Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [67]
Springfield was fortunate that its troubles received publicity. It seemed to own the chlorine trifluoride of CDOs. The AAA rated tranches were unstable and lethally toxic to portfolio value. The three CDOs Springfield originally purchased for $13.9 million in the summer of 2007 were valued by Merrill at around $1.2 million by January 2008. Merrill repurchased the CDOs for the full amount of $13.9 million.
Vickie Tillman, executive vice-president at Standard & Poor’s defends its AAA ratings: “of the 26,000 structured securities originally rated AAA by S&P between 1978 and 2007, fewer than 0.1 per cent [sic] subsequently defaulted.”27
That may be true. It may even be true that AAA ratings on securities that were imploding did not have ratings withdrawn to remove them from the data set. But that is not the point. When it counted, when the U.S. housing markets and municipal bond markets depended on the integrity of the ratings, the rating agencies failed. There were a lot of teeth marks in those “boxes” of CDOs backed by mortgage loans. Smart investors avoided CDOs and ate some See’s Candies.
In August 2008, a draft version of an SEC 38-page report on the rating agencies revealed that an S&P analyst emailed a colleague that they should not be rating a particular structured finance deal. The colleague responded that they rate every deal: “it could be structured by cows and we would rate it.”28
Deal after CDO-squared deal brought to market in 2007 had AAA rated tranches downgraded below investment grade within months after the deals came to market. This is unprecedented. Deals brought in 2006 are similarly troubled as are deals brought in the last half of 2005. Dollar values involved are in the hundreds of billions. It is a travesty. Investors in AAA structured finance products are losing substantial principal. Some nominally, AAA bond insurers were downgraded from AAA to junk. The AAA ratings of others Slid lower. Municipal bond markets and student loan markets are in confusion. Investment banks sold auction-rate securities with long maturities as if they were money market instruments.They told customers that the coupons reset at regular auctions at short-term intervals, and if the auctions failed to find buyers, the investment banks would step in and buy back the securities. Investors could not get their money. Investors from large corporations to condominium boards investing members’ assessments held frozen assets. Yet they had been told the bonds are exactly like cash. By the fall of 2008, banks and investment banks were compelled to buy back auction rate securities from retail investors to settle claims with U.S. regulators that they improperly sold these bonds to uninformed customers. 2930 Larger investors are forced to settle their own disputes.31
In the face of its contribution to enabling a cycle of shoddy home loans resulting in massive foreclosures, declining housing prices, deteriorating ratings of bond insurers, and lack of liquidity due to shaken confidence in the markets, Standard & Poor’s demonstrates a curious combination of arrogance and truthiness.
The markets have nothing to replace the rating agencies other than individual initiative. Rating agencies are currently protected by government regulation, barriers to entry, institutionalized investor reliance, and the profit margin of approximately 40 percent that they make on their traditional business of rating corporate credits. As maddening as the recent actions of the rating agencies might seem, they are like a fellow who knowingly sells a horse to an investment banker named Black Bart. Without investors’ money funneled through investment banks to predatory mortgage