Standard & Poor's

Alan Grayson's Right; But He Misses the Larger Point

Joseph M. Firestone — Fri, 14 Sep 2012 22:28:00 -0400

Alan Grayson's e-mail on Moody's warning that it might reduce the US's AAA rating, suggested that Moody's was either threatening a downgrade because it wants to get the Bush tax cuts for the rich extended, or, alternatively, that “Moody's is living in what Aristophanes called "Cloud Cuckoo Land."” He says this because Moody's is upset about the possibility that the US may go over the so-called “fiscal cliff,” even though if it did, it would theoretically result in $560 Billion of deficit reduction annually, without further legislative changes, and it makes no sense on the surface for a ratings agency to think that the risk of US bond default is greater when the annual deficit is being reduced by $560 B per year, than by some lesser amount, which is likely to happen if Congress doesn't take us over that “cliff.”

Grayson was right to call attention to this seeming contradiction and the possibility that Moody's is just pressuring Congress to do more for rich people; but I think he should also have made the larger and more important point, that Moody's warning, just like the one it delivered in January of 2010, is an empty threat without significant consequence, even if it were carried out. How do we know that? For a number of reasons.

First, as is widely known, all the ratings agencies including Moody's gave the CDOs and CDSs that led to the collapse of AIG their highest AAA ratings. In addition, they downgraded Japan's credit ratings a long time ago, with no measurable impact on its bond interest rates or costs, even though Japan's debt-to-GDP ratio has continued to increase over time and is now in the neighborhood of 200%. More recently, in April of 2011, Standard & Poor's downgraded the outlook on US debt from stable to negative. What happened thereafter? There was a flight to Treasuries on the International markets and interest rates have fallen more than 1% since S & P delivered its downgrade.

So, one may be forgiven for wondering why anyone should listen to the ratings ravings of Moody's and the other agencies at all. In fact, one may begin to suspect that their ratings have little influence on the bond markets, and also, given the Japanese and US experiences, one might even suspect that the bond markets don't influence to any appreciable degree or control the interest rates that Governments sovereign in their own currency must pay.

Second, since the United States is a nation with a fiat non-convertible currency system, with a floating exchange rate, and no debt denominated in any foreign currency, it is impossible for the United States to be forced into a default by any external party, simply because its ability to create the currency it owes its obligations in, is unlimited. Voluntary default could be caused by a Congress which acts stupidly, and in a manner contrary to the 14th Amendment of the Constitution, to constrain the Treasury from paying its obligations when they come due, coupled with a Treasury that accepts Congress's constraint in conflict with the clear admonition of the Constitution that the debts of the United State shall not be questioned.

The objective risk of default by the US Government is not increased by the increased size of the deficit, debt, or debt-to-GDP ratio. And Moody's apparent view that the risk of default is increased by such increases, only shows that Moody's doesn't understand the monetary operations of nations sovereign in their own currencies. Increases in these numbers don't in any way lessen the constitutional authority of the Government (including the Congress) to spend or make money.

It's basic solvency, in other words, is untouched by any deficit reduction deal that may or may not be made by Congress. And, if the Executive uses its own legal currency creation powers, then the economic/fiscal risk of default, as a result of any deficit reduction deal made or not made, is exactly zero. Whatever additional risk exists from a failure to avoid the fiscal cliff, or a negotiated deal that provides for deficit reduction, or doesn't provide for it, is purely political.

It comes only from the possibility that Congress, mistakenly thinking that the Government is like a household, or, for ideological reasons, determined to "starve the beast", might try to constrain the Executive from meeting its obligations, and declare a US default when there is no reason to do so. Even here though, there is actually very little political risk because so many options exist for the Executive to get around any panic that may afflict the Congress.

Third, Moody's warning assumes that its ratings and the bond market itself can actually influence, or even control, the interest rates that Governments like the United States must pay. But the problem is that they don't!

The Federal Reserve, and sometimes the Fed and the Treasury in collaboration, target bond interest rates and set these for the bond markets by manipulating bank reserves. Specifically, one way to do this, is that the Fed can buy long-term debt removing much of it from the market, and the Treasury can cease issuing any more long-term bonds, and can sell only three-month bonds when it issues debt.

Three-month bond interest rates are generally controlled by overnight rates for bank reserves, and overnight rates can be driven down to near zero by flooding the banks with excess reserves. That's basically how the Japanese keep their bond interest rates near zero, and that's how we've been doing the same for some time now. In fact, the Fed announcement just yesterday included plans to buy more long-time securities.

