Ratings Agencies 2007 = Equity Analysts 2000 ?
Way back in the late 1990s into the early 2000s, a previously well regarded group -- stock analysts -- subtly shifted the objectives of their work. Previously, they plied their skills looking for stocks their clients and trading desks could make money buying and selling.
But things change, commissions shrunk from 10 cents per share to 6 to 3 to mere half pennies today. The old business model no longer applied. What rose in its place was a new model that emphasized not the trading of equities, but the investment banking fees that accompanied IPOs. Many analysts compromised their objectivity on the altar of banking fees. This was especially true in the Internet/Technology/Telecom space.
Thus, they went from being somewhat valued allies of the investor class to the guys helping to dump the dogs into an unknowing public's portfolios. Since then, many of this crowd has been vilified (Jack Grubman, Henry Blodgett, etc.), and the securities industry got Spitzerized to the tune of some $$1,387.5 Million dollars in fines (a deal I suspect they would do all over again if they could).
Fast forward to the early 2000s. Interest rates are at 46 year lows, and this time around, another group of shameless whores analysts are following the same playbook: The ratings agencies that gave their AAA blessings to the now defaulting alphabet soup of RMBS, CDOs, CLOs, ABX structured products that has so recently seized up the credit markets.
It was a simple case of pay-to-play to get rated. Portfolio's Jesse Eisinger goes into the ugly details of a surprisingly familiar story:
"Moody’s and S&P dominated for decades, and their business model was straightforward: Investors bought a subscription to receive the ratings, which they used to make decisions. That changed in the 1970s, when the agencies’ opinions were deemed a “public good.” The Securities and Exchange Commission codified the agencies’ status as self-regulatory entities. The agencies also changed their business model. No longer could information so vital to the markets be available solely by subscription. Instead, companies would pay to be rated. “That was the beginning of the end,” says Rosner.
It might come as a surprise, but rating credit is a heck of a business to be in. In fact, Moody’s has been the third-most-profitable company in the S&P 500-stock index for the past five years, based on pretax margins. That’s higher than Microsoft and Google. Little wonder that Warren Buffett’s Berkshire Hathaway is the No. 1 holder of Moody’s stock.
McGraw-Hill’s most recent financial report shows that S&P has profit margins that would put it in the top 10. Fitch Ratings, owned by the French firm Fimalac, is a distant third in market share but nevertheless has an operating margin above 30 percent, about double the average for companies in the S&P 500.
In 2006, nearly $850 million, more than 40 percent of Moody’s total revenue, came from the rarefied business known as structured finance. In 1995, its revenue from such transactions was a paltry $50 million. . ."
The entire article is well worth your time to read in full.
Yes, Moody's, S&P, and Fitch were complicit in what is slowly coming to be viewed as widespread fraud. However, there is more than enough blame for the failure of the credit markets to spread around. The ratings agencies fraudulent ratings -- I won't even bother with the word alleged -- are merely the tip of the iceberg.
As much as the whores credit agencies have a large share of responsibility in this mess, do not forget to save some blame for an even greater ethically challenged industry: those clever folks who work at Wall Street's biggest iBanks. As related by Reuter's Patrick Rucker, it seems that Wall Street often shelved damaging subprime reports. (Sweet!) Here are the details:
"Investment banks that bundle and sell home mortgages often commissioned reports showing growing risks in sub-prime loans to less credit-worthy borrowers but did not pass on much of the information to credit rating agencies or investors, according to some of those who prepared the reports.
The mortgage consultants, known as due-diligence firms, were hired by investment banks to make sure blocks of mortgages conformed to the mortgage seller's own standards. The studies provided a first glimpse of loan quality for ratings agencies and investors who do not normally see the full reports.
As the U.S. housing boom reached its crescendo in 2006 and investors showed a strong appetite for mortgages, lenders relaxed their underwriting standards, and millions of borrowers with poor credit records were able to obtain subprime mortgages as a result.
