{"id":1341,"date":"2013-09-08T07:00:29","date_gmt":"2013-09-08T11:00:29","guid":{"rendered":"http:\/\/www.dougsbriefcase.com\/blog\/?p=1341"},"modified":"2013-09-07T13:59:33","modified_gmt":"2013-09-07T17:59:33","slug":"crony-capitalism-goes-bad","status":"publish","type":"post","link":"https:\/\/www.dougsbriefcase.com\/blog\/crony-capitalism-goes-bad\/","title":{"rendered":"When Crony Capitalism Goes Bad"},"content":{"rendered":"

<\/p>

\"The<\/a>

The gov\u00adern\u00adment has final\u00adly found some\u00adone to blame for the mort\u00adgage melt\u00addown: S&<\/span>P, a rat\u00adings agency. But the accused says the gov\u00adern\u00adment has oth\u00ader motives. [Cred\u00adit: Boston Globe]<\/p><\/div>What hap\u00adpens to crony cap\u00adi\u00adtal\u00adism when things go bad\u00adly? Every\u00adbody lawyers up and charges and coun\u00adter\u00adcharges fly hard\u00ader and faster than in a nasty divorce.\n

That, at least, is what\u2019s hap\u00adpen\u00ading in the most sub\u00adstan\u00adtial gov\u00adern\u00adment reac\u00adtion yet to the hous\u00ading mar\u00adket melt\u00addown: a $5 bil\u00adlion civ\u00adil action<\/a> by the Jus\u00adtice Depart\u00adment against Stan\u00addard and Poor\u2019s. The gov\u00adern\u00adment alleges that S&<\/span>P, which rates res\u00adi\u00adden\u00adtial mort\u00adgage-back secu\u00adri\u00adties (RMBS<\/span>) and deriv\u00ada\u00adtives known as col\u00adlat\u00ader\u00adal\u00adized debt oblig\u00ada\u00adtions (CDOs), com\u00admit\u00adted mail, wire and finan\u00adcial insti\u00adtu\u00adtion fraud dur\u00ading the hal\u00adcy\u00adon days of the hous\u00ading bubble.<\/p>\n

S&<\/span>P\u2019s brief, filed last week in response to the charges, includes the claim that the Jus\u00adtice Depart\u00adment is pros\u00ade\u00adcut\u00ading them only because the rat\u00adings agency down\u00adgrad\u00aded its rat\u00ading of US<\/span> Trea\u00adsury debt<\/a>. S&<\/span>P stripped the US<\/span> gov\u00adern\u00adment of its gold-plat\u00aded AAA<\/span> rat\u00ading in 2011; none of its com\u00adpeti\u00adtors took that step. As far as S&<\/span>P is con\u00adcerned, this whole case is an act of retal\u00adi\u00ada\u00adtion by an Admin\u00adis\u00adtra\u00adtion still stung by the downgrade.<\/p>\n

The Jus\u00adtice Depart\u00adment, for its part, calls the claim \u201cpre\u00adpos\u00adter\u00adous<\/a>.\u201d  But maybe not.<\/p>\n

DOJ<\/span>\u2019s com\u00adplaint begins with a recita\u00adtion of how gov\u00adern\u00adment, rat\u00adings agen\u00adcies and large finan\u00adcial insti\u00adtu\u00adtions all worked togeth\u00ader to cre\u00adate the dodgy mort\u00adgage financ\u00ading struc\u00adture that gen\u00ader\u00adat\u00aded tril\u00adlions in rev\u00adenue before its col\u00adlapse. Banks would orig\u00adi\u00adnate mort\u00adgages, often with\u00adout prop\u00ader\u00adly assess\u00ading the abil\u00adi\u00adty of bor\u00adrow\u00aders to make pay\u00adments. They then would sell them off, some\u00adtimes to big\u00adger banks but more often to gov\u00adern\u00adment-spon\u00adsored enter\u00adpris\u00ades, known as Fan\u00adnie Mae and Fred\u00addie Mac. Fan\u00adnie, Fred\u00addie and oth\u00ader finan\u00adcial insti\u00adtu\u00adtions would then bun\u00addle the mort\u00adgages into securities.<\/p>\n