Another move the US can make to remove the effects of the bond markets and the ratings agencies upon public finances, is for Congress to stop requiring new debt issuance in coordination with deficit spending, and for the Treasury to stop issuing debt. In other words, allow Treasury to credit its Fed account to repay debt and spend appropriations already approved by Congress at will.

Alternatively, the Executive Branch could use its legal power to mint proof platinum coins with Trillion dollar face values, and then deposit those coins at the Fed to cause it to issue electronic credits tn the Treasury General Account (TGA) in amounts great enough to remove the need to issue debt instruments in coordination with deficit spending. If we did either of the above things, then the credit rating agencies' impact on the bond market for US sovereign debt would be irrelevant from that day forward.

In short, the bond markets and the ratings agencies aren't in control of US public finances. They are not in a position to influence what our taxing or spending policies ought to be, or whether we will default on our obligations, unless we allow them influence.

So forget about Moody's and its idle threats! They're part of the great austerity distraction preventing us from focusing on our real problems. There's nothing that Moody's and the bond vigilantes can do to hurt us, unless we let them. Let's not let them. Tell them to bring those ratings changes on! Tell them to go ahead and destroy their own credibility, the way S & P did last year!

In fact, let's give them what they deserve for their role in the crash of 2008, and their continuing arrogance and fraudulent ratings behavior designed control various democracies, including our own, since. As Bill Mitchell says in his post on outlawing the credit rating agencies:

"The real question that I always ask is why governments allow these undemocratic criminal organisations to exist. They can just outlaw them. This would force the corporate players to create better ways of informing the markets about their risk characteristics and leave governments alone to do what they are democratically elected to do – advance public purpose.

Further. as part of my preferred financial market reforms I would render illegal a whole swag of derivative assets which would lessen the problem of pricing risk.

It is time to wean the private financial markets off these agencies. The best way would be to declare them illegal.. . . . "

-- Mike Norman provides the same conclusion in this timely video!!!

(Cross-posted from New Economic Perspectives.)

Still Superman?

Joseph M. Firestone — Sun, 07 Aug 2011 23:31:43 -0400

There have been many reactions to S & Ps action in downgrading the credit rating of the US, Apart from the widespread annoyance and repudiation of S & P and its procedures, there are some who are saying that it won't have much effect on interest rates. Others even saying that it is a “non-event,” and still others saying that S & P should be investigated and prosecuted on a number of grounds. However, I found two views of the “non-event” particularly interesting.

The first was Warren Buffet's quoted by Fox Business news:

Berkshire Hathaway Chairman and CEO Warren Buffett told the FOX Business Network that S&P's downgrade of the United States' triple-A credit rating "doesn't make sense."

"I don't get it," Buffett told FBN late Friday night. In fact, Buffett reaffirmed his belief in the quality of the United States' credit telling FBN, "In Omaha, the U.S. is still triple A. In fact, if there were a quadruple-A rating, I'd give the U.S. that.”

Buffett also said:

"Think about it. The U.S., to my knowledge owes no money in currency other than the U.S. dollar, which it can print at will. Now if you're talking about inflation, that's a different question."

And so, now we know that Warren Buffett gets a fundamental premise of MMT!

He knows that the US cannot become insolvent because it can make USD at will and it owes nothing that is not denominated in USD!

We can only hope that he'll clue in his friend Barack Obama that the US is NOT running out of money. Perhaps Mr. Buffett even knows about Proof Platinum Coin Seigniorage (PPCS) and he can tell his friend Barack that using it would be a good way to give S & P a sharp stick in the eye.

The other reaction was one to my post on S & P tugging Superman's cape. The commenter asserted that, considering the US Government's domination by an increasingly powerful oligarchy, “the US Government is not Superman.” This squares with views being expressed by Yves Smith and others that this downgrade is about a power struggle. People who write about this struggle characterize it differently.

I think it is a power struggle between sovereign nation states and globalizing international elites whose loyalties are to the emerging new international feudalism in which corporations and enormously wealthy individuals wield the only real power. Some write as if they think that nation states are already and irrevocably subordinate to international elites. But I think that is not yet true.

The forces of nationalism are not yet spent, and will still be used against the international elites when the reality of their growing power and its negative impacts on working people are both fully recognized. People still need nation states for physical protection. People without a favored position in the emerging plutocracy still owe their primary loyalties to their nations, and I don't think they will long accept the subordination of their national Governments and institutions to foreign powers, whether those are other nations or international financial interests. At the moment, the influence of globalizing elite institutions is very great and very real; but they still exist and function on the sufferance of nation states and their internal politics, however parasitical they may be.

Even with all its faults and the mess being made by the special interests and the parties, the US is still Superman if we can free ourselves from the constraints imposed by various Congresses in the past, and from the financial lilliputians.

