies. It’s just a phenomenally huger version of the crap that goes on (or went on) between Inspectors and Appraisers and Real Estate agents…with the exception that licensed inspectors can and sometimes do lose their licenses if they get caught with their finger on the scales.

    In my opinion, this was actually the trigger-mechanism on the global melt-down, because if the bundled sub-prime’s had been accurately rated there is no way in hell they would have drawn the amount of investment capital that ended up being flushed into the murky void.

    Of course it took the Credit Default Swaps fiasco to exponentially blow this mess into the clusterfuckiest financial fiasco of most of our lifetimes. Another bright idea from the Wall Street Wizards.

    Fuck.

  11. 11
    arguingwithsignposts says:

    John,

    the Planet Money podcast covered this recently here. Short of it, the ratings agencies have been protected by the first amendment!

    I know, teh stupid.

  12. 12

    The SEC passed new rules for the credit-rating agencies yesterday, as seen here. Though the actions by the SEC yesterday are only the beginning, I believe comprehensive action and investigation will occur after the new administration takes office and the next session of Congress begins. I have confidence that the Obama transition team will nominate a SEC chairman who is far more competent and proactive than Chris Cox.

  13. 13
    Sean says:

    Draconian criminal penalties for knowing malfeasance, and rating all securities in some sort of blinded manner.

    I am not an expert, but if you could hide who the issuer was and the size of the issuance, could you still make an accurate rating? Would that remove the ability to game the system?

    What about having issuers submit their prospectus (or whatever they submit) for rating to an anonymous bureau of several agencies help?

  14. 14
    Comrade Stuck says:

    when are the credit ratings folks going to pay a price for their hand in the current financial mess?

    Not to worry about them, they landed on their feet watching the blue waves crash on a Tahiti beach. Picking their teeth and socking down drinks with little umbrella stir sticks. No belt tightening in their future, lest it be the money belt.

  15. 15
    Xenos says:

    Yikes. I just went back and checked that class action suit. The plaintiffs are the Teamsters. It must be fun to sit around the office and contemplate how the Teamsters consider you to be guilty of blowing a couple billion out of their pension fund.

  16. 16
    srv says:

    John, this is the Age of Accountability, bought to you by Accountability Man, George Bush.

    We are all Bush now.

  17. 17
    Rick Taylor says:

    We should have figured this all out during the Enron debacle.

  18. 18
    BombIranForChrist says:

    I think your question is related to my question:

    "At what point do we start sending people to jail?"

    I think it’s related, because I think these rating agencies have committed fraud, and I want the top of their organizational hierarchy making license plates. Now.

    If I am going to bail these suckers out, I want my pound of flesh. Oh, and it’s the law.

  19. 19
    Bill Arnold says:

    …that class action suit. The plaintiffs are the Teamsters.
    Wow! This could be a very fun story.

    Specifically, the complaint alleges that throughout the Class Period, Defendant misrepresented or failed to disclose that the Company assigned excessively high ratings to bonds backed by risky subprime mortgages including bonds packaged as collateralized debt obligations – which was materially misleading to investors concerning the quality and relative risk of these investments. Moreover, even as a downturn in the housing market caused rising delinquencies of the subprime mortgages underlying such bonds, Moody’s maintained its excessively high ratings, rather than downgrade the bonds to reflect the true risk of owning subprime-mortgage-backed debt instruments.

    In a nutshell. Nice.

  20. 20
    Jon H says:

    Given that there are three rating agencies, it ought to be possible to have each party in a deal have an agency give an opinion, and have the third agency there to break split decisions and keep the others honest.

    Another possibility would be to anonymize the ratings, by having a non-profit independent agency act as an intermediary. Companies would pay a fixed fee to the intermediary, and the agency would arrange for the rating with one of the three rating agencies on a subcontracting basis.

  21. 21
    Jon H says:

    The BBC had a story about the financial crisis, and talked about one of the rating agencies being sued. The plaintiff bought a security, which was rated AAA, in July. In August, the security was knocked down by 17 steps, to junk status, bringing the veracity of the July rating into question.

  22. 22
    Jon H says:

    Doesn’t it seem like the local gas station that does auto emissions testing is probably more strictly regulated than these ratings agencies?

  23. 23
    Comrade Stuck says:

    @Rick Taylor:

    We should have figured this all out during the Enron debacle.

