Busting the Rating Agency

Frat Party

Yo everybody 5-0! 5-0!  The cops are here!

The US Justice Department filed a lawsuit yesterday against Standard & Poors, for its role in over-rating mortgage bonds, CDOs, and other securities in the years 2004 to 2007, securities which later proved to be weapons of mass financial destruction – the initial catalysts of the Great Credit Crunch.

When I read the story this morning, I suffered an involuntary eye-roll, the type I discourage in my daughters.

If a fraud was committed in those years, the rating agencies, frankly, are not the prime suspects here.

If the Wall Street mortgage bond market was the greatest financial frat party of all time, in the years 2002 to 2008, the rating agencies were the freshman pledges.  We needed them for continuity, and because they provided a reason to host a party.  But look, nobody really respected them.  They did what Wall Street told them.[1]

But then the party went horribly awry.  Somehow the upperclassmen frat brothers are way too smart to still be at the scene.

Now, with the frat house furniture stolen, the neighbor’s cat shaved and duct-taped, the Dean’s house toilet-papered, and the entire kitchen and basement burned black, the police have shown up and seized all the stupid pledges they found passed out in the back garden.

Yes, the pledges were at the party.  And yes, they kind of knew it could all go wrong somehow,[2] but not really.  They weren’t really in on it.  They didn’t have the upside that the Wall Street firms had.  They were just trying to appeal to the big frat brothers, who might someday invite them to be part of the inner circle.[3]

So, I rolled my eyes this morning because the cops can definitely bust Standard & Poors, but it begs the question of “Why?”

[1] Who paid their fees?  Oh, Wall Street firms did?  ‘nuff said.

[2] The US Justice Department has damning emails from S&P employees saying things like 1. ““Let’s hope we are all wealthy and retired by the time this house of card falters.” And 2. ““We rate every deal. It could be structured by cows and we would rate it.”  Hey guys?  I know you have that personal opinion, but seriously, never write that shit down.

[3] Michael Lewis makes the great point in The Big Short that the rating agency folks generally didn’t have the educational pedigree of the Wall Street in-crowd, but many hoped one day to join the firms themselves.  This “next-job” focus often leads to conflicted professional behavior and may help explain why the rating agencies acted like pledges at the frat party.


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