1. As I say in this piece, and Marshall Auerback says in this one, the US (the Fed and the Treasury) can control interest rates contrary to the desires of the bond markets and the vigilantes. There is no realistic prospect that benchmark interest rates will go up unless the Government wants them to.

2. The US can also de-certify the ratings agencies and prosecute rating agency executives for fraud and other violations. I think they'd be well-advised to do so, if only to show S & P who's boss. And

3. The President, finally, can use very high value PPCS and kill the “austerity” trope of the international elites for good.

So, forgive me my optimism, I still think that's Superman!

(Cross-posted from Correntewire.

Standard & Poor's Tugs on Superman's Cape

Joseph M. Firestone — Sat, 06 Aug 2011 02:24:09 -0400

Last December, my friend, beowulf, had this to say at the time Moody's began to make noises about downgrading US debt. He said:

”I don’t think we’ll see Moody’s or any other rating service based in the US ever downgrade US Treasuries. It would cause a tremendous amount of financial loss and would leave Moody’s and its executives exposed to criminal prosecution. If I were Moody’s general counsel, I’d tell the CEO in no uncertain terms, Do Not Tug On Superman’s Cape.

14th Amendment, Sect. 5

”. . . .the validity of the public debt of the United States, authorized by law… shall not be questioned”

Criminal Mischief statute

18 US 1361. Government property or contracts

"Whoever willfully injures or commits any depredation against any property of the United States, or of any department or agency thereof, or any property which has been or is being manufactured or constructed for the United States, or any department or agency thereof, or attempts to commit any of the foregoing offenses, shall be punished as follows:

If the damage or attempted damage to such property exceeds the sum of $1,000, by a fine under this title or imprisonment for not more than ten years, or both; if the damage or attempted damage to such property does not exceed the sum of $1,000, by a fine under this title or by imprisonment for not more than one year, or both."

But, Standard & Poor's has decided to tug on Superman's cape by downgrading US debt to Double A status for the first time in history. Don't get me wrong, I'd love to see S & P executives frog-marched out of their offices and imprisoned for a year for violating the criminal mischief this statute. After their role in the Crash of 2008, that's the least they should get from an outraged populace. However, I have to say that their action will be of little or no consequence if the Treasury responds correctly to their foolishness.

Contrary to popular belief, and also the apparent belief of this Administration, ratings agencies and the bond market itself don't actually control the interest rates that Governments like the United States must pay. Sure, they will determine interest rates if the Government sits idly by and lets them drive the market.

However, the Federal Reserve and the Treasury, can target bond interest rates and set these for the bond markets by manipulating bank reserves. Specifically, one way to do this (As Warren Mosler suggests), is that the Treasury can cease issuing long-term bonds, and sell only three-month bonds. Three-month bond interest rates are generally controlled by overnight rates for bank reserves, and overnight rates can be driven down to near zero by flooding the banks with excess reserves. That's basically how the Japanese keep their bond interest rates near zero, and that's how we can do the same.

Alternatively, another move we can make to remove the effects of the bond markets and the ratings agencies upon public finances, is for the Treasury to stop issuing debt in advance of deficit spending. If we did this, the credit rating agencies and the interest rates in the bond market would be irrelevant from that day forward. And we can do it using Proof Platinum Coin Seigniorage (PPCS) to generate revenues to pay back debt, and deficit spend current or future appropriations.

On the other hand, the ratings agencies are currently hurting US states, and Eurozone nations with their deeply corrupted ratings processes and judgments. We should take very seriously Bill Mitchell's Conclusion in his post on outlawing the credit rating agencies:

"The real question that I always ask is why governments allow these undemocratic criminal organisations to exist. They can just outlaw them. This would force the corporate players to create better ways of informing the markets about their risk characteristics and leave governments alone to do what they are democratically elected to do – advance public purpose.

(Cross-posted from Correntewire.

Why Are Discredited "Agencies" Like S&P Dictating Our Economic Future?

Richard Eskow — Sun, 24 Jul 2011 20:29:20 -0400

"Who does Standard & Poor's think it is?" asks Matt Miller, the reasonable and congenial host who represents the "center" on NPR's "Left, Right, and Center." Miller's understandably outraged that this discredited organization still has so much power and influence. But he's asking the wrong question.

S&P knows exactly what it is, and so should everyone else. It's the for-profit company which, while masquerading as a credit rating "agency," bartered its coveted AAA ratings for increased profits. The real question is why? Why does S&P still have the power to cost the government billions of dollars in added interest payments, which is what would happen if they downgraded our credit rating?

The pronouncements of these for-profit "agencies" have no more credibility than the murmured compliments of an overpriced escort in a candlelit hotel room. So why do they still have the power to endanger the financial security of millions of Americans?