    We did, but unfortunately George Bush was still preszit of rich people. Enron began in 1999 and the only difference between them and the thief’s and idiots that came after was their willingness to gamble on GB getting elected to get a head start on the heist. And it is a heist, and I laugh when people say it was a long time in coming, even before Bush. Nonsense. We have business downturns and occasional grand larceny by a few white collar crooks, but nothing on this scale, at least since the Robber Barons. This has been one big wink and nod to the Oligarch dreamers from their man in the Oval Office to back up the Limo and fill er up with loot. Our loot. Before it’s over and we puzzle together the shredded documents to find out how they did it, they will be owning our asses, along with the Chinese.

  24. 24
    r€nato says:

    I like Jon H’s idea.

    If you have the SEC or some government body take over ratings, it will work fine… until the GOP gets elected again (and someday, they will be) and they gut the body/agency in the name of deregulation and getting big government off business’ back.

  25. 25
    Jasper says:

    What should happen is the SEC should strip them of recognized status. Their entire business depends on them being a "nationally recognized statistical ratings organization" (NRSRO) or trusted enough for other market participants to rely on the ratings. If an entity is required to hold only A rated or above securities, they can depend on Moody’s ratings only because the SEC says Moody’s is OK to rely on.

    After all this, the SEC should simply strip them of their status and make some other group come in and assume the business. No reason to trust them ever again.

    Of course that assumes that the free market lovers on Wall Street actually believed in free markets. It’s clear free markets are for the little people. Manufacturing workers, for example.

  26. 26
    Matt McIrvin says:

    So they’re protected by the First Amendment. Assume we believe in the wonder of efficient markets, as all these guys in the business supposedly do. Isn’t this a business opportunity for some (n+1)th party to jump in and start rating investments? It takes a long time to build trust, granted, but shouldn’t the guys now in the business have no reputation left anyway?

    If not, it seems like a pretty serious market failure.

  27. 27
    Matt McIrvin says:

    Oh, I think Jasper answered my question while I was typing it.

  28. 28
    Alex R says:

    Here’s a link to the PBS NOW investigation of the credit rating company’s involvement in the economic crisis. It’s only a half hour and explains it pretty concisely.

    http://www.pbs.org/now/shows/446/index.html

  29. 29
    Dennis - SGMM says:

    Quis custodiet ipsos custodes?
    -Juvenal
    (Who watches the watchmen?)

  30. 30
    Brian J says:

    I’m now reading a very good book called Spin-Free Economics. I guess it’s somewhat old, although probably by less than a year or so, because the version I have says it’s an updated version that has a spin free view of the financial crisis. If it contains good stuff, I’ll let everyone here know because, well, it never hurts to have a good reference.

    But seriously, you should pick this book up regardless. I’m certainly not an economist, and while I think I know a decent amount, I felt like I was lacking in some areas. The book is highly accessible for an average person like me, and while it doesn’t seem to go into great detail into one area more than the others, that’s not a bad thing. It’s a greater primer on the basics of the economic debates we hear or see some version of in the media.

  31. 31
    Ken J says:

    Our gracious host wrote:

    " That is all well and good, and I am sure people who run good newspapers will thrive and survive"

    Well, no. I’m not sure why you used the newspaper story as the hook for a story about the ratings agencies. While I agree that the ratings agencies ought to be hanged for their performance in the 2000s, I doubt that the newspaper business is one of the things they got wrong. Because tremendous numbers of analysts, tech writers and bloggers have been discussing the coming fall of newspapers and magazines for years.

    This isn’t a case where someone sold a fantasy. The print media business was solid for years. But, like the recorded music business, the paper news media business is being undone by a generational shift, plus the Internet. Running a good business with a good product is no defense against a cultural shift like this one.

    The big killers for the newspapers: people younger than 40 lost interest in reading a physical paper (lots of them seem to have lost interest in any sort of hard news). The Internet made it possible for most people to get their news for free, and the rise of political blogs (hi, Mr. Cole!) accelerated that process. Craigslist on the internet grabbed off the classified advertising business.

    As a body politic, we face a tremendous problem here. How are we going to pay for primary newsgathering when the newspapers go down? Even acclaimed chains like McClatchy, well respected in the reality-based world for their work on the Iraq war, are in danger. Outside of a few exceptions like Talking Points Memo, the blogs don’t do primary reporting: essentially they re-edit and re-comment the news which the dying paid print media have already gathered.

