Calpers vs Credit Ratings

The California Public Employees’ Retirement System, Calpers, has launched a law suit against the ratings agencies Moody’s, Standard & Poor’s and Fitch.

Zero Hedge has a copy of the complaint, which not only contains a helpful summary of what’s at issue as well as some interesting details, but a surprisingly readable and comprehensive history of SIVs and the ratings agencies in general.

In fact, it’s worth reading the whole thing — though we’ve presented a few snippets here.

To start, here’s a summary of the complaint:

At the time of Calpers’ purchases the senior debt issued by the three SIVs was rated AAA/A+1 by S&P, Aaa/P-I by Moody’s, with Fitch rating Sigma AAA.

Those ratings, according to the lawsuit, “ultimately proved to be wildly inaccurate and unreasonably high.”

Here’s some detail on what Calpers alleges to have happened:

The complaint goes on to claim that the agencies used flawed tests when rating the three SIVs, using scenarios that did not account for the possibility the SIVs would be unable to liquidate the assets in their portfolios. Calpers also alleges the asset correlations used by the agencies (possibly some sort of stochastic formula) that didn’t capture the whole risk of the SIVs given that they held lots of RMBS and CDOs, comprised of loans from the same regions.

In short, Calpers claims there was more than a little ratings shopping going on, with the agencies collaborating with SIVs to ensure they would get a rating high enough to get investment from institutions like Calpers. The agencies are only paid by the issuer if the deal is rated.

Perhaps most interesting is the structure of the SIVs themselves and the behaviour of the ratings agencies once the subprime crisis, which decimated their underlying CDO and RMBS assets, started to take hold.

While the Calpers suit obviously centres on the actions of the ratings agencies, on a wider note there are also a couple of interesting lawsuits centring around securitisation currently taking place. The bankruptcy proceedings of Sigma, the biggest ever SIV, continue in the UK, while Zero Hedge has pointed out another possible landmark case related to the bankruptcy of a Lehman SPV. In Zero Hedge’s opinion:

While the case has not generated much traction yet in the legal system, once investors realize the potential ramifications it is likely that this could become the most followed legal development whose adverse repercussions could throw a major wrench in the administration’s wheels, which as everyone is aware, are fully focused on doing all that is necessary to not only restart securitization but to bring leverage to the same dizzying heights that brought the system to a grounding halt the first time around.

We think that’s unlikely.

While SIVs are dead and the legal battles over the division of their failed carcasses are beginning, new forms of securitisation that share their basic purpose are being created by the banks as we speak. No doubt the above legal action outlined above will give them and related financial institutions pause for thought — but we doubt it will be a very long one.

Related links:
Rating cows – FT Alphaville
When junk was gold – FT
Calpers to sue credit agencies over ratings – FT
Is Calpers passing the buck? – Naked Capitalism

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