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Home Publications Blogs Beat the Press Robert Samuelson Is Worried the Justice Department is Persecuting S&P

Robert Samuelson Is Worried the Justice Department is Persecuting S&P

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Monday, 11 February 2013 05:53

Robert Samuelson is worried that S&P is being persecuted by the Justice Department which is suing the company for mis-rating tens of billions of dollars of mortgage backed securites. He argues that S&P was suckered by the housing bubble just like everyone else.

While the claim that they believed that house prices could only rise is probably true (most economists and policy types believed this in the years 2002-2006 -- you don't get fired in economic policy work for making huge mistakes) that has little to do with the charges leveled by Justice Department. These charges claim that S&P changed its rating model in order to get more business. If S&P did not alter ratings to get business then the Justice Department will probably not get far with its case.

There is no inconsistency between the claim that actors in the financial industry both believed in the bubble and committed fraud, as Samuelson seems to think. In a rising housing market every mortgage is a good mortgage. Even if the borrower never makes a single payment, the lender ends up in possession of a home that has risen in value and can likely be resold to cover the cost of the mortgage. This could mean that lenders issue mortgages without proper underwriting (e.g. they make up information) because they know that there will be plenty of potential buyers for the mortgage. The investment banks go along with the hoax because everyone is making money. So do the rating agencies and the captive regulators. The fact that all of these people might be clueless about markets and the economy hardly precludes the possibility that they committed massive fraud.

 

 

Comments (12)Add Comment
Samuelson versus Baker, Conservative versus Progressive
written by Last Mover, February 11, 2013 7:12
Dean Baker here is actually in agreement with Robert Samuelson on the "who could have known" question with one key exception.

Every player on the selling and buying side could not possibly be complicit in the cause of the bubble in terms of actually engineering it, compared to simply benefitting from it. That's why Baker has repeatedly singled out those like Greenspan and Rubin as most responsible, in contrast to the standard line by Samuelson that no one could have known given overwhelming support of the bubble in its making.

It's similar to a major traffic jam that occurs regularly. Everyone knows it's there but everyone continues to contribute to its cause because individually the net benefit is positive, even though collectively the net benefit is negative.

The difference with a bubble is that the collective benefit is also positive up until the bust. Samuelson wants you to believe that ultimately, the government proactively caused the bubble by crowding out the private sector, and now the government is unfairly suing the private sector for something it - the government - caused.

In contrast, Baker demonstrates that the bubble originated in the private sector and drove itself primarily from there to the bust, specifically enabled and engineered through willful ignorance by those in high government positions who knew or should have known but intentionally went mute or cheered it on.

In effect, both Samuelson and Baker agree that the bubble was the only game in town and anyone who did not participate lost out economically except at the end. The essential disagreement is whether laizze faire capitalism itself, instead of the government, caused the bubble.
The Feds downgrade S&P
written by Peter K., February 11, 2013 8:06
I like Time magazine's headline.

A good sign is that the Feds are actually taking them to court instead of settling which is what they have been doing. And they are getting creative in their application of the law thereby raising their chance of winning the case.
recall what Buffett said....
written by pete, February 11, 2013 10:09
Something to the effect of..."We don't use ratings agencies...we do our own credit analysis." This is the problem with regulation...we lower our guard because we think someone else is doing a good job. Listening to compounding pharmaceuticals on NPR this morning...almost laughable if it wasn't sad. Another regulatory failure.

The issue is imagining that there are all-knowing robotic regulators who have no human frailties like overconfidence and myopia. These traits are common in the population, so why not also in regulators. Ratings agencies developed on their own, then the SEC began requiring them, and does not approve new ones. Most economists would say 3 is not a competitive number.

...
written by skeptonomist, February 11, 2013 10:47
What is needed is not prosecution - one a bubble has gotten underway, fear of future penalties is not a major hindrance. There is a general attitude that the old rules don't apply anymore and a discounting of risks of all kinds. To prevent bubbles, there must be restructuring and tighter regulations which are applied automatically - you can't count on regulators not participating in the general euphoria (Greenspan was probably not a participant in the euphoria, but he was a major instigator of deregulation and expansion of leverage, on general Randian principles).

