Moody's and S&P's stock got hammered yesterday after a judge refused to throw out a lawsuit against them credit rating agency.
From Bloomberg
Moody’s and S&P, both based in New York, have been criticized by investors and lawmakers including Senate Banking Committee Chairman Christopher Dodd, who has said the companies wrongly assigned top credit rankings to U.S. subprime-mortgage bonds just before that market collapsed in 2007. The companies have fought lawsuits by arguing that the letter grades they assign to bonds to predict the risk of default are opinions protected by the First Amendment of the Constitution.
Up until now, Moody's has gotten away with saying their ratings are merely opinions like those you'd find in a Wall Street Journal Op-Ed. Except, there are no laws requiring bonds to be rated by shills at the journal. There are laws however, requiring bonds to be rated by Moody's.
Scheindlin said in her ruling that the First Amendment of the U.S. Constitution doesn’t provide a defense in the case because the rating firms’ comments were distributed privately to a select group of investors and not to the general public.
Enough Facts
Without ruling on the merits of the lawsuit, the judge said opinions by the ratings companies may be the basis for a lawsuit "if the speaker does not genuinely and reasonably believe it or if it is without basis in fact." She said there are enough facts alleged against the two rating companies and Morgan Stanley, the sixth-biggest U.S. bank by assets, for the lawsuit to go forward with evidence gathering needed for any trial.
Even if they could hide behind the First Amendment, their "opinions" would still contradict what they actually knew to be true: The bonds they rated AAA were JUNK. They lied so they could make more money.
How do I know they lied you ask?
Because they not only rated the bonds; they structured them. They created the bonds themselves knowing full well the ticking time bombs lurking underneath their sham ratings. This decision will allow evidence to be gathered that will probably prove it and open the floodgates.
Credit raters participate in every level of packaging a CDO, says Calomiris, who has worked as a consultant for Bank of America Corp., Citigroup Inc., UBS AG and other major banks. The rating companies tell CDO assemblers how to squeeze the most profit out of the CDO by maximizing the size of the tranches with the highest ratings, he says. "It's important to understand that unlike in the corporate bond market, in the securitization market, the rating agencies run the show," he says. "This is not a passive process of rating corporate debt. This is a financial engineering business.
The three largest raters are always paid by the issuers of the debt they're rating. Conflicts in rating CDOs are more acute because the raters work with financial firms in creating these debt packages, says Karl Bergqwist, a senior manager at Gartmore Investment Management Plc in London. "When you assign a traditional rating on a company or a bank, it is as it is, and you just make an assessment," says Bergqwist, who worked at Moody's until 1994. "When you move into structured finance, the agencies are effectively involved in structuring these transactions."
Two obvious conflicts of interest here.
- Moody's is paid by the people they are grading.
Yet the assertion that the rating firms deserve the same free speech protections given to journalists doesn’t seem intuitively quite right. For instance, the agencies are paid by debt issuers, analogous to a media organisation's sources rather than its audience. And the rating firms’ status as Nationally Recognized Statistical Rating Organizations in the US - and similar recognition by authorities elsewhere - gives them a veneer of officialdom that would be unheard of in the context of a free press.
The company's latest proxy statement lists 21 companies as peers. Among these are a half-dozen money managers including BlackRock, several equity and futures exchanges, and even the Union Bank of California. There’s not one newspaper publisher among the bunch, though Thomson Reuters and McGraw-Hill make an appearance thanks to their financial data businesses.
- Moody's actually structured the bonds.(This would be like Glenn Beck being paid by a nursing home to help smother someone, and then report that not only is the nursing home safe, but it has fabulous throw pillows.)
The case is Abu Dhabi Commercial Bank and King County, Washington v. Morgan Stanley, 08-7508, U.S. District Court, Southern District of New York (Manhattan).