Standard & Poor's shoots France in the head, then says it's sorry. Time for a duel.

In the midst of the Eurozone/Euro mess, as the troika (the European Commission [EC], the European Central Bank [ECB] and the International Monetary Fund [IMF]) work furiously to contain (didn't Bernarke claim “containment” re: subprime disaster in 2007?) the contagion of investor panic and debt yields rising to unsustainable levels, Standard & Poor’s “accidentally”sent out an "erroneous" email on Thursday suggesting that it lowered France's triple-A rating.  Not that it was planning to lower it, but that it already had.

Hmmm.  Can it be a coincidence that the EC is planning to issue new rules on credit ratings agencies in a few days?

In the U.S. we've already seen the damage wrought by the three Stooges, Standard & Poor's, Moody's and Fitch's.  They plastered triple-A ratings all over toxic waste mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs--which entail pooling MBSs and slicing them up).  As the true nature of these putrid instruments revealed itself, the credit ratings agencies downgraded the obtuse structured financial vehicles to junk bond status, sometimes dropping them several notches within a week.

Because the issuers of the "debt" pay the agencies to rate them, the conflict of interest was (and still is) evident.  The agencies have strong incentive to lie upwards and they did to a fantastic degree.  Unfortunately, the damage was done.  Pension funds and other fixed income cash cows were caught holding the bag.

In the U.S. the credit ratings agencies hide behind the First Amendment.  Their legal argument is that they cannot be held accountable because they are merely issuing "opinions".  It's your tough luck if you take them seriously.  You rock the financial world, not them.

The European regulators are trying to put protections in.  A draft released earlier this week made that clear:

European supervisory authorities would be able to temporarily prevent the issuing of ratings on countries in "a crisis situation."

Investors would also gain a framework to take legal action against agencies "if they infringe intentionally or with gross negligence" on their obligations.  A ratings agency would also have to disclose information about is rating methodologies.

Standard & Poor's errant email went out on Thursday just before 4pm Paris time when the European markets were still open.  Its "opinion" thrust a knife into "containment".  The yield for France's 10-year bond jumped 25 basis points to 3.48% and the spread between 10-year French and German bonds hit 1.7%, a euro-era record.  S&P waited 2 hours to issue a correction, after the European markets had closed.

A shot across the bow, eh?  A bit of nasty extortion.

Standard and Poor's Lacks All Credibility

On Friday, August 5, 2011, Standard & Poor’s downgraded U.S. sovereign currency from AAA to AA+. This despite a $2 trillion error it made when submitting its decision to the White House and the reason it gave for the downgrade:

In its announcement Friday night, S.& P. cited the political gridlock in Washington during the debt limit debate as a main reason for its decision. “The gulf between the political parties,” S.& P. said, had reduced its confidence in the government’s ability to manage its finances.

The other two major credit rating agencies, Fitch and Moody’s, did not downgrade the currency.

Not only did S & P’s move appear to be basically political as opposed to a determination made on sound financial ground, it also seems to have leaked information to selected hedge funds before it made its downgrade public in order to curry favor and possibly offer a chance to the funds to make insider bets on the dollar.

It’s amazing that anyone takes the credit ratings agencies seriously in the wake of securitization. Back in 2008, their triple-A ratings of subprime mortgage-backed securities and collateralized debt obligations were downgraded very quickly from triple-A to triple-C, sometimes within a few weeks. Lehman Brothers was rated triple-A a month before it went bankrupt.

The credit rating agencies were a huge part of the 2008 collapse. The reason was obvious: they were paid by the bond issuers. That’s where their loyalty was, not with investors. If an issuer (like Goldman Sachs) didn’t like Moody’s ratings on a RMBS stuffed with lousy mortgages, it’d walk across the street to S & P’s to get a better one.

But Standard & Poor’s, just like every entity in the daisy chain of securitization, wasn’t held accountable for its conflicts of interest. Despite its selfish, politicized motives, the mistakes it made with simple arithmetic, its obscure methodology which has proven so damaging to investors in the past, it’s still taken seriously by the marketplace.