Dean has proposed changes to the rating process, although whether random assignment would be adequate may be doubtful (the agencies will still try to draw business by assigning high ratings in general). The main thing which supposedly justified high ratings of MBR's was credit default swaps, which were thought to reduce risk, when they actually did the opposite. CDS's are still around, for no good reason, except to justify speculation.
...
written by Roger Bloyce, February 11, 2013 10:51
Wall Street stock, bond and mutual fund analysts are well aware that going against the consensus can damage a career. If they guess right, the reaction is generally ho-hum, and their colleagues might even become resentful. If they go against the tide and guess wrong, however, they are likely to be fired.

Since S&P bond analysts only need to know the consensus, the issue here is not whether they are clueless. The issue is whether accepting fees for ratings creates a conflict of interest, which, obviously, it does.

While the Justice Department's suit will hurt McGraw-Hill stockholders, the individuals involved in the mortgage-backed securities debacle will surely go unpunished, and Wall Street fraud will continue unabated.
...
written by David S., February 11, 2013 12:12
The idea that everyone was of the belief that underwriting standards and the mortgagors' ability to pay were irrelevant cuts AGAINST the ability of the government to prove fraud in most cases.

If a plaintiff has not materially relied upon the misrepresentation or omission, then a necessary element of fraud is absent.

As many will recall, this was the Goldman Sachs defense with regard to the debt instrument it allowed Paulson to stuff with obligations which were of poor quality and, in Paulson's opinion, so likely to fail that he took a short position on that instrument. According to Goldman (and Paulson), the buyers of the instrument were sophisticated and either did their own due diligence or should have done so.

Of course, the case against the ratings agencies is somewhat different. The raison d'etre of S&P, Moody's and Fitch is to represent that they have done sufficient due diligence to pronounce the instruments as worthy of the ratings bestowed upon them by said agencies. If the agencies made material misrepresentations or omissions in the process, then it is reasonable to conclude that purchasers relied to their detriment on those ratings. I do no think it would be a sufficient defense for a ratings agency to say, hey, why did you rely on us, you had the sophistication to do your own analysis? Even a large bank or hedge fund can make the reasonable decision that it is cost-effective to rely upon the ratings agencies rather than devote in-house resources to due diligence.

The ratings agencies could try to avoid liability for fraud by arguing that the buyers were not the "intended beneficiaries" of their epresentations, but rather the only intended beneficiaries were the issuers and underwriters with whom they were in privity (i.e., under contract) (who of course selected the ratings agencies in this sordid and compromised process).

Nonetheless, S&P and the others could argue that the AAA ratings were bestowed only for the benefit of the underwriters and issuers, so that they could market to the buyers -- who of course suffered the losses. The agencies could then argue that, only if the buyers are first successful in winning judgments against the underwriters or issuers could the underwiters/issuers then go after the agencies for fraud.

But what a cluster-you-know-what that would be! The agencies would be on record as telling buyers that their ratings are not to be relied upon although perhaps buyers have already figured that out!) and the issuers and underwriters would have to go after the ratings agencies for failing to identify the truly awful mortgages which they, the issuers and underwriters, themselves stuffed into their own instruments for sale to the duped buyers.

Thus, the only escape hatch for the ratings agencies, the issuers and the underwriters might be a marketing and public relations nightmare, one which could scare away a significant share of any future market.
It would be odd if they had not committed fraud
written by Jennifer, February 11, 2013 2:26
The simple fact was that these agencies, and the employees, made more money if they rated things higher.
Most of the books about the financial crisis admit this, especially Joe Nocera's, that there was tremendous pressure for things to be rated higher. Many of the employees stated that there was a notable difference when the companies went public. The real answer to the ratings issue it to open source it and then you don't need the rating agencies.
www.nakedcapitalism.com/2012/1...opoly.html
Pete and Hoover
written by David, February 11, 2013 2:39
written by pete, February 11, 2013 11:09
... This is the problem with regulation...we lower our guard because we think someone else is doing a good job. ...

