Wednesday, February 22, 2012

Is Australia About to Slay the Ratings Monster?

Uh oh. Looks like Standard & Poor's may be on the verge of getting its comeuppance for all those hallucinatory, fee-inspired AAA ratings, in of all places, Australia. A 10-week court case has just concluded.

So what happened? The AAA rated investments weren't really all that bad, were they?
The twelve [NSW] councils bought a bunch of “Rembrandt” toxic structured-finance products in 2007. They tanked 90 per cent in six months and now the councils are suing investment bank ABN Amro for making the Rembrandts, Local Government Financial Services (LGFS) for selling them and S&P for appending their once-hallowed AAA credit rating.
Okay, okay. Let's be philosophical. Things tank sometimes. That's life in Market Land. At least this was the kind of well-established, safe product upon which S&P has historically bestowed a AAA rating right?
Looking at the closing submissions which have now been filed with the Federal Court, the councils contend that S&P failed to exercise reasonable care and had “no reasonable grounds” for its AAA rating on the Rembrandts.

The councils argue that this is supported by the limited historical data relied upon to rate the product. This was a new product, a “CPDO”, even more risky than a CDO and based on an index of derivatives which had only been going for a couple of years.
Have no fear, legal team! In court, S&P undoubtedly showed itself to be tough and independent when modeling these particular investments. Yes?
They also say S&P made a “critical error” when it relied on the advice of investment bank ABN Amro regarding the Rembrandt's historical volatility.
Fine. One mistake. But that was surely just one input into S&P's otherwise complex model, so we can overlook this lapse in judgment?
“The evidence at trial established that S&P did not conduct any modelling for the Rembrandt 2006-3 Notes, or discuss the results of such modelling at any ratings committee."
Yipes! Looking grim. But at least things can't get any worse, huh?
“Further, the Rembrandt 2006-3 Notes were assigned AAA ratings “because S&P did not want to reveal to investors the error they had made in assigning a AAA rating to the Rembrandt-2”.
Oops. Can you say "slam dunk," Timmy?