    The stories just keep piling up. Christian Science Monitor shuts down its daily print edition in spring 2009. US News & World Report is dropping its print news magazine, retaining the title only for special issues. TV Guide’s print business was recently sold for one dollar — that’s not one dollar per copy, that’s one dollar for the whole thing. The New York Times has some sort of awesome debt payment due in early 2009.

  32. 32
    Brian J says:

    @Ken J:

    The newspaper companies will probably have to figure out some other ways to make money, unless they can make the shift on their own. I remember reading that The Washington Post is supported by Kaplan Educational services, but not every paper can do that. I just wonder what sort of consolidation we’re going to see, if any.

  33. 33
    MNPundit says:

    A point on newspaper, I happen to know the situation of a small-to-medium sized media outlet. They own a lot of newspapers, most in small towns some in large towns or small cities. The owner of the business itself is always pushing the web stuff, and the online department is the one that is making the money–but the dead tree departments are all united in ignorance and fear of the online stuff and constantly attempt to screw over the online stuff.

    It’s a ridiculous turn of events.

  34. 34
    DougJ says:

    Let’s not forget we wouldn’t be in this pickle if all those minority homeowners hadn’t walked away from their mortgages. Those are the real villains, along with the libruls who passed the Community Reinvestment Act and ended the wise practice of red-lining.

  35. 35
    Fraud Guy says:

    But it was the risk modeling….

    Really?

    Is this the same risk modeling that has me with a foreclosure, 6 charged off credit cards, a charged off home equity loan, and a delinquent current mortgage that had my credit score jump up 20 points after the foreclosure became final?

    And that has my credit score higher than my wife’s, who has less debt, better payment history, and no major derogatory events?

    If you don’t want someone to actually make the decision, don’t take the risk.

    And from the fraud perspective, the primary decider for someone to commit fraud is opportunity, followed by the likelihood of being caught. The SEC should bar any VP or higher at any of these institutions (except those who pointedly resigned in protest) or regulatory agencies who missed this from holding a position in any fiduciary relationship or publicly traded company ever again.

  36. 36
    slippytoad says:

    Hey, will the Wall Street Journal hit the skids next? Because that would be, like, karma.

  37. 37
    JR says:

    Newspapers are failing because they failed to bring us news. Instead they went for the shiny objects and celebrity idolatry.

    Oh, and by becoming the Con movement’s propaganda mouthpiece and allowing our nation to be defaced through wars of aggression, torture, rendition, domestic spying, corporate collusion … there is that too.

  38. 38
    Rick Taylor says:

    No one could have possibly have predicted that having the rating’s agencies receive fees from the companies they were rating would make those raitings worse than worthless.

  39. 39
    ksmiami says:

    Just my $.02 is that the ratings agencies have a lot in common with the Sotheby’s -Christie’s situation. They have a complete lock on the market and act in collusion to approve deals. Of course, companies would pay vast sums to these guys to get approved so the pressure to bow the customer wants I think led them to approve tranches that shuld have undergone more scrutiny and in the future, their repuatations should have permanent black marks. I don’t know what else to say excep that our cosiety as a whole should not make debt its biggest economic engine.

  40. 40
    les says:

    @Alex R:

    That program is an eye-opener. They have a long interview with the asshole who came up with a way to bundle a shitpile of b rated securities and call the bundle aaa. How, you ask? Why, they pulled it out of their ass at $250K a pop. A complete fact-and-theory-free scam.

  41. 41
    binzinerator says:

    I don’t want to unfairly tar and feather here, so if I am wrong, tell me, but aren’t these guys partially to blame?

    I think the worry you ought to have is that there won’t be enough tar to thoroughly coat all these greedy lying fuckers, since entire industries were part of the whole ponzi scheme and tar is petroleum based, and we’ve likely passed Peak Oil.

    On the bright side, I think the US poultry industry that hasn’t yet been outsourced to China is still large enough to supply the required feathers.

  42. 42
    binzinerator says:

    @Ken J:

    Running a good business with a good product is no defense against a cultural shift like this one.

    I have no idea if newspapers ran their business well; I’d guess they made a big blunder when most of them viewed the web as a competitior not an opportunity, and bloggers as beneath them not as a resource that could complement their work.

    I’ll opine too that they didn’t have ‘good product’ either. We just had 8 years of testing the quality of their product. We got infotainment yar-yar brained diddleheaded bullshit of the he said/she said variety at a time of great need for truth and telling truth to power.

    Do you remember Stephen Colbert’s White House Correspondents Dinner speech? Never truer words were spoken about the failures of the press. It is no surprise this decline of newspapers when our comedians sound like truth-tellers and our supposed truth-tellers sound like comedians.