Default rates on many of those subprime mortgages are now rising, some borrowers face foreclosure on their homes, and investors in the mortgages face losses." (emphasis added)
At this point, we should expect to see a flurry of investigations into the rating agencies and the same slew of Wall Street firms that were involved in the last analyst scandal.
The saving grace for Wall Street maybe (emphasis maybe) that this was less of a "systemic fraud" than the 1998-2002 scandal. They may perhaps escape by merely jettisoning these bad actors, throwing them under the bus to save their own skins. Perhaps.
We will also find out if the S.E.C. has developed the cojones to go after their own, a shortcoming sadly lacking last go round.
Finally, if the S.E.C. fumbles, we may learn if NYS Attorney General Andrew Cuomo is willing to do what his predecessor, Eliot Spitzer did: challenge Wall Street's God given right to do anything it can regardless of consequences to earn banking fees.
I suspect the next 24 months are going to be quite intriguing . . .
>
UPDATE: August 15, 2007 7:15am
The WSJ also has a page 1 column on the subject: How Rating Firms' Calls Fueled Subprime Mess >
>
Sources:
Overrated
The subprime-mortgage meltdown could— finally—end the credit-ratings racket.
Jesse Eisinger
Portfolio, August 14, 2007 (September 2007 Print Issue)
http://www.portfolio.com/news-markets/national-news/portfolio/2007/08/13/Moody-Ratings-Fiasco
Wall Street often shelved damaging subprime reports
Patrick Rucker
Reuters, July 27, 2007
http://www.iht.com/articles/2007/08/01/bloomberg/sub.php
Mirror (IHT)
http://www.boston.com/business/articles/2007/07/27/
wall_street_often_shelved_damaging_subprime_reports/
How Rating Firms' Calls Fueled Subprime Mess Benign View of Loans Helped Create Bonds, Led to More Lending
AARON LUCCHETTI and SERENA NG
WSJ, August 15, 2007; Page A1
http://online.wsj.com/article/SB118714461352698015.html
Wednesday, August 15, 2007 | 06:34 AM | Permalink
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mad lawsuits....
Posted by: SINGER | Aug 15, 2007 7:48:26 AM
Mr Ritholtz,
I read your website daily and I enjoy your satirisation of the various market players. But today, I really think that you went too far. To equate whores with credit anaylysts is very insulting to whores; and not even slightly accurate.
Whores provide a valuable service to society and my personnal experience is that they are honest professionals. I would rather trust my money, and have done, to a whore, than to a credit analyst.
Whereas credit analyst, plus their close relations investment analyst, stock brokers and investment bankers, are only interested money earned dishonestly. In fact the more elaborate the deceit the better. A whore provide an honest and enjoyable service.
The trillions of dollars wasted on credit analysts and ilk would have been better spent on whores. And I might add, much more enjoyably too!!!
So please stop this slanderous comparision of whores to credit analyst or to any of the other disgusting financial swindlers that dispoil our financial centres.
Yours sincerly
Aldous Oscar Orwell
~~~
BR: My apologies to the ladies of the evening who work in the "comfort" industry . . .
Posted by: Aldous Orwell | Aug 15, 2007 8:01:36 AM
I think it's funny how 'rating' agencies are now screwing people the other way.
Take home appraisers. They are now (this from WSJ) being very very stringent in their appraisals -- obviously -- so people trying to refi are discovering -- suprise -- their home is worth a lot less than their current mortgage and so they not only can't extract cash, they can't even get a better rate.
Now that these dipwads are finally doing what they should have done all along... they're screwing people over once again.
I assume the new strict standards -- like the banks not accepting that MBS crap as collateral is going to hurt the hedge funds in the same way -- although deservedly so.
Posted by: ari5000 | Aug 15, 2007 8:29:58 AM
If I understand this correctly: The owner, the handicapper and the jockey were in on the fix. How did they get the horse to co- operate? Oh, now I see. The horse is just a bunch of meat with legs!
