23 July 2010

Ratings agencies refuse to rate collateralized asset securities

I just found this today and haven't tracked it any further than the link:
The Three Big Ratings Agencies (hereinafter, TBRA) are refusing to rate asset backed bonds due to the stepped up regulations of the financial reform package. This is ground-shattering news that already demonstrates the effectiveness of the new legislation. I'm going to tell you why.

Now, if you listen to CNBC or NPR's Marketplace, this is meant to be a Very Troubling Development. You see, according to existing securities regulations, you can't sell asset backed bonds without a ratings agency stamp on it that tells buyers the TBRA's "opinion" of their risk. That's a principle of transparency. You need an "objective" third party assessment of the risk for such bonds. If one of the TBRA doesn't rate the bond, you can't sell it. So, the bond market for asset backed bonds is at a dead stop: no ratings, no sales. Full stop.

So, what's the NEW problem? The financial legislation just signed into law makes the TBRA's liable for the opinion they give on a bond. If, for example, they give a bond a very strong rating (AAA, say), and the bond turns out to be junk, and it turns out that the ratings agency was negligent in its assessment, it can be sued by the bondholders. This has sent shockwaves through the financial set, but not only because it exposes the ratings agency and forces them to be honest in their assessment of the bonds. Rather, it pinpoints the precise pressure zone in the whole asset backed securities market and forces changes all the way down the line. They are screaming bloody murder and essentially blackmailing the government precisely because the new law cascades throughout the system...
More at the link, and a discussion thread at Reddit.

5 comments:

  1. "If one of the three big ratings agencies doesn't rate the bond, you can't sell it." That seems to say that all three agencies must give it a rating. If a rating from any one of the three big ratings agencies is all that is necessary, then maybe it should read "If not one of the three..."

    I'm not wanting to sound pedantic about it, just wanting to clarify if one or three ratings are required.

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  2. Grammatically, you are correct. The writer of the piece was less precise than he/she should have been.

    Kudos - not many people would have picked up on that subtle turn of phrase.

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  3. Thank goodness the new law has some teeth.

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  4. I like it. I just hope that these agencies are refusing to rate coll. asset securities because they're junk rather than a general fear of being sued. I'm a bit worried that the net is too large, or at least perceived as too large. If rating agencies fear for being sued because there's a degree of uncertainty over 'when' they can be sued (i.e. there's a giant stick continually hovering over their heads, regardless of whether they correctly rate an asset), then it might reduce these agencies giving any ratings... which actually leads to a lack of transparency over the risk of assets.
    Just so long as this law only applies to negligence, and these agencies have confidence in the application of the law, then I think this is a great way to increase transparency. Which is exactly whats needed, and in some way the only thing that is needed for people to make the right choices.

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  5. This is silly. Ratings are an art not a science. It's like saying that you can't sell your art unless everyone likes it. No wonder no one wants to rate these things, if you mess up, then you're on the hook for the lot.

    Did I say silly? I meant stupid.

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