Change of Heart

S&P's threatening to downgrade the government unless there's a $4 trillion deficit deal within 90 days. That's a demand, a timeline, and a figure it had never mentioned before. Ezra Klein reminds us that in October they had concluded our AAA status was 'stable' for the foreseeable future, and that in April they had said we needed to address the deficits within two years rather than 90 days. Klein asked what changed.

The more you think about the response from S&P's David Beers, the less sense it makes. "We live in a dynamic world," said Beers. "... (T)he idea that we or anybody else who does analysis around U.S. public finances would have a fixed and unvarying view over time is simply naive." But the US government wasn't overthrown between April and July. Nothing has radically changed. Taken to its logical conclusion, Beers is arguing that it's "naive" to believe that today's opinion won't be radically different from one offered six months earlier or three months later.

The logical next question goes unasked: Why should such unpredictable opinions be given any weight? How can you tell me what will happen to an entire nation in five or ten years, when you can't even tell me what your own opinion will be three months from now?

Politics as Usual

S&P's warning mentioned the "Rising Risk Of Policy Stalemate," and Beers says "politics" changed their assessment. Or to put it in Klein's words, that "America is not acting like a country that deserves a AAA-credit rating." Klein adds: "Nice job, Congress."

Except that Congress hasn't been acting in a vacuum. Yes, Republicans have acted wildly and recklessly. But senior Administration officials have been privately saying for years that they want to cut government spending on entitlements and other programs. That seems to reflect an economically conservative worldview and fits nicely with the President's "post-partisan" re-election strategy. To all appearances, the White House has been using the Republican House as a "bad cop" to serve its own endgame.

But none of this is news, and none of it explains this new pronouncement - or the sudden appearance of the $4 trillion target as S&P's make-or-break number.

A Proven Record of Failure

Beers was practically thumping his chest when the Wall Street Journal caught him on his way to meet with Congressional Republicans. "You have to call these things as you see them," he said, "and that's what we are committed to doing."

You'd never know that 90% of the subprime-backed mortgage securities S&P and its competitors rated AAA in 2006-2007 - which means they're as sound as Treasury notes - were later downgraded to junk bond status. But he's right about one thing: It is naive to expect S&P or its peers to be reliable or dependable. That commitment to "calling things as they see them" was nowhere to be found when they were giving out ratings like they were party favors.

"Agencies" like S&P trade on the quasi-governmental ring that the word "agency" provides, but executives at S&P and the other raters are charged with increasing revenues and profits to boost profits. And that's one part of their job they take seriously - so seriously, in fact, that Sen. Levin's Permanent Subcommittee on Investigations made this observation: "The ratings agencies weakened their standards as each competed to provide the most favorable rating to win business and greater market share. The result was a race to the bottom."

Republican Senator Tom Coburn characterized these "agencies" as "key enablers of the financial meltdown." S&P rolled over when Goldman Sachs complained about S&P's original rating for a collateralized-debt obligation called Abacus 2006-12. Abacus was at the heart of the government's lawsuit against Goldman Sachs, which eventually paid $550 million to settle charges of market manipulation.

Because of the bipartisan "reforms" passed in the 1990's, products like Abacus were completely unregulated at the time. Only pseudo-agencies like Standard & Poor's were left to protect the public and investors from malfeasance and fraud. They failed. But then, why wouldn't they? Their business model, which has yet to change, creates the perfect incentive for just such failures.

The Levin Subcommittee's documents provided a tantalizing trail for Justice Department investigators to follow and opened the door for members of both parties to push for massive reforms. Instead the agencies got a free pass to carry on as they had before. The laws and regulations that give their ratings enormous influence have gone unchanged.

Some officials may be regretting their generosity. Recently Administration officials went to the ratings corporations with hat in hand, begging them not to downgrade the US government's AAA rating, and were dismissed with imperious scorn.

Confusion ... or Cover?

If logic doesn't explain this sudden move by Standard & Poor's, what does? Is this "agency" once again trading on its influence to please the Wall Street banks that are its bread and butter? Or is it all just a coincidental confluence of opinion and events? That gets us into the realm of speculation. But it's funny how it's all working out, isn't it?

S&P emerged from its scandal more powerful than ever. Its latest ruling is a politically useful one that provides cover for an unpopular move, and Republicans (as well as some Democrats) are already using that way. PCCC polling shows that 80% of voters polled in the front-line states oppose cutting Social Security, Medicaid, and Medicare to fix the deficit, and strong majorities want higher taxes for the wealthy. (Note to those who say they're looking for the "center": You just found it.)