Posted by: Ross | Aug 15, 2007 8:39:50 AM
The difference being that this time around it will be the so called "smart money' that takes it in the shorts as well. There is very little difference between the poor sap home debtor, and all the companies who believed in the various Rating Agencies prognostications. In both cases they thought you actually could spin Gold from Straw forever. Nothing lasts forever.
Posted by: SPECTRE of Deflation | Aug 15, 2007 8:47:41 AM
This outcome is what we were all prognosticating at least a year ago. Even myself, a non-economist with a smattering of econ classes could see the handwriting on the wall, unlike the lenders, borrowers, and the appraisers who had lemming like behavior.
But I have to agree with the consensus here the comparison to whores is maligning a decent and honest profession which in the US had some respect before the 1920's. It seems ironic though that when we started stigmatizing prostitution we sarted glorifying economists. (No insult intended toward you Mr. Ritholtz) No I see thenm more as pimps.
Posted by: Metroplexual | Aug 15, 2007 8:48:05 AM
The markets may be disillusioned by this news, but I doubt that anyone who reads this blog regularly is.
ps I agree with Aldous. Comparing the two professions is like comparing afterglow and bankruptcy.
Posted by: Idaho_Spud | Aug 15, 2007 9:10:19 AM
Speaking of iBanks, just saw the newswire where Goldman is reducing their fees on the GEO fund now taking only 10% of the profit and eliminating the 2% asset managment fee. They appear desperate for cash inflow given that today is Redemption Day! Sounds like a sucker's bet to me!!
Posted by: W.Edwards | Aug 15, 2007 9:17:07 AM
Barry, did you mean $1.387 Billions in fines? (vs 1,387)
~~~
BR: Ooops! I better fix that . . . Its either $1,387.5 million, or $1.3875 billion!
Posted by: Louis | Aug 15, 2007 9:19:35 AM
Everleigh Prostitutes. Sounds like they had a better sense of business than our current crop of analysts.
http://www.nytimes.com/2007/08/12/books/review/Calhoun-t.html?_r=1&em&ex=1186891200&en=88edb9b6c0796421&ei=5087%0A&oref=slogin
Posted by: Metroplexual | Aug 15, 2007 9:23:09 AM
Why are the buyers not to blame? What responsible and sensible portfolio manager would buy this drek? Doesn't that person have a fiduciary responsibility to understand the assets he manages? No one purchased these securities under duress so why are the buyers not to blame? Whatever happened to "caveat emptor"?
Posted by: Rob Levinson | Aug 15, 2007 9:31:13 AM
the correct spelling is "altar"
Posted by: barlow | Aug 15, 2007 10:11:30 AM
I'm sorry but I don't agreee with you equation... However you're on the right path. The acrual equation is more like....
RATING AGENCIES 2007 = EQUITY ANAILYSTS 3 (cubed) 2000...!
This is a lot worse and it will play out a lot worse.
Best Regards,
Econolicious
Posted by: ECONOMISTA NON GRATA | Aug 15, 2007 10:30:35 AM
Market closes up today...after all you would'nt want to panic people into filling out those redemption papers today now would you?
Market spoke to that yesterday.....
Ciao
MS
Posted by: michael schumacher | Aug 15, 2007 10:35:51 AM
Bill Regardie, prior to the S&L debacle:
The time to get out is when the bull shitters start believing their own bull shit.
Posted by: Marcus Aurelius | Aug 15, 2007 11:01:22 AM
With regard to the redemption reckoning day at hand...the actual selling to raise cash would occur between now and the end of the quarter, right?
It's not like all the hedge funds are going to announce the number of redemptions they received. If they received a lot of redemptions, they are just going to have continue to dump stuff until the end of the Q, no?
