Calpers Sues Rating Agencies: Where's Obama? Where's Congress?

"The nation's largest public pension fund has filed suit in California state court in connection with $1 billion in losses that it says were caused by 'wildly inaccurate' credit ratings from the three leading ratings agencies.... Calpers maintains that in giving these packages of securities the agencies' highest credit rating, the three top ratings agencies -- Moody's Investors Service, Standard & Poor's and Fitch -- 'made negligent misrepresentation' to the pension fund, which provides retirement benefits to 1.6 million public employees in California."

New York Times

Finally, someone is going after the ratings agencies who were in up to their eyeballs in propagating the great fantasy finance fraud. The only surprise should be why it took this long for a lawsuit like this to be filed.

By helping the large investment houses and banks get AAA ratings for junk securities, these agencies did very well indeed. Moody's in fact had the highest profit margin of any corporation five years running from 2002 to 2007.

The Calpers (California Public Employees Retirement System) suit takes us into the heart of fantasy finance. For reasons almost beyond comprehension, the $173 billion public pension fund bought $1.3 billion worth of securities in 2006 that its managers could not possibly have understood. Those securities collapsed to near worthlessness during the crash and still are in sorry shape. Actually I do know why Calpers bought them -- they were AAA-rated and had a rate of return that looked good compared to the alternatives at the time. (They're not alone: Five Wisconsin school districts lost nearly $200 million in a similar scam. See The Looting of America. The first chapter featuring the Wisconsin school swindle is posted at here)

What did they buy? They don't know because, "Information about the securities in these packages was considered proprietary and not provided to the investors who bought them." Now that's gall.

Here's how this game was played. Large banks, investment houses, or other originators would come to a rating agency with a complex security embedded with loads of fees for the banks involved (of course). The securities often consisted of a set of bets on other securities that were not owned by the originators. The only way to assess their value was through complex modeling that, as it turned out, might just as well have applied to housing on Mars. The ratings agencies helped the banks construct the security so that it would seem, based on the Mars models, to be safe and secure, thereby worthy of an AAA rating. Then after it was "tested" by the model, the agency blessed it with the AAA rating.

At the time, everyone involved was extremely happy about the arrangement. The rating agencies got a nice fat fee, up to a million dollars per transaction (and there were a lot of transactions going on), for helping to tweak the Mars model. They also got their usual fat fee for rating the bond. The originating bank made tens of millions in fees for putting together the security and selling it off. And buyers like Calpers were happy to get the promise of a high return from a secure AAA-rated security, even though they had absolutely no idea what they actually were buying. (Bernie Madoff, are you smiling?)

When the value of junk debt stopped rising and then started to decline, the Mars models showed that these securities now were nearly worthless. In fact trillions of dollars worth of fantasy finance instruments that had made Wall Street fat and rich crashed in value all over the world. The banks became insolvent and we had to rescue all of Wall Street with trillions of loans, grants and guarantees to prevent the next depression.

So what are we going to do about it? Here's what the Obama and Congress seem afraid to do:

1. Prohibit the creation and marketing of any and all special derivatives until they are approved by a federal agency, just like we would approve a drug. What else has to happen to the world economy before we finally admit that this kind of financial innovation is guilty until proven innocent?

2. In any case, like dangerous drugs, no complex derivative security should be peddled within a thousand yards of a school district, public agency or any pension fund that is publicly owned or guaranteed by public funds.

3. Set up a "Public Option" rating agency that would have the ability to rate any and all securities, even those already rated by private agencies. This kind of competition would keep everyone on their toes. Imagine how Moody's would feel if it rated something AAA and the Public Option agency rated it as junk.

4. Slap a hard wage cap on the entire financial sector: No one can earn more than the President of the United States until the $13.1 trillion of subsidies are repaid by Wall Street to the US treasury. Not only is this fiscally sound but it would remove the temptation that regulators must feel when they know that if they shave a rating just a bit, the bank or investment house might hire them for ten times their current salary.