Now the stars are aligning in a way that lets politicians do exactly what the public doesn't want. Democrats and Republicans can each blame each other, and they can both blame Standard & Poor's "objective" findings. The passage of this wildly unpopular economic program could become a murder scene with no fingerprints - and with more suspects than an Agatha Christie novel.

And like an Agatha Christie novel, they might all turn out to be guilty - that is, unless Democrats in the House and Senate hold the line against any agreement that hits the poor and middle class while sparing the wealthy.

Speaking and listening

"The question isn't whether S&P should be listened to," says Ezra Klein. "It's whether the market will listen to them." But even that's not the right question. It's not "who's listening to Standard & Poor's?" but "who is Standard & Poor's listening to?"

We may never know. But politicians are still required to ask voters a question from time to time, too: Can I count on your vote? If your answer depends on the way they handle these deficit talks, this would be a good time to let them know.

They've heard from Standard & Poor's, but they probably haven't heard from you.

Richard (RJ) Eskow, a consultant and writer (and former insurance/finance executive), is a Senior Fellow with the Campaign for America's Future. This post was produced as part of the Curbing Wall Street project.

Richard can be reached at "rjeskow@ourfuture.org."

Coup d'Etat: Standard & Poor's Is Now Giving Orders to Congress ... and the American People

Richard Eskow — Mon, 30 Aug 2010 15:09:07 -0400

There's been a lot of talk recently about the enormous power that's been given to the Deficit Commission, which is co-chaired by Alan "Social Security recipients are milking it" Simpson and dominated by people who have advocated cuts to Social Security and Medicare. But here's an aspect of the story that's gone unremarked: Standard & Poor's, the credit rating agency whose reputation should rightfully have been shattered by the economic crisis, is now dictating policy to the United States government. S&P just put our elected officials on notice: Submit to the proclamations of the Deficit Commission or we'll downgrade our rating of government debt.

That's blackmail, plain and simple. This threat comes from a privately-owned company whose rating process is riddled with conflicts, and which has gotten virtually every critical assessment of recent years spectacularly wrong. Enron? Lehman? Subprime mortgages? They were zero for three. Yet rather than reining back their penchant for reckless proclamations, the chairman of S&P's "sovereign rating committee" said that our elected officials' response to the Deficit Commission would be crucial to its analysis of US debt. John Chambers said last week: "It is very important for the credit standing of the United States that the Congress considers very carefully what the fiscal commission proposes." Just in case his intent wasn't clear enough, he added: "It is very important for Congress to take the required steps."

"Sovereign" is right. That's a kingly proclamation.

Bear in mind, we supposedly don't know yet what the Deficit Commission will propose. (We have a good idea, of course, since both the Democratic and Republican co-chairs are long-time advocates for cutting Social Security.) The total extent of the Commission's recommendations, and the extent to which they'll actually provide financial stability, are supposed to be completely unknown at this point. S&P's statement isn't an analysis, since there's nothing to analyze. It's a threat: Turn your authority as elected representatives over to this unelected body or we'll cause financial damage to the United States Government.

It's not a hollow threat, either. This statement was made one day after S&P downgraded Ireland's debt. A downgrade could cause massive harm to the United States government at a time of extreme difficulty. Debt could be harder to obtain, and it would become more expensive. That, in turn, would plunge the US deeper into debt. So who, exactly, is issuing this warning? What kind of credibility do they have?

Standard & Poor's is a division of McGraw-Hill, a publicly traded publishing company. They are a for-profit company, as is their fellow rating agency Moody's (which issued a similar threat last March). Both of these for-profit companies have eagerly pursued the very institutions they were rating, to disastrous effect. Internal documents obtained by the Levin Subcommittee showed that both Moody's and S&P let the profit motive compromise their judgments in the run-up to the economic meltdown. As we noted in a previous analysis, one internal S&P email said this about a rating they did for a customer: ""I don't think this is enough to satisfy them. What's the next step?"

Here's another example of S&P's integrity. When an analyst asked to review loan files for a security he was asked to rate, his supervisor told him the request was "TOTALLY UNREASONABLE!"

And consider this reported comment, which occurred during exploratory acquisition talks with investment research company Morningstar: "The S&P people insisted to Joe Mansueto (Founder/Chairman) that he was leaving big mounds of money on the table by not charging mutual funds for their 'star' ratings. Joe replied to the S&P bidders that it was an obvious conflict of interest to charge the funds for their own ratings -- how would Morningstar maintain its independence? They called him naive -- and stopped the merger talks."

The comments, though unconfirmed, have not been denied. Expert money manager Barry Ritholtz, who reported the story, indicated his confidence in his source and added, "This anecdote rings rather true to me."