Posted by: Sven | Aug 15, 2007 11:02:36 AM
I do not expect any announcement but I gather enough information will leak to someone who can reasonably put together a snapshot of what we could expect.
The second answer is yes.
Ciao
MS
Posted by: michael schumacher | Aug 15, 2007 11:15:22 AM
But I have to agree with the consensus here the comparison to whores is maligning a decent and honest profession which in the US had some respect before the 1920's. It seems ironic though that when we started stigmatizing prostitution we sarted glorifying economists. (No insult intended toward you Mr. Ritholtz) No I see thenm more as pimps.
Posted by: Metroplexual | Aug 15, 2007 8:48:05 AM
I agree completely. Whores must actually work for a living, and when it's over everyone in the transaction is happy. The Ratings Agencies can't say that same thing.
Posted by: SPECTRE of Deflation | Aug 15, 2007 11:15:58 AM
Thornburg: “Out of our 38,000 mortgages only 58 loans are 60 days past due”
Their stock was down by 80% and it is still trading below the book value (based on marking it to market yesterday).
The market is trading based on irrational fear and panic, completely ignoring the fundamentals.
The market transformation from extreme euphoria (market top) to extreme pessimism with panicky fear (market bottom) is almost complete.
Posted by: Mike | Aug 15, 2007 11:34:45 AM
Re: redemptions
Typically people wouldn't hear about the size of redemptions taking place. Personally, I expect to hear quite a bit more this time around when the hedgies come out and say that they won't honor those redemptions for fear of being forced to sell assets at below their "fundamental" value.
All this talk will of course generate additional fear in a weak marketplace causing a downdraft in asset prices ultimately forcing them to sell.
Posted by: W.Edwards | Aug 15, 2007 11:38:30 AM
"Take Home Appraisers...they are now being very stringent....screwing people all over again"
To Ari5000:
I have been in the appraisal business for over 20 years. I entered the profession because of the ethical values it encompassed as well the ability to be "independent" in my analysis. I took my role of being the only party to the transaction without self-interest. I protected the lender, as well as the buyer, with an independent opinion of value. What happened to our profession in this debacle, is too many "bad apples" were allowed into the field. The other part of the story is the mortgage brokers. If your appraisal didn't make the deal fly, they went to another appraiser who was willing to "hit the number". What you have now valueing property is the "good" appraisers -- the bad apples have all left the party.
BTW many appraisers who have been in the profession 10 + years and did "stick to their ethical practices" are now so disheartened by the industry they are leaving. I've been mulling it over myself. What was all the regulation after the S&L crises for????
Posted by: rappraisal | Aug 15, 2007 11:39:16 AM
To Mike:
Paulson?!?!
Is that you??
Posted by: KP | Aug 15, 2007 11:41:05 AM
more selling:
Even during today's weak rally -- QIDs have been up strong -- even when the QQQQs were up.
and there's good volume. Someone is obviously anticipating carnage...
Posted by: ari5000 | Aug 15, 2007 11:43:31 AM
A revelatory example of the difficulties of being an analyst with integrity or a CEO on a marketing alley?
The analyst may well be RIGHT The Russian information recently admitted that 1/3 of the Russian corporations were showing negative operating profits.
All banks are not deemed to lend to the major oil and gas cies.
http://www.bloomberg.com/apps/news?pid=20601109&sid=a0qZdO5WuEnI&refer=home
Posted by: Philippe | Aug 15, 2007 11:47:19 AM
Where there is a will there is a way. Wall Street seemingly finds ways to skirt regulation or create these shell games while leaving someone else holding the bag. This time, I suspect we will all be left holding the bag. I wonder how many centuries it will take for legislators to quit accepting PAC and election money from "The Crew" and realize that those who are chosen to protect our money (banks), need to be held to a higher standard and de-regulation has no place in institutions which are meant to be protecting our wealth.
Posted by: BDG123 | Aug 15, 2007 11:54:52 AM
