S&P

The Rating Game: PowerPoints and Emails Illustrate the Play-For-Play "Agencies" Scheme

Richard Eskow — Sat, 06 Aug 2011 13:22:27 -0400

(Reposted from May of last year to commemorate the S&P "downgrade." The "agency" scams have since spent millions in lobbying money to weaken and delay the Franken Amendment and other urgently needed reforms.)

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.)

Fix Foreclosure Fraud With a Borrowers' Bill of Rights

Richard Eskow — Thu, 20 Jan 2011 02:20:54 -0500

People are debating the need for a "systemic fix"to address the foreclosure crisis. What we really need is a systemic redesign, from the ground up. Fortunately, the design was laid down centuries ago - by 800 years of law, and by the idea that free people are entitled to limit the unwarranted power of others over their persons and property. These principles are a good foundation for structuring future negotiation, legislation, or regulation.

The President wooed corporate executives this week with a Wall Street Journal editorial called "Toward a 21st Century Regulatory System." What we really need is a 21st century banking system, built on ancient principles and not fly-by-night profiteering.

You could encode those principles in a document and call it the Borrower's Bill of Rights. You could even call it the Mortgage Magna Carta, since some of the basic principles involved date back that far.

People are taking action. The Commonwealth of Virginia is debating a law that would restore some basic homeowner rights and would severely restrict the use of MERS, a database and pseudo-company created by the mortgage industry to bypass property law and expedite the buying and selling of bundled mortgages at something approaching the speed of light. Homeowners and investors in mortgage-backed securities are teaming up against the banks (although they'll part way again soon, since their interests conflict in many ways). Attorneys General from all 50 states are conducting a joint investigation and are negotiating with the major banks. FDIC Chair Sheila Bair wants to create a "claims commission" for wrongly foreclosed homeowners, like the claims program for victims of the BP disaster in the Gulf.

These efforts are good, but they lack a unifying principle. Even the idea of a "systemic fix" or "systemic redesign" doesn't go far enough, because it doesn't establish the foundation for redesign. What's needed is a new charter, a new set of rights and principles for people who engage with the banking system (or have rescued it with their tax dollars). These "borrower's rights" would stabilize the banking system and protect both investors and stockholders. That means we're not talking about a socialist revolution, just the rule of law and sound business practices.

Let's not pretend that we live in a system where anyone who doesn't like the terms of a loan can turn it down. Banks operate in close collusion, so if you want to borrow you'll have to do it on their terms. It's an asymmetrical relationship. People can't turn these loans down individually, but they can set the rules of the road as a society, by working through their elected representatives.

What would those rules of the road, these borrower's rights, look like? Let's throw out a few to get the ball rolling:

1. Contracts must be honored. As banks sold mortgages to each other, the new mortgage holder often ignored many of the terms of the original loan. Due dates, penalties, and other provisions were unilaterally changed, often with no notice to the borrower until the penalties started showing up. A contract is an agreement between both parties, and it must be understood that if a bank breaches its terms that bank has broken the contract.

2. State and local laws can't be overruled by private enterprise. MERS was created to bypass the law by naming itself as the "owner" of mortgages that it freely admitted it didn't own. It was a dummy corporation, but we were the dummies for letting it happen. MERS permitted banks to foreclose without proper documentation, without holding the deed to the property, and without giving the homeowner his or her day in court.

From the Magna Carta, 1215 C.E.: "No free man shall be seized or imprisoned, or stripped of his rights or possessions, or outlawed or exiled, or deprived of his standing in any other way, nor will we proceed with force against him, or send others to do so, except by the lawful judgement of his equals or by the law of the land."

3. Real-world assets (like homes) can't become digital gambling chips. They must be backed by deeds and other documents that link them with reality. Mortgage bankers will tell you MERS was created just to make transactions faster and easier. There's nothing wrong with electronic databases and exchanges. But you can attach the digital image of a deed or court record very, very easily. By not requiring that these documents be obtained and registered in county courthouses, it became too easy to flip mortgages in the speculative market.

If this 'digital gaming' system didn't create the housing bubble and market collapse, it certainly made it more likely. The process needs to decelerate a little to stabilize the economy. There's nothing wrong with electronic databases, but it's easy to attach the image of a document to any computer record. That reconnects the economic virtual reality of the bankers with the physical (and legal) reality where actual people live in actual homes.

4. If you break the law, you pay the price. No more retroactive immunity, easy plea-bargain deals, or soft fines for bank crimes. What's more, if a bank exectutive breaks the law, the fine must be paid by the executive, not the bank's shareholders.