Moody's fared even worse in our review of Levin Subcommittee documents. Of four key objectives for its Structured Finance Group, responsible for ratings, "high quality ratings and research came in dead last - behind "generating increased revenue," "increasing market share ...," and "fostering good relationships with issuers and investors."

Get the picture?

Why would companies like Standard & Poor's and Moody's issue threats of this kind? There could be many reasons. One might be to please its corporate clients, who would like to see government spending cut for both ideological and business reasons. Another might be to encourage cuts in Social Security because, under current proposals from both parties, that would place more retirement savings in funds and accounts managed by S&P's key clients. Moody's may also legitimately believe that the deficit needs to be reduced immediately, which is debatable on economic grounds. But if the Moody's action was arguable, S&P's statement is indefensible.

The ratings agency system is broken. These private companies have accrued enormous power without earning it. A lot of that power has been handed to them by government actions that rely on their ratings. That's why the Senate voted for the Franken Amendment, which -- while leaving these companies private -- would have removed the inevitable conflict of interest that's created when they compete for business. (The House/Senate Conference eliminated the Franken Amendment, calling instead for a two-year study. While the final bill is weighted toward an action of the kind called for by Franken's amendment, two years gives lobbyists a long time to influence the outcome.)

Standard & Poor's are called "agencies," but they should be called by their proper name: For-profit companies. These "ratings companies" have undermined the free market by allowing powerful issuers and investors to influence their own ratings. Markets with bad information - information that's bought and paid for - aren't really "free."

Now the "rating companies" are targeting the democratic process, too. We need a national discussion about the proper role of these companies, before they cause even more damage. Standard & Poor's should be reprimanded for its inappropriate and unprofessional intrusion into the working of government. And everyone needs to be reminded: Neither Congress nor the Executive Branch can 'outsource' the democratic process. They are our elected representatives. They must not be forced to submit to conflict-ridden private companies with a track record of failure.

Law and Order: AIG

Richard Eskow — Tue, 01 Jun 2010 19:48:12 -0400

President Obama's Department of Justice announced last week that there would be no indictments in the collapse of AIG, an event which led to a worldwide economic collapse and cost the American taxpayer trillions. As someone who once worked for AIG I was shocked, but apparently that's how this mystery ends: Hundreds of millions of victims, smoking guns in every room, and not a perp to be found anywhere.

Yves Smith is disappointed that PriceWaterhouseCoopers, the auditors who signed off on AIG's financial claims despite mounds of disturbing evidence, escaped serious legal scrutiny. She observes that our "Potemkin" financial reform (her word) won't remove the barriers that prosecutors face in pursuing secondary parties like auditors (although I believe the Supreme Court ruling she cited only addressed civil suits.) Not only is the auditor protected, but that allows the fraudster himself to use the defense that he kept his auditor informed - kind of like Bush and Cheney using John Yoo's legal opinion to inoculate themselves from criminal prosecution.

Here's another possible reason there won't be a prosecution: Our economy was shattered by a syndicate, a ring, a cabal at the top of the financial pyramid. To move against any one of them - AIG's Joe Cassano, the auditors, Goldman Sachs, or even the credit agencies - would trigger a chain reaction of rats turning on one another, summoning each other to testify, and spilling each other's dirty secrets in an attempt to save themselves.

Of course, that's exactly what most prosecutors want. But doing that could topple that pyramid at the top of our economy, and it looks like our leaders don't recognize that this would be a good thing. We must protect the booming stock market, whatever it takes. If it means leaving the con artists in power, leave 'em in power. If it mean breaking America's longstanding social contract in the name of "deficit reduction," that's okay too. (There's an irony in the fact that Great Britain's new government is under pressure to make cuts to keep its AAA rating. and that we may be next. The ratings agencies are part of the problem, and now it looks like they're controlling governments instead of the other way around.)

Was there reasonable suspicion regarding Cassano and AIG Financial Products? Let's review the record: AIG paid $80 million to settle criminal charges against Cassano's unit in 2004 when it helped PNC Financial conceal assets. AIG didn't just pay a settlement. It also signed a deferred prosecution agreement with the Justice Department leaving it open to criminal prosecution if it misbehaved again. (There's a good timeline here.)

After that Cassano kept reassuring the public - and investors - that his products were safe throughout 2007. (It's illegal to mislead investors.) Cassano fought the independent auditor who was brought in to watch his books, preventing him from looking at certain critical books of business and eventually driving him to resign. Cassano insisted that PwC stay out of his way when he prepared for a presentation to investors in December 2007 (hello, Securities and Exchange Commission!)