It would be easy to blame Calpers for buying something that was impossible to decipher. It certainly makes you wonder about their due diligence. But they were not alone. This junk was peddled successfully all over the world. In fact Morgan Stanley is doing it again. (See "Morgan Stanley Plans to Turn Downgraded Loan CDO Into AAA Bonds" )

The real problem is that fantasy finance inevitably leads to financial crashes, and those crashes are a disaster for the real economy. Along the way, many bankers get filthy rich. But when the game goes bust, it is we, not them, who are picking up the tab.

Our biggest problem right now is that the Administration and Congress seem unwilling to take on the financial community. The big boys on Wall Street are testing them to see who will blink first. Unfortunately, we're looking at a lot of fluttering eyelashes at 1600 Pennsylvania Ave and on Capital Hill.

Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What We Can Do About It, Chelsea Green Publishing, June 2009.

 

 

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Comments

[ErnestineBass]

Gall, indeed!

If only this administration would implement your four suggestions.

[HenryDavid]

It is ultra-frustrating. Barack had great campaign rhetoric, but his administration is not panning out at this point. I assumed the reason for this was that congress had a back room talk with him about giving support for his healthcare plan if he would turn a blind eye to wall street shenanigans; not that they'd honor their commitment, but at least put him offtrack for awhile. Barack is still 20 times better than McCain would have been, but that shows where we're at.

So, in sum, congress is corrupt, the supreme court is a variable stacked deck, and the executive branch is possibly intimidated by the party or congress. Our remaining symbol of democracy is a 4th of July display of music and fireworks from Washington, D.C.

We need an extremely capable and proven public servant who is beyond politics and corruption, someone like General George C. Marshall. FDR and Truman depended on him greatly and were in awe of him. Marshall lived by the code of honor and self-sacrifice, and had a genius for clarity. He was instrumental in setting up the WPA and CCC, and military forces for WWII. Later, Truman asked him to serve as Secretary of State where he designed the Marshall Plan. Truman later said, "There may never be another person like George Marshall."

We desperately need a George Marshall. At present, we're like the ancient Diogenes out walking with a lantern in the endless search for an honest man.

[MinasTirith]

We have the best government money can buy... And the corporations want to be sure they are getting what they paid for in the officials they helped elect or place into positions of power.

[robinhood1]

Didn't Calpers have any of its OWN financial analysts to review potential investments? Did they take the cheap route and just rely on the rating agencies' AAA rating? If they did, they made a big mistake. They probably made another mistake being based in Sacramento rather than in a financial center such as downtown Los Angeles or San Francisco, where they could have had access to a wider talent pool of investment professionals.

[blindhog]

Thank goodness somebody is doing something to get the money back.

I had to laugh to myself when I saw the two stickers on the vehicle I followed in traffic this afternoon. One was "NOBAMA" the other was "WORST PRESIDENT EVER" with the recognizable campaign generated Obama O in the word worst. Those stickers were on the back of a VERY, VERY EXPENSIVE HIGH END FOREIGN-MADE SUV!!!!!! Now we know who wants Obama to fail--that is, unless we didn;t know already.

[outnow]

Let loose the trial bar against these bankers and the financial industry. Lawyers are effective in compensating victims and deterring future misconduct where government regulation fails. Many lawyers I know are gearing up for the Great Derivatives Fraud cases. The rating agencies seem to have been a huge part of the problem. Without their "blessing" the toxic assets would not be toxic because they would be selling for much less on the market, considering the actual risk.

The paper trail is already in the Congressional record as to the rating agencies who had conflicts of interest in their payment arrangements.

[saltysea]

What can we do about this ultra-frustrating lack of will in the administration, though? We've been yelling, writing congress, etc., but it falls on deaf ears. At the least, you'd think we could get the bill through to audit the Fed, but even that is being held up (by Sen. Nelson?). What do we do?