And how about a little jail time now and then? If you launder drug money for the Mexican cartels and don't wind up in the joint - just because you're a banker - then the criminal justice system needs a "systemic fix" too. Remember: If you can't do the time, don't do the crime.

5. When you cut a plea-bargain deal, or get rescued by the taxpayer, you must admit your wrongdoing. We said no "easy" deals or cushy settlements. There will be deals and settlements, of course. But an admission of wrongdoing should be required in every case. And it should be issued publicly, by the bank's CEO.

(I'm lookin' at you, Jamie Dimon! That Alabama corruption case was really sleazy.)

6. No more clauses allowing the banks to enter "abandoned" homes. Banks have been forcing this provision into their contracts for years. (Remember, it's not a symmetrical negotiation between two equal parties.) This provision has been the source of many abuses, and it should be outlawed. If a bank thinks it has the right to seize a home, let it go to court like everybody else.

(See the Magna Carta quote, above. What is this - a Monty Python routine?)

7. Auditors must be legally liable if they certify sketchy and/or fraudulent bank programs as financially sound. PriceWaterhouseCoopers just skated on a technicality from an investors' lawsuit over allegedly fraudulent activities at AIG, in businesses which PWC certified to be sound. That's a miscarriage of justice.

If you should've known better - in PWC's case it was their job to know, and it's impossible to imagine how they could not have known - you should pay the legal price for your behavior. (Conflict alert: I used to work at AIG.)

8. We need ratings agencies that aren't inept, corrupt, compromised, or beholden to the companies they're rating. And yes, I do mean S&P and Moody's. Their iternal emails and other documents showed they were morally compromised at best,. Tthey got everything wrong. They rated the worst junk in the world "AAA." They were a fundamental reason for the economy's collapse.

Raters should be able to rate - and when they call themselves "agencies," that should mean "agency" as in the EPA and not "agency" as in "ad agency." I'm not familiar with the work of Jules Kroll, but his new rating company sounds like a good idea. Rather than just read what the banks give him, he says he'll conduct due diligence and investigate them. What a concept - it sounds almost like a business. Or an agency.

9. If we rescue you, we call the shots.From now on, anybody who rescues a bank without creating strict rules of conduct going forward shall be deemed to have committed "regulatory malpractice." If one business rescues another - a manufacturer rescuing a supplier, for example - it takes a chunk of the profits and sets the terms for future deals. We rescued the big banks, did a victory dance just for getting our money back (they made a bundle off interest), and are still giving them sweet deals. What's more, they're sticking it to the American consumers who rescued them, every chance they get.

That's gotta stop.

10. Nobody gets rich by f*cking up. If you run your company into the ground, so that it will fail without massive taxpayer help, you're a failure in business. Period. If you pay yourselves massive bonuses after we rescue you, you're rewarding yourselves for being lousy at your jobs. (Here's a case in point.) That ends now. If anybody collects billions in payouts, it's us (see above).

And stop telling us you're worried about the deficit - it just gives us more reason to pay it down with the bonuses you couldn't have earned without us.

11. If you're collecting low (or zero) interest money at the Fed's "discount window," you better be lending it. Too many banks are collected those low-interest loans and investing it in non-productive areas, or flat-out speculating with it. Financial reform slowed that down a little, but didn't stop it. Lending is down, for both businesses and homeowners. So why is there such a long line at the discount window?

12. 'Claims Commissions' are good, but the list of acceptable claims should include fraudulent lending and inappropriate contract changes - and they shouldn't be limited to defaulting homeowners. Many underwater homeowners are paying loans that were deceptively issued and/or administered. The "claims commission" idea shouldn't be used to convince the public that only a few extreme cases are responsible for the problem. Millions of mortgages are defective, and should be repaired in a just way. Sounds like a job for the Claims Commission.

13. Banks shouldn't make money writing bad deals.Banks make money on bad deals when they own the servicing companies that collect fees and penalties. Even the best underwriting will miss a few risky borrowers. But the book of business at any major bank is saturated with defaulting or struggling homeowners. That means the bank wrote a lot of loans it shouldn't have written. By owning the servicers, banks can make money from their own bad judgment. And it's an egregious conflict of interest.

Banks shouldn't own servicing companies, or profit from their own underperformance in any other way.

14. Underwater homeowners shouldn't be bailing out hugely profitable banks. Sure, bank earnings are down for some banks this quarter (though others are doing spectacularly.) Whatever their margins, they're in a lot better shape than most underwater homeowners. So why aren't banks being asked to renegotiate the principal on some of these loans, especially primary residences? They're being bled dry so that banks don't have to admit they're sitting on a lot of artificially inflated assets. That's just prolonging the inevitable, at a high human cost.