Then, of course, all hell broke loose. With that history, why didn't Cassano face trial? As the Wall Street Journal reports, "prosecutors obtained information about Mr. Cassano's disclosures to AIG senior executives and AIG's outside auditor, PricewaterhouseCoopers LLP. That changed the course of the investigation, these people said." So he stonewalled the outside auditor, but he shared info with the cozy inside one? Apparently a compliant auditor is even better than a Father Confessor - you're absolved when you tell him your sins, and he'll never give you "go and sin no more" nonsense.

PriceWaterhouseCoopers weren't just AIG's auditors. They were Goldman Sachs', too. That's right: they had another huge contract with the counterparty whose thirteen billion dollar claim was paid in full on the instructions of Tim Geithner's New York Federal Reserve. So PwC let two massive financial institutions engage in a highly speculative venture - one possibly misleading the other - and raised no warning flags.

Publicly traded companies are required to disclose corporate threats in their 10-K statements, which are approved by their auditors. Here's what AIG said in its 2005 statement (buried several pages into the "Risk Factors" section): "AIG's liquidity could be impaired by an inability to access capital markets or by unforeseen significant outflows of cash." (Gee, ya think?) That's about it for risks. PwC either ignored or missed the warning signs as AIG accumulated losses great enough to break the world's economy.

How have they suffered for this dismal track record? Their revenues rose 8% to $28.2 billion in 2008, and operating profits grew in the fiscal year ending June 2009. And why not? A lot of businesses enjoy the, uh, shall we say flexibility that comes with an auditor like that. Of course, there's no proof their conduct was criminal. They may have just overlooked the worst meltdown in modern financial history.

How about the ratings agencies? The warning signs were there: A plea deal on a charge of criminal fraud, ongoing negotiations with the New York Attorney General, leading economists expressing concern about the stability of the housing market. Yet remarkably (or not), leading ratings agencies S&P and Moody's were rating AIG well right up until September of 2008, when it became clear that it had already lost $18.5 billion and the worst was yet to be revealed. Until that point, S&P had given AIG's counterparty deals the top rating of A-1+, which means "obligor's capacity to meet its financial commitment on the obligation is (very) strong."

In 2007, well after the Spitzer investigation was underway, Best's affirmed that in its judgment AIG's creditworthiness was "superior," saying that "AIG's renewed focus on accounting integrity and future successful remediation of accounting concerns provides a level of stability."

Accounting integrity? Write your own joke, as Ed McMahon used to say. When it comes to PwC and the ratings agencies, Upton Sinclair got it right: "It is difficult to get a man to understand something when his job depends on not understanding it."

We've already reviewed the emails and internal documents showing that ratings agencies were always selling their services to these institutions, a hopeless conflict of interest. The Franken Amendment would improve that situation significantly, but there's no guarantee it will survive the House/Senate negotiations - which should be fully transparent to the public (sign the petition to televise them here, folks.)

My own background as an AIG exec adds an extra dimension to my sense of outrage. The company was destroyed by the ratings agencies, the auditors, and Goldman Sachs (AIG's replacement CEO, Edward Liddy, served on the Goldman board). I heard horror stories about hard-working people who had nothing to do with the scandal receiving death threats or having to pull their kids out of school. Joe Cassano kept his ill-earned salary and bonuses, and for a while after he left was paid $1 million every month at Liddy's behest. PwC had a boom year, and the ratings agencies still (remarkably) have some credibility.

But a once-thriving company is dead. We've paid hundreds of billions of dollars directly, and trillions of dollars indirectly. 15 million people are out of work. The gamblers in the Wall Street casino are still placing bets, secure in the knowledge we'll cover their debts. As they said about Nicky in Casino, they "had a good system: When they won, they collected. When they lost, they told the bookies to go f**k themselves."

And now we're told that nobody's guilty. That's getting it backward. It's like Murder On the Orient Express: They all did it. But apparently we're the only ones who are going to pay for it.
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(We'll be discussing financial reform and other critical issues with Simon Johnson, Nancy Pelosi, Alan Grayson, Robert Kuttner, Arianna Huffington, Bob Herbert, and a host of other luminaries at the Campaign For America's Future Annual Conference on June 7-9.(1) Walk-ins welcome! More info here. Come on in!)

(1) As they (never) taught me on Wall Street, "always be closing."

The Rating Game: PowerPoints and Emails Illustrate Franken's Victory

Richard Eskow — Thu, 13 May 2010 16:24:30 -0400

PowerPoints, emails, and transcripts obtained by Sen. Carl Levin's Permanent Subcommittee on Investigations illustrate the real magnitude of Sen. Al Franken's victory today. Sen. Franken was able to pass an amendment which eliminates the conflict of interest that's created when ratings agencies "compete for business." It passed the Senate in a 64/35 vote - and it was a bipartisan victory, no less, with 10 Republicans joining 54 Dems to support it.

