Here they go again. In the wake of the trillion dollar write downs of toxic structured finance products, the frozen credit markets, and the global financial crisis, Wall Street banks are re-packaging downgraded collateralized debt obligations (CDOs) and other structured finance products for sale as new debt investments with top AAA ratings, Bloomberg.com reported recently. The article, by Pierre Paulden, Caroline Salas and Sarah Mulholland, flows from marketing documents obtained by Bloomberg and focuses on Morgan Stanley’s plans to sell downgraded loan CDOs as AAA rated bonds, even though they should not be rated as AAA.
Morgan Stanley is selling $87.1 million of securities it expects to receive AAA ratings that were created from a CDO that was originated in 2007 by Goldman Sachs. Other Wall Street banks have been doing the same thing with CDOs backed by commercial mortgage-backed securities.
As was the case with the toxic securities that led to the collapse of some “too big to fail” financial institutions and continue to stifle the economy, it appears that the top ratings given these new securities are unwarranted. Many banks and insurers “cannot buy anything but AAA,” says Sylvain Raynes, a principal at R&R Consulting in Nee York and co-author of “Elements of Structured Finance” to be published in November. “You’re manufacturing AAA out of not AAA, therefore allowing those people who have AAA written on their forehead to buy.”
In the midst of writedowns of toxic assets and the worst recession since the 1930s, finance companies have had to raise approximately $1.27 trillion in capital, according to Bloomberg. More Wall Street banks have issued billions of dollars of these repackaged securities that by “magic” manufacture AAA ratings out of lower grade debt. “Somebody does something and it seems to make magic, and the other guy says, ‘Hey, let’s do that, too,” says Raynes.
Morgan Stanley and Goldman Sachs declined to comment for the Bloomberg article.
As noted in blogs in this space posted on October 29, 2008 (“Credit Rating Agencies Offer Excuses to Congress”) and November 3, 2008 (“Are Credit Ratings Agencies Just a Bunch of Bull?”), and February 24, 2009 (“Suit Against Moody’s Allowed to Proceed”), Congress inquired into apparently corrupt credit ratings issued by Moody’s, Standard & Poor’s, Fitch, Inc., the leading credit rating agencies. Internal emails and documents were especially devastating to the credit rating agencies. Moody’s employees expressed tension and anxiety as the sub-prime mortgage related securities that were awarded top ratings by the firm were staggered by ballooning delinquencies. An unidentified Moody’s employee wrote, as part of a survey after a September a 2007 town hall meeting, “It seems to me that we have blinders on and never question the information we were given. Combined, these errors make us look either incompetent at credit analysis, or likely we sold our sole to the devil for revenue, or a little bit of both.”
In an internal email that came to light during hearings on the Hill, one S&P analyst admitted that their credit ratings were inflated and unsupported, saying, “it could be structured by cows and we would rate it.” In other words, the credit ratings were a bunch of bull. In another internal exchange, a different analyst told a co-worker, “let’s hope we are all wealthy and retired by the time this house of cards falters.”
Millions of investors who relied upon Moody’s and the other credit rating agencies to issue unbiased, objective evaluations of the credit worthiness of the sub-prime securities suffered major losses. Are investors being burned again?
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