The most moderate approach would be to say that banks and homeowners got into this mess together and should share the cost of getting out. I wouldn't be that "moderate."

15. After you've wrecked everything, don't make me listen to your complaints about regulation. This isn't exactly a "right," unless you count the right to be free from unwarranted intrusion of absurd ideas into a person's brain. But it's inhumane to make sensible people keep listening to whining about regulation - from executives who ran their own companies, their entire industry, and the complete freakin' world economy into the ground. The President shouldn't be apologizing for regulations in the Wall Street Journal. He should be reminding its readers that on the street for which that paper is named, highly paid executives brought their companies to the brink of ruin and had to be saved by the government they so freely disparage.

In the name of sanity and decency, let's stop hearing complaints about regulation from people whose unregulated actions caused a worldwide economic meltdown. What's next - gripes about radiation safety from the people who operated Chernobyl?

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These aren't randomly selected ideas. Together they re-establish the rule of law, anchor the lending process back in physical reality, reduce the "moral hazard" that lets bankers avoid the consequences of their actions, and restore balance between banks, government, and their trading partners.

As we said, they're mostly meant as food for thought. Better ones would be appreciated. But isn't it time we made the most important "systemic fix" of all - the one that repairs the broken link between a bank and the society in which it operates?

This post was produced as part of the Curbing Wall Street project.

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.

Warren Buffett, Rating Agencies and Corruption

Zach Carter — Wed, 02 Jun 2010 08:30:18 -0400

Today's Financial Crisis Inquiry Commission hearing on credit rating agencies promises to shed quite a bit of light on one of the most profitable and corrupt businesses in Corporate America. Rating agencies score huge profits regardless of how accurate their ratings prove, and thus never felt any serious pain from the financial crisis, despite the central role rating agencies played in the collapse.

The basic model for rating agencies like Moody's, Standard & Poor's and Fitch Ratings is a conflict of interest. These companies rate securities-- if a bank wants to package a bunch of mortgages into a security to sell to investors, the rating agencies stamp a rating on that security to indicate how safe the investment is. But Moody's et al do not get paid by the investors who use their ratings. Instead, they get paid by the banks that create and package the securities. That creates a clear incentive to inflate ratings in order to win more business from banks.

So not surprisingly, the rating agencies have a pretty terrible record. They slapped top-grade AAA ratings on trillions of dollars worth of mortgage-backed securities, only to watch those securities plummet in value and default like crazy when home prices started to decline in 2007.

Expect lots of discussion about the way whistleblowers at rating agencies were treated, and lots of damaging emails about rating agency top brass pressuring underlings to ignore clear signs of stress in securities they were rating.

But also pay close attention to the testimony of Berkshire Hathaway chief Warren Buffett. Buffett was once viewed as a financier who invested in quality firms and didn't hesitate to criticize major problems with the financial system. That reputation has been severely tarnished by the financial crisis and the following battle for financial reform-- Buffett spent decades criticizing the market for derivatives, but has since lobbied hard to protect his own derivatives interests. He's lobbied so hard, in fact, that Buffett's Senator, Democrat Ben Nelson of Nebraska, joined a Republican filibuster to block Wall Street reform.

Buffett has adopted a similar strategy on ratings. He's been very critical of rating agencies for years, all while owning a huge stake in Moody's, and making a killing off of it.

Nobody likes the rating agencies. Even staunch defenders of big Wall Street banks hate Moody's and Fitch and S&P because they provide a convenient scapegoat. But it's important not to loose sight of the fact that, even at their worst, rating agencies were essentially just acting as agents of the big banks. And despite this widespread animosity, rating agencies still hold a very prominent place in the global economy by rating sovereign debt. With Greece and Spain under intense budget pressure, rating agency downgrades of each nation's debt has a tremendous impact on bond markets and the ability of government's to finance basic public services. Moody's has been particularly nefarious in this respect, even threatening to downgrade U.S. government debt, despite no evidence of default, and heavy demand among investors for U.S. Treasury bonds.

All of these are major issues involving Wall Street reform, many of which are still up in the air as Congress moves to reconcile the House and Senate bills. Come to the America's Future Now! conference from July 7 through July 9 to hear from some of the top experts on these issues: Simon Johnson, Robert Johnson, Heather Booth, Heather McGhee, even Phil Angelides, the Chair of the FCIC, will all be there.

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."