Here's how broken our current system has become: Not only are the ratings agencies competing as for-profit businesses, but our two largest agencies are publicly traded companies. That means they don't just worry about making a profit. They also have to worry about impressing the stock market on a quarterly basis to boost their stock prices and further enrich their executives. And who influences stock prices the most? Traders on Wall Street, who are also the agencies' customer base and the objects of their scrutiny.

Nowhere is this inherent conflict of interest better illustrated than in a PowerPoint presentation which consultants gave to Moody's Investor Service in 2002. Consultants held focus groups and conducted interviews with key Moody's executives and associates in the Structured Finance Group (SFG), which is responsible for rating complex and potentially risky financial products. Here's the money shot:

Got that? The people responsible for rating risky financial instruments thought their business objectives were "increased revenue," "increasing market share," and "fostering good relationships" (with issuers before investors). Seemingly as an afterthought, the Moody's group added that they should develop "high quality ratings and research." An equally critical paragraph appears further down on the same slide:

"When asked about how business objectives were translated into day-to-day work, most agreed that writing deals was paramount, while writing research and developing new products and services received less emphasis. Most agreed that there was a strong emphasis on relationships with issuers and investment bankers." (emphasis mine)

In other words, getting more business came first - hence the mentions of revenue, market share, and pleasing the issuers and investment bankers who drive those numbers. Research got "less emphasis." And why wouldn't that be the case? Moody's parent corporation (which is listed on the New York Stock Exchange as MCO) has quarterly earnings to meet. So does its principal competitor, Standard & Poor's. S&P is a division of publicly traded McGraw-Hill (NYSE:MHP), with annual revenues of $2.61 billion for 2009 (that's nearly 44% of the parent company's $5.95 billion in revenue).

No wonder the Levin Subcommittee found internal emails like this one from S&P: "I don't think this is enough to satisfy them. What's the next step?" Even more telling is this question from the transcript of the "Managing Director's Town Hall Meeting" at Moody's in September of 2007. Managing Director Raymond McDaniel was asked about "the financial outlook for the rest of the year." The question continued: "... my thinking is there's a much greater concern about the franchise. Everyone in this room is a long-term investor (ed: presumably in Moody's stock), for sure ... It's disheartening ... to see what's going on with the stock price."

In other words, the people entrusted with rating financial products are concerned about the value of the stock they hold in their own company ... which is driven by the actions of the people they're rating! McDaniel responded that critics "are not going to find anything at Moody's in terms of corrupt or bad actions."

To that point, New York Attorney General Andrew Cuomo is investigating eight banks for allegedly having given false information to Moody's and its competitors. The New York Times also reports that sources say Cuomo is "interested in the revolving door of employees of the rating agencies who were hired by bank mortgage desks to help create mortgage deals that got better ratings than they deserved." The Cuomo investigation was sparked by an earlier Times report which said that "Wall Street was given access to the formulas behind those magic ratings -- and hired away some of the very people who had devised them."

Ratings agencies were then shocked -- shocked -- to learn that banks might have manipulated their models - models which they freely gave to them as their "customers." Yves Smith considers it very plausible that the ratings agencies were "duped, rather than dumb" - or worse, complicit. But these possibilities are not mutually exclusive. At the very least, Levin Subcommittee exhibits like the Powerpoint slide, internal emails, and Moody's Town Hall transcript show that it was in the agencies' financial interest not to know the truth.

The Franken Amendment fixes this problem by directing the SEC to create a board that will assign one rating agency to rate each new issue-backed security. The majority of seats on the board would go to investors. (More detail here.) As Sen. Franken explained during today's debate, the system would provide incentives for accuracy (rather than for ratings that please issuers), and the board is self-governing. Issuers would be free to seek other ratings once the board-approved agency had made its conclusion.

While the amendment passed today, it does have opponents. In an uncharacteristically inarticulate floor speech today, Sen. Chris Dodd opposed the bill for reasons he couldn't quite specify, saying that it made him "uneasy" and he "wasn't sure it was sound." Since the reasons for his opposition were unclear, it's equally unclear whether any deals might be underway to weaken the amendment with other provisions during the negotiation process.

Hopefully that can't or won't happen, but the mentality and the power base that create our current ratings agency problem is alive and well. Sen. Franken has won an important victory today, and it needs to be defended at all costs.

(Note to my fellow observers and scribes: Now that he's helped transform the financial world, can we please write about Sen. Franken without making "playful" references to his entertainment career? He's earned that.)