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Standard & Poor’s

from Peter Radford

It is good news that Standard & Poor’s is being sued by the government. S&P was complicit in the market rigging that led us to the bubble and the destruction of a boatload of wealth. It has escaped, thus far, any serious damage from its involvement in the creation of crisis and deserves to be taken down a peg or two. The amount of damages being sought is roughly equivalent to one year’s income of S&P’s parent company McGraw-Hill. That’s not enough to put the company out of business, but it is noticeable.

Anyone who is committed to a free market system will applaud the suit. Market rigging is about as serious a problem as can be imagined in a free market. It impedes the flow of information that is essential to proper price setting, distorts outcomes, and exposes those market players not involved in the scam to potentially massive losses. While I would never argue that any participant in the sale or purchase of complex derivatives is entirely innocent – they all claim to be sophisticated investors and/or advisors – clearly some folks were duped. The loss to pension funds was significant, which means that many an average retiree or average worker saving for retirement was exposed to possible loss.

Anyone, like me, who has a more jaundiced view of markets  and their ability to work without significant external propping up, will also applaud. Although in our case we will also ask why it took this long for the suit to be filed.

The question is, of course, whether S&P was complicit in rigging the market.

To me the answer is unequivocal: Yes.

But was it fraud?

The problem with the rating agencies is that they collect their fees and thus make their living by charging for the ratings they issue. This deprives them of any impartiality. It exposes them to the lure of bribery. It makes them an insider rather than an outsider offering objective opinions. No matter how hard they try to create artificial barriers and to protect their analysts from these problems the cold hard fact is that the rating agencies – S&P is not alone – are all part of the Wall Street ecosystem. They are thus feeders at the same trough as the investment banks, and rely on the deal flow the banks generate. Giving negative ratings would block that deal flow. It would reduce earnings and bonuses. So the bias is always to give positive reviews.

The only plausible defense that S&P can offer for its manifest errors is that it was simply deploying industry standard financial thinking when it gave out AAA ratings to what turned out to be junk investment products. In this it was not alone. The issue I have with this is that it implies that S&P has no higher standard or analytical ability than the average market player. This undermines its credibility as an expert. If S&P has no particular higher skill its opinions are not that useful. So why would we rely on its ratings? Furthermore, since we now know that the analytics underlying the entire mortgage derivative market were deeply and fatally flawed, to argue that S&P simply adhered to those analytics is tantamount to admitting duplicitous stupidity. In which case those ratings are even less useful. No one would pay top dollar to listen to the ramblings of a dunce.

And S&P was either a dunce or was trying to dupe innocent investors. Its business model was either built upon its own ignorance or upon preying on that of others.

I think the reality of the crisis was that the banks and their various co-parties were complete fools. They all jumped in willingly. They turned out to be latter day alchemists trying to turn lead into gold. Along the way they convinced themselves, in a spectacular example of group think, that they were brilliant and consequently deserving of enormous compensation. That they turned out to be petulant fools deserving of nothing hasn’t quite sunk in yet. S&P’s special corner of the Wall Street fools and idiots club was that it was the organization waving the magic wand over the lead and saying that it was gold. For this catastrophic stupidity it ought to be held accountable.

I am not sure that what S&P did was criminal. The fraud all took place inside the banks where distorted incentives and lax oversight encouraged, or at least turned a blind eye, to persistent lying. I tend to see S&P simply as a blind fool who was easily ensnared in the wider scam and made to feel significant by the flow of cash. Greed took over and S&P moved quickly from dupe to complicit duper. The problem being that it didn’t know what it was doing.

Remember that in the feeding frenzy of the bubble years all standards dropped to historic lows. Idiots were seen as geniuses. Pedestrian analysts were viewed as unparalleled seers. The self regard of the entire ecosystem shot through the roof. That it was all alchemy was yet to be revealed. The banks, the rating agencies, the lawyers, and the accountants all feeding at the trough never gave a second thought to intelligence, severe analysis, or public responsibility. They were all blinded by the cash. The massive volume of activity, the late night meetings, the urgency of getting the deal done, the adrenaline of the rapid pace and the lure of bonuses  all drove them totally mad. They were all irresponsible and utterly stupid. None should be trusted ever again. But they were not all criminal.

They were gigantically negligent. They were horribly destructive. They deserve all the opprobrium we can muster and hurl at them. This law suit is merely a start. Their culture still exists. The error could be repeated. They still represent a danger to us all. They need to be broken and discarded.

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