When Fitch relayed its initial concern to IKB that its SIV guidelines limited home equity loans to only 10% of this sort of SIV, IKB replied, “This is probably not good news for bringing you all on board the SIV. Please let me know if your guidelines will be able to stretch as far as we are looking for.” When it was all said and done, 60% of the Rhinebridge SIV was home equity loans.
How much — and why — was the standard stretched to get Fitch deeper into the bond rating game?
That high degree of home equity loans (HELs) made Moody’s “a bit uncomfortable” as well, as the company knew they were illiquid assets, but it ranked them as liquid anyway, and in so doing made the Rhinebridge SIV viable. A closer examination of the structured investment vehicle — after the fact — determined that had those HELs been properly determined as illiquid to begin with, Rhinebridge would have failed its liquidity tests at its onset. Conversely, had the SIV not held any HELs, it would have survived the subprime mortgage meltdown.
Moody’s analyst David Rosa acknowledges that the decision to rework the standard was a mistake. However, and again, one has to wonder what really prompted such a “mistake” in the first place.
One of those scenarios alone, while embarrassing for their respective credit raters, wouldn’t have gotten a great deal of traction in any courtroom. All of them combined, though — and in concert with dozens of more alarming instances of questionable morals and misguided ideas detailed in this official complaint — paint a concrete picture of systemic corruption within the bond rating world.
Investors have been clamoring for financial reform for years, and the industry says they’ve gotten it. That’s just lip service, though. The only reality that induces change within for-profit organizations is hitting them where it counts … in the pocketbook. And up until now, neither the SEC nor the federal government nor plaintiffs in a federal court could actually pin these companies down firmly enough to penalize them for glaringly errant ratings.
The state of New York, however, has managed to do what others haven’t: define fraud as knowingly misleading statements of opinion. It’s not much, but it’s a start, and should give the plaintiff’s lawyers plenty of ammo to use in court.
Bigger still is the reform such cases could prompt — credit rating companies are now being held accountable in a meaningful way, and as such, change will be required.
It won’t be a cheap or easy change, mind you, and it won’t come quick. These rating companies must now find a way to prioritize accuracy and de-prioritize profits, and that might mean major overhauls that were actually merited a couple of years ago. But it’s a start.
In the meantime, that period of change could make life less than fun for the folks who own or operate these companies … but we’ll all be better off for it.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.