That\u2019s where rat\u00adings agen\u00adcies came in. In exchange for fees, S&<\/span>P, Moody\u2019s and oth\u00ader rat\u00adings firms would grade the bun\u00addle of mort\u00adgages. Typ\u00adi\u00adcal\u00adly, an RMBS<\/span> or CDO<\/span> would car\u00adry rat\u00adings from at least two agen\u00adcies. The bet\u00adter the rat\u00ading, the hap\u00adpi\u00ader the issuer (Fan\u00adnie, Fred\u00addie or a pri\u00advate bank) who paid for the rat\u00adings. Gov\u00adern\u00adment involve\u00adment fig\u00adured in here as well. In addi\u00adtion to accred\u00adit\u00ading the rat\u00adings agen\u00adcies, it required that fed\u00ader\u00adal\u00adly insured banks pur\u00adchase only \u201cinvest\u00adment grade\u201d secu\u00adri\u00adties, those that got a rat\u00ading of at least BBB-<\/span>. Reg\u00adu\u00adla\u00adtions were stricter for cred\u00adit unions, which were required to hold secu\u00adri\u00adties that received at least an AA-<\/span> rat\u00ading from at least one rat\u00adings agency.  Anoth\u00ader rea\u00adson why issuers cov\u00adet\u00aded high rat\u00adings from S&<\/span>P and others.<\/p>\n

This inces\u00adtu\u00adous rela\u00adtion\u00adship between gov\u00adern\u00adment and banks worked well for all involved. At one point, S&<\/span>P had rat\u00aded $4 tril\u00adlion<\/a> worth of RMBS<\/span> and CDOs, gen\u00ader\u00adat\u00ading sub\u00adstan\u00adtial rev\u00adenue. Banks and investors also were doing well. So were bor\u00adrow\u00aders. Peo\u00adple were liv\u00ading in homes they couldn\u2019t afford and ris\u00ading hous\u00ading prices were turn\u00ading hous\u00ades into ATMs, as peo\u00adple bor\u00adrowed against illu\u00adso\u00adry equity.<\/p>\n

But noth\u00ading lasts for\u00adev\u00ader, par\u00adtic\u00adu\u00adlar\u00adly when it rests on a foun\u00adda\u00adtion of bad cred\u00adit. The results are well known \u2013 the col\u00adlapse of hous\u00ading prices, fore\u00adclo\u00adsures, bank fail\u00adures, bailouts, reces\u00adsion, per\u00adsis\u00adtent\u00adly high unem\u00adploy\u00adment and an econ\u00ado\u00admy still slog\u00adging through a slug\u00adgish recov\u00adery. The cul\u00adprits, it would seem, are every\u00adwhere: banks who lent to peo\u00adple who couldn\u2019t pay them back, bor\u00adrow\u00aders who took on more debt than they could han\u00addle, the gov\u00adern\u00adment that encour\u00adaged and sub\u00adsi\u00addized such behav\u00adior and induced banks to load up on RMBS<\/span> and CDOs, and rat\u00adings agen\u00adcies who cer\u00adti\u00adfied the qual\u00adi\u00adty of those instruments.<\/p>\n

But for all of that, the Jus\u00adtice Depart\u00adment would have us believe that they have found the true vil\u00adlain: S&<\/span>P.<\/p>\n

\u201c<\/span>S&<\/span>P\u2019s desire for increased rev\u00adenue and mar\u00adket share in the RMBS<\/span> and CDO<\/span> rat\u00adings mar\u00adkets led S&<\/span>P to down\u00adplay and dis\u00adre\u00adgard the true extent of the cred\u00adit risks posed by RMBS<\/span> and CDO<\/span> tranch\u00ades in order to favor the inter\u00adests of large invest\u00adment banks and oth\u00aders involved in the issuance of RMBS<\/span> and CDOs who select\u00aded S&<\/span>P to pro\u00advide cred\u00adit rat\u00adings for these tranch\u00ades.\u201d [pp. 2\u20133<\/a>]<\/p><\/blockquote>\n

S&<\/span>P, accord\u00ading to the gov\u00adern\u00adment, delib\u00ader\u00adate\u00adly engaged in grade infla\u00adtion to entice issuers like Fan\u00adnie, Fred\u00addie and the big invest\u00adment banks to pay them, rather than their com\u00adpeti\u00adtors, to rate their securities.<\/p>\n

In its response brief, the rat\u00adings agency flat\u00adly denied that it cooked the rat\u00adings to col\u00adlect more fees than its competitors.<\/p>\n

\u201c<\/span>S&<\/span>P Rat\u00adings did not antic\u00adi\u00adpate the full speed, sever\u00adi\u00adty, and breadth of the col\u00adlapse of the hous\u00ading mar\u00adket and its impact on the econ\u00ado\u00admy as whole. S&<\/span>P Rat\u00adings was not alone. Oth\u00ader rat\u00ading agen\u00adcies that have not been charged with fraud or mis\u00adcon\u00adduct by the Unit\u00aded States issued rat\u00adings sim\u00adi\u00adlar to and often iden\u00adti\u00adcal with those of S&<\/span>P Rat\u00adings. Indeed, every CDO<\/span> tranche cit\u00aded in the Com\u00adplaint received iden\u00adti\u00adcal rat\u00adings from S&<\/span>P Rat\u00adings and at least one oth\u00ader rat\u00ading agency.\u201d [p. 3<\/a>]<\/p><\/blockquote>\n