The issue is imagining that there are all-knowing robotic regulators who have no human frailties like overconfidence and myopia. These traits are common in the population, so why not also in regulators. Ratings agencies developed on their own, then the SEC began requiring them, and does not approve new ones. Most economists would say 3 is not a competitive number.


Nationally recognized statistical rating organizations:

Standard & Poor's
Moody's Investors Service
Fitch Ratings
Kroll Bond Rating Agency[13]
A. M. Best Company
Dominion Bond Rating Service, Ltd
Japan Credit Rating Agency, Ltd.
Egan-Jones Rating Company
Morningstar, Inc.
HR Ratings
http://en.wikipedia.org/wiki/ ...ization#L
ist_of_NRSROs


Hoover (before and after his presidency) tried the route of self-regulation by non-government associations (maybe if we were all Quakers it would work) and it failed. He attempted regulation (see http://hoover.archives.gov/exh...index.html), but it was myopia and overconfidence distinctly majorly located in the private sector that led to that crash and subsequent Depression. And once again we are having a 10 year doldrums thanks to short-sighted businessmen and their GOP stooges.
The Big Three
written by David, February 11, 2013 2:47
Moody's, S&P each have about 40% of the market, and Fitch another 14%. But there are competitors. The lack of competition is not due to the SEC, despite what Pete has fantasized. In fact, I think this is a wonderful time to diversify the ratings market. Standard OR Poors, instead of Standard AND Poors. Yeah.

Pete, you might find this an interesting alternative to large ratings firms: Austrian mathematician Dorian Credé has developed another useful idea for decentralizing the ratings (thus minimizing the chance for abuse), an open source ratings platform, Wikirating: http://en.wikipedia.org/wiki/Wikirating
...
written by urban legend, February 11, 2013 4:50
Last mover said: "Baker demonstrates that the bubble originated in the private sector and drove itself primarily from there to the bust, specifically enabled and engineered through willful ignorance by those in high government positions who knew or should have known but intentionally went mute or cheered it on."

Let's not forget the way Bush's Office of the Comptroller of the Currency in 2003 and 2005 -- i.e., early enough to have an impact -- applying a highly-questionable and generally discredited interpretation of the doctrine of Federal preemption, prevented a number of attorneys general from various states from bringing deceptive practices actions against the national banks like Countrywide who did the bulk of risky lending. They were left to go after the small fry state banks who did little of the deceptive lending and re-marketing of mortgages for bundling into high-return "mortgage-backed securities" that could be sold into the financial marketplace.

National lawsuits attacking the whole process could well have punctured the real estate bubble well before it became so destructive of the entire financial system. The Bush administration wanted the bubble to prop up consumer demand and employment with exploding construction activity and phony equity wealth. The whole thing wasn't supposed to pop until a Democrat could be blamed for it.
Economic Engines
written by JP, February 11, 2013 6:26
Profit, even predatory profit, has the unfortunate effect of bringing along others for the ride. It was also common for appraisers to jump on the train if they wanted to survive. Appraisers who did not supply a product acceptable to the mortgage writers were no longer called upon for their services. The whole process became a boom for those willing to be complicit inthe process and the other appraisers, those of higher moral fiber, went out of business.
...
written by watermelonpunch, February 11, 2013 8:19
Geez, with arguments like that...
Then many types of fraud should be legal as long as a lot of people are making money?
Who gets to decide these things?

If it weren't for the financial crisis, Bernie Madoff's scam may have gone on "successfully" for several more years.
If there was no financial crisis, would that mean that Madoff's scam was OK?

This makes no sense.
But it's what I noticed immediately a few years back, when I watched the hearings. It was like everyone who testified was just pointing the finger at someone else.

Since when did tu quo que become a valid argument?

It doesn't work in the legal system for all the gang criminals who wind up in prison because by the nature of their childhood circumstances they became corralled into the gang lifestyle.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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