According to Gretchen Morgenson’s piece in the October 24, 2008 NYT Op-Ed Page, (“They’re Shocked, Shocked, About the Mess”), this is an actual email between:
“(t)wo analysts at S.& P. speaking frankly about a deal they were being asked to examine.
“Btw — that deal is ridiculous,” one wrote. “We should not be rating it.”
“We rate every deal,” came the response. “It could be structured by cows and we would rate it.”
First, some background, so we can all appreciate just how outrageous this admission is. According to everybody’s friend (mine anyway) Wikipedia, “S&P” means: “Standard & Poor’s (S&P) is a division of McGraw-Hill that publishes financial research and analysis on stocks and bonds. It is one of the top three companies in this business, along with Moody’s and Fitch Ratings.”
The “top three companies” who publish and rate stocks, bonds and other financial instruments have a lot of clout out there among those who invest, whether they be individuals planning for their retirement or institutions, who have literally billions of dollars which they have to put to work to make more dollars for the pensions of unions, teachers, public employees, select investors and many other groups.
As historians pick apart in future years the economic Trainwreck we are living through, the rating agencies who blessed the exotic financial instruments, including credit default swaps and other highly leveraged things that few understand, will not come through this unscathed.
“It could be structured by cows and we would rate it.”
I worked as a teenager at an Army Navy surplus store in the old North End of Boston in the 60’s, long before they gentrified the area to make Haymarket Square the Yuppie Heaven that it is today. It was a mighty funky neighborhood in those days only a few years after honky tonk Sculley Square was demolished to make way for the new Government Center, a concrete, modern bastion of the age. The owner would buy all kinds of military and government surplus items and we would figure out how to sell them. One fine day we took delivery of many huge bales of white, cotton, Korean War surplus socks—enough to meet the sock needs of a small nation.
At my instigation, on a whim, a co-worker and I set up three bins and we marked them, successively: ‘39 cents; 59 cents, and; 79 cents.’ We then randomly divided up a few bales of those socks into the three bins—mind you, all the socks were exactly the same; only the price differed. To my, and the store owner’s astonishment, the 79 cent box would sell out fast and repeatedly, and customers would come back and sing the praises of those 79 cent white, wool Korean War surplus socks, telling us how much better and longer-lasting they were than those cheaper ones!
The rating agencies were the enablers in a whole lot of this current economic mess. First, you take a box full of lousy, “C minus” mortgages and you divide them into three smaller boxes. Next, let’s give them chi-chi, cutesy names to attract those who love such things—“tranches.” (Our friend, Wikipedia, tells us that: “In structured finance, a tranche [misspelled as traunch or traunche] is one of a number of related securities offered as part of the same transaction.” — It is French for “slice, section, series, or portion.”) Presto, our bundle of “C minus” crap can now be dealt out into an “A” box, a “B” box, and a “C box.” Kind of like my idea with those Korean War socks.
We have just transformed the proverbial sow’s ear into the highly desired silk purse. Well, that’s what some of the ratings agencies apparently did with some of these exotic financial instruments, according to much that I have read of late. Then, they cranked up the leverage machine. If a 3 or 4 times return was good, well, then, let’s go for 30 or 40 times! Reserves? We don’t need no stinking reserves.
The email exchange quoted in the beginning of this article tells it like it is: “It could be structured by cows and we would rate it.” Who was watching the rating agencies while they truly were putting lipstick of all shades on these pigs? Who was checking to see if the rating agencies might have a few wee, tiny conflicts of interest which might seduce them into rating boxes of crappy Korean War socks that should sell for 39 cents into deluxe Korean War socks that could and did sell for 79 cents?
We often wind up getting what we deserve in life. Call it karma, call it ratings games, call it Korean War socks.