S&<\/span>P notes that its rat\u00adings did not dif\u00adfer from those of its com\u00adpeti\u00adtors, sug\u00adgest\u00ading that it was no more sub\u00adjec\u00adtive \u2013 and no less mis\u00adtak\u00aden \u2014 than they.  The brief also argues that the agency was not alone in fail\u00ading to antic\u00adi\u00adpate the impact and mag\u00adni\u00adtude of the hous\u00ading mar\u00adket col\u00adlapse. It reminds the Jus\u00adtice Depart\u00adment that none of the par\u00adties that ben\u00ade\u00adfit\u00aded by help\u00ading inflate the hous\u00ading bub\u00adble \u2013 includ\u00ading its biggest abet\u00adtors, the Trea\u00adsury Depart\u00adment, the Fed\u00ader\u00adal Reserve, Fan\u00adnie Mae, Fred\u00addie Mac and a panoply of gov\u00adern\u00adment reg\u00adu\u00adla\u00adtors \u2013 fore\u00adsaw its com\u00ading col\u00adlapse. Then-Trea\u00adsury Sec\u00adre\u00adtary Hank Paul\u00adson said at the time that it wasn\u2019t a \u201cseri\u00adous prob\u00adlem<\/a>\u201d and Fed\u00ader\u00adal Reserve Chair\u00adman Ben Bernanke said after\u00adward that he nev\u00ader saw the cri\u00adsis com\u00ading<\/a>.<\/p>\n

If they missed it, why would the Jus\u00adtice Depart\u00adment sin\u00adgle out S&<\/span>P for blame? Because, the brief argues, only S&<\/span>P had the temer\u00adi\u00adty to down\u00adgrade US<\/span> gov\u00adern\u00adment debt.<\/p>\n

\u201c<\/span>Only S&<\/span>P Rat\u00adings down\u00adgrad\u00aded the Unit\u00aded States and only S&<\/span>P Rat\u00adings has been sued by the Unit\u00aded States, even though the S&<\/span>P rat\u00adings chal\u00adlenged by the Unit\u00aded States were no dif\u00adfer\u00adent than those of at least one oth\u00ader rat\u00ading agency.\u201d [p. 70<\/a>]<\/p><\/blockquote>\n

If that sounds a bit dra\u00admat\u00adic and vague\u00adly implau\u00adsi\u00adble, the Jus\u00adtice Department\u2019s rebut\u00adtal hard\u00adly con\u00advinc\u00ading. DOJ<\/span> notes that it began its inves\u00adti\u00adga\u00adtion of S&<\/span>P in 2009. That\u2019s true, but it didn\u2019t file charges until Feb\u00adru\u00adary 2012, months after the agency down\u00adgrad\u00aded US<\/span> Trea\u00adsury debt. The down\u00adgrade was well known and wide\u00adly report\u00aded at the time. Was pres\u00adsure put on the department\u2019s pros\u00ade\u00adcu\u00adtors to pro\u00adceed with a complaint?<\/p>\n

S&<\/span>P will have a dif\u00adfi\u00adcult time prov\u00ading that the DOJ<\/span> act\u00aded improp\u00ader\u00adly. That would not, of course, make S&<\/span>P inno\u00adcent of hand\u00ading out decep\u00adtive\u00adly good rat\u00adings. The DOJ<\/span> com\u00adplaint is filled with alle\u00adga\u00adtions that they did, alle\u00adga\u00adtions that may hold up in court despite S&<\/span>P\u2019s denials. That is some\u00adthing for the courts to sort out.<\/p>\n

What is evi\u00addent is that S&<\/span>P was but one crony among many in a scheme that dis\u00adtort\u00aded hous\u00ading prices. For\u00adtunes were made on this scheme, which depend\u00aded on entan\u00adgle\u00adments between gov\u00adern\u00adment and big finan\u00adcial institutions.<\/p>\n

