Standard & Poor's sub-prime wrist slap ignores the real problem

Global Outlook

Andrew Dewson
Saturday 24 January 2015 01:21

It has taken the Securities and Exchange Commission (SEC) the best part of eight years finally to get around to settling with the credit ratings agency Standard & Poor’s for its part in the sub-prime mortgage crisis.

On Wednesday the US financial regulator slapped S&P with a $77m (£51m) fine and a one-year ban from performing certain kinds of analysis – analysis it had stopped doing anyway, but never mind about that.

Before going any further, it’s worth recapping what S&P did to become the first ratings agency to get hit with a fine or a ban. While the US housing boom was in full swing, banks were busy bundling mortgages into packages that were fancily referred to as “mortgage-backed securities” and “collateralised debt obligations” – the idea being that a whole bunch of crap is a better investment than a single piece of crap.

It’s much easier to sell something that nobody really understands if a ratings agency is kind enough to give it a good rating, and S&P obliged. In order to win more business and make more profit for itself, the agency deliberately changed its rating system without telling customers. Fraud, in other words, despite S&P issuing the usual “we’ve settled for millions but are not admitting guilt” statement.

Wednesday’s settlement is by some distance the smaller of two payouts that S&P is expected to be forced into. There is potentially a much more significant cheque in the works, with the US Department of Justice and a handful of state attorney generals. That settlement is expected to be close to $1.4bn – enough to wipe out S&P’s profits for a year.

Therein lies part of the real problem.

Credit ratings agencies, of which there are only three that matter – S&P, Moody’s and Fitch – are all corporations, or subsidiaries of corporations, whose primary aim is to make a profit. There’s nothing wrong with existing to make a profit and, for the most part, the people who work at these agencies do difficult jobs without the rock-star salaries their Wall Street contemporaries expect. But they are profit-seeking companies nonetheless.

The problem is less that they seek to make a profit from their activities and more that such faith is placed in their integrity. So if Goldman Sachs produces a note saying that some investment it is selling is brilliant, we would rightly take it with a pinch of salt. No such salt exists with credit ratings agencies; their word is taken as gospel. That’s the problem. It is not the work that they do but the trust that investors place in it.

Why do we place such trust in it? It’s not very glamorous, so there’s that. If it’s not very glamorous, like accountancy, we tend to have more faith in it than, say, prospecting for gold or managing a rock’n’roll band.

It’s also useful to have a scapegoat when things go wrong, and who doesn’t like having a scapegoat? So a bond fund manager puts together a portfolio based on credit agency ratings, and if it goes pear-shaped then he has someone to blame other than himself. Even though most large bond fund management companies add their own contemporaneous research to rating agencies’ largely historical data, it’s still nice to have a fall guy.

So the SEC’s wrist slap and time out on the naughty step are papering over the cracks. Bond credit ratings agencies like S&P do important work and most of it is excellent. But you could say the same thing about Goldman Sachs or Barclays Capital, and nobody in their right mind thinks they aren’t in it to make a buck.

Rating bonds isn’t the same as rating stocks, but analysts in credit ratings agencies make the same kind of calls as any other bond analyst – sometimes correct, sometimes incorrect. We need to see credit ratings agencies for what they are – financial corporations seeking to make a profit, just like the rest of them – and adjust our degree of faith in them accordingly.

American land seized for oil ... but there will not be blood

The company that wants to build the Keystone XL pipeline chose a good week to begin to force Nebraska ranchers in to court. President Obama’s zinger at the State of the Union address grabbed the headlines, thus saving the pipeline’s Republican supporters some very awkward questions.

TransCanada, which will presumably rename itself if the pipeline gets built, filed “eminent domain” – the forced sale of private land for public use – in order to get the last holdout ranchers to allow the use of their land. TransCanada wants their land for the pipeline route, but these ranchers don’t want it running through their fields.

The pipeline has become a cause célèbre for the Republicans – or the “grand old party” (GOP). Support from the American right has reached fever pitch, even though TransCanada itself said that the pipeline would create no more than a few hundred permanent jobs. That’s some way off House Speaker John Boehner’s claim of 100,000 jobs and the US Chamber of Commerce’s 250,000 claim, to put it mildly.

Despite huge variance in job creation claims, you could be forgiven for thinking that supporting a foreign corporation over Nebraska ranchers and private landowners might dampen support. But apparently not. That is exactly what happened this week, and not a peep out of pipeline supporters in Congress.

Republicans are so invested in support for the XL pipeline, there is almost nothing that could happen that would make them reassess that support, for to do so would mean losing face. Worse than losing face, it might mean siding with Democrats – a fate worse than death.

TransCanada won its eminent domain case in Texas in 2012, so is likely to win in Nebraska where the state legislature supports the pipeline proposal.

So we are left, then, with an extraordinary situation where politicians, those from the party of private property rights no less, are going to support the repeated, forced use of private land by a foreign corporation for the possibility of a few hundred permanent jobs – virtually none of which will be in Nebraska.

Luckily for Republicans, the irony is almost certainly lost on their supporters.

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