  43. 43
    binzinerator says:

    The plaintiffs are the Teamsters. It must be fun to sit around the office and contemplate how the Teamsters consider you to be guilty of blowing a couple billion out of their pension fund.

    Heh. I hope there is a future involving a few thousand yards of concrete as part an Interstate for these ratings guys.

  44. 44
    Ecks says:

    The reason all the news organizations turned to celebs and pom poms was because they started feeling the economic squeeze and discovered that celebs reliably brought more eyeballs (read $$$) than actual analysis of what was happening in Russia and Sierra Leone. It’s a symptom not the cause.

    So now we have news organizations that do the expensive work of sending reporters to the various war zones and capitals of the world, assembling stories, aggregating information – and bloggers who are paying a low price for this raw information, and repackaging it into presentations that people spend the actual money (via advertising revenue) to watch.

    If this evolves much further, you’ll see a realignment whereby the organizations who collect news will become increasingly separate from the one’s who present news, and will stop trying to present it directly themselves, whence it can be ‘stolen’, but will instead sell it to bloggers and TV stations. Or something like that anyway.

  45. 45
    binzinerator says:

    @Ecks:

    The reason all the news organizations turned to celebs and pom poms was because they started feeling the economic squeeze and discovered that celebs reliably brought more eyeballs (read $$$) than actual analysis of what was happening in Russia and Sierra Leone. It’s a symptom not the cause.

    So if the pom-poms brought in the bucks, why are they failing? I cut the subscription to my city’s daily back to just the sunday edition because it has become dumber and dumber. I added a sunday-only subscription to the NYT because I still wanted reporters who could actually write beyond the ability of a high school student, and I wanted better reporting.

    But if the name Judith Miller rings a bell, you’ll know why I have turned more and more to the net for news. No, not for news. For figuring out what’s really going on. The last 8 years has proved the newspapers cannot provide this.

    This was not a huge problem back before the dot com bubble, before BushCo. Consider how no one cared or knew to care about the mortgage market and credit default swaps etc until everyone’s retirement got a lot less appealing.

    Maybe this was like the Big 3 auto execs: Gas was cheap, chase the dollars brought in by the SUVs, ignore then forget how to make the business work building energy efficient cars, then forget how to make vehicles people want, then watch bankruptcy loom.

    They had other choices. Honda and Toyota both made different choices: all small cars for Honda, no fat SUV profits either but now some sales increases. Toyota chased the SUV profits but hedged with the Prius. They took a big hit but not as bad as Detroit and unlike Detroit they have had a hybrid in mass production. If the media were automobile manufacturers, the newspapers would be GM, Ford and Chrysler. (Maybe McClatchey is Toyota, hit hard too but what they have is solid: they didn’t forget how to report.).

    The newspapers have forgotten what their core business was. I wanted something better than the many useless morons who filled the papers with asinine shit, and lo and behold I found the internet filled the void.

    Consider this intelligent post full of critical thinking and damn good wit by Tanta writing about the mortgage crisis and the useless shit the newspapers feed to to us (Oh god I’m going to miss Tanta!).

    From Tanta’s post at CR:

    There’s a definition of “news” that involves providing relevant information that readers don’t already have—true information, even—and there’s a definition of “serious reporting” that involves not providing unintentional comedy by parading one’s ignorance about mortgages in an article full of high-minded tut-tutting over ignorance about mortgages. There is. Really. Maybe we should send out a press release.

    Maybe the public didn’t need a press release, maybe they figured it out on their own.

  46. 46
    Comrade grumpy realist says:

    Would like to put in a word for the rating agencies–almost got *hired* by Moody’s to design those CDOs as a quant, so here is my take on things:

    First, financial engineering whiz-kids (usually from maths or physics) put together a package of mortgages/bonds/whatever into a bundle, figure out under what conditions X% will fail Y amount, assuming "historical averages of failure", hedge, hedge, hedge and attaching 10 pages of caveats and restrictions.

    Second, this gets tossed to the guys in the front office, who immediately strip off all the caveats, stamp "AAA" on it, and hand it over to the sales force, who go out touting the thing as Never! Will! Fail! AAA! Safe! As! Anything!

    And then things turn turtle, system goes away from historical averages of failure, correlations go to one, and whoops, guess that CDO wasn’t all that AAA after all…

    "The difference between physics and finance is that molecules never scream, panic, and run to one corner of the box. Humans often do."

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