Had S&<\/span>P reduced its rat\u00adings of these instru\u00adments when things were going well, they would like\u00adly have incurred the wrath, not only of the banks who were buy\u00ading and sell\u00ading the secu\u00adri\u00adties, but of the gov\u00adern\u00adment itself. Fan\u00adnie and Fred\u00addie would not have react\u00aded well to a down\u00adgrade of their finan\u00adcial instru\u00adments. Nor would their reg\u00adu\u00adla\u00adtor. Wall Street titans who bun\u00addled the secu\u00adri\u00adties also would have been enraged and looked to oth\u00ader agen\u00adcies to rate their secu\u00adri\u00adties, poten\u00adtial\u00adly cost\u00ading S&<\/span>P hun\u00addreds of mil\u00adlions in lost fees. Com\u00admu\u00adni\u00adty banks and cred\u00adit unions, who car\u00adried the RMBS<\/span> and CDOs on their bal\u00adance sheets as part of their cap\u00adi\u00adtal reserves, would have said the S&<\/span>P down\u00adgrades would impair their capac\u00adi\u00adty to lend to house\u00adholds and small busi\u00adness\u00ades and lob\u00adbied the gov\u00adern\u00adment to act.  Con\u00adgress would have react\u00aded, alleg\u00ading that S&<\/span>P was jeop\u00adar\u00addiz\u00ading its goal of expand\u00ading home\u00adown\u00ader\u00adship. The polit\u00adi\u00adcal pres\u00adsure on the rat\u00adings agency would have been enor\u00admous. There may even have been calls for an inves\u00adti\u00adga\u00adtion into its rat\u00adings practices.<\/p>\n

But S&<\/span>P did not stray from the herd. It con\u00adtin\u00adued to assign invest\u00adment-grade rat\u00adings to RMBS<\/span> and CDOs that sub\u00adse\u00adquent\u00adly cratered. The gov\u00adern\u00adment says that its behav\u00adior was will\u00adful. S&<\/span>P says that it was caught up in the same dynam\u00adic as home\u00adown\u00aders, mort\u00adgage orig\u00adi\u00adna\u00adtors, invest\u00adment banks, gov\u00adern\u00adment-spon\u00adsored enter\u00adpris\u00ades, investors, and the gov\u00adern\u00adment, includ\u00ading the Sec\u00adre\u00adtary of the Trea\u00adsury and the Chair\u00adman of the Fed\u00ader\u00adal Reserve, all of whom played impor\u00adtant roles in cre\u00adat\u00ading the bub\u00adble and bear a share of the blame for the sub\u00adse\u00adquent misery.<\/p>\n

But admit\u00adting shared guilt is not how crony cap\u00adi\u00adtal\u00adism works. Once bub\u00adbles burst, it\u2019s every crony for him\u00adself. The trick is to avoid blame by shift\u00ading it to oth\u00aders. Of all the cronies, gov\u00adern\u00adment bears the largest share of the blame. It also is the one insti\u00adtu\u00adtion with the legal author\u00adi\u00adty, not only to blame oth\u00aders, but to brand them as criminals.<\/p>\n

The gov\u00adern\u00adment has decid\u00aded to charge S&<\/span>P, as though the prob\u00adlem wasn\u2019t with the RMBS<\/span> and CDOs them\u00adselves or the wide\u00adspread excess that inflat\u00aded their val\u00adue, but with one of the agen\u00adcies that, like its com\u00adpeti\u00adtors, assigned them high rat\u00adings. How the Jus\u00adtice Depart\u00adment arrived at this deci\u00adsion remains a mys\u00adtery. But it is cer\u00adtain\u00adly pos\u00adsi\u00adble that S&<\/span>P sealed its fate as a scape\u00adgoat when it down\u00adgrad\u00aded the government\u2019s debt.<\/p>\n","protected":false},"excerpt":{"rendered":"

What hap\u00adpens to crony cap\u00adi\u00adtal\u00adism when things go bad\u00adly? Every\u00adbody lawyers up and charges and coun\u00adter\u00adcharges fly hard\u00ader and faster than in a nasty divorce.<\/p>\n","protected":false},"author":3,"featured_media":1346,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"nf_dc_page":"","wp_typography_post_enhancements_disabled":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_feature_clip_id":0,"_jetpack_memberships_contains_paid_content":false,"nfd_image_url":"","nfd_onboarding_generated":"","footnotes":"","jetpack_publicize_message":"","jetpack_publicize_feature_enabled":true,"jetpack_social_post_already_shared":true,"jetpack_social_options":{"image_generator_settings":{"template":"highway","default_image_id":0,"font":"","enabled":false},"version":2},"jetpack_post_was_ever_published":false},"categories":[560,18,371,370],"tags":[1201,93,563,561,224,237,239,484,285,485,97,170,565,506,502,567,566,562,492,564],"class_list":["post-1341","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-banking","category-economy","category-federal-reserve-economy","category-monetary-policy","tag-banking","tag-ben-bernanke","tag-cdos","tag-crony-capitalism","tag-doj","tag-eric-holder","tag-espionage-act","tag-fannie-mae","tag-foreclosures","tag-freddie-mac","tag-hank-paulson","tag-justice-department","tag-moodys","tag-mortgage-backed-securities","tag-mortgages","tag-ratings-agencies","tag-risk-based-capital-requirements","tag-sp","tag-ted-stevens","tag-us-treasury-bonds"],"aioseo_notices":[],"aioseo_head":"\n\t\t\n\t\n\t\n\t\n\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t