Though Cowards Flinch

People who wish to continue to believe that, while capitalist systems of finance may have their ups and downs, they are probably the most sensible way of managing the word’s affairs, are advised to look away now.

People who wish to see what the capitalist world of high finance is really about are invited to read some of what Eric Kolchinsky, a whistleblower sacked by international credit rating agency Moody’s had to say on Wednesday,  in testimony before the US House Committee on Oversight and Government Reform:

‘My name is Eric Kolchinsky, and during the majority of 2007, I was the Managing Director in charge of the business line which rated sub-prime backed CDOs (Collateralized Debt Obligations) at Moody’s Investors Service. More recently, I was suspended by Moody’s as a result of a warning I sent to the compliance group regarding what I believed to be a violation of securities laws within the rating agency.

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The conflicts of interest which ail the ratings industry remain unmanaged. Senior management still favors revenue generation over ratings quality and is willing to dismiss or silence those employees who disagree with these unwritten policies.

The Credit Policy Group is a team of analysts whose role is to ensure that the methodologies and procedures used in the rating process are sound and meet minimum credit standards. Unfortunately, the Credit Policy Group at Moody’s remains weak and short staffed. The group’s analysts get routinely bullied by business-line managers and their decisions are over-ridden in the name of generating revenue.

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In many ways the incentives for rating agencies have become worse since the credit crisis. There are now more rating agencies and they are all chasing significantly fewer transaction dollars. The new controls put in place by regulators are too weak to significantly alter this dynamic.

As an example of how little things have changed, ABS  (Asset-based Securities) are being rated once again. These are the same products which are responsible for hundreds of billions of dollars of losses at major financial institutions. They were significant contributors to the problems at Citibank, Merrill Lynch and AIG. While the CDOs held by these institutions had the highest ratings possible, they still ended up being nearly worthless. I firmly believe that ABS CDOs cannot be rated with any certainty and especially not during this volatile period in the capital markets.

The ‘new’ methodologies used to rate ABS CDOs have not improved their poor credit performance – many of the recent deals have been downgraded or have had to resort to restructuring to maintain their ratings. This toxic product needs to be consigned to the dustbin of bad ideas, but unfortunately, there are still no incentives for rating agencies to say ‘No’ to a product no matter how poorly thought through.’

Those are just the highlights of his statement.  The whole day’s witness testimony merits a thorough read, including the Chairman’s closing statement in which he compares the credit rating agencies’  secretive practices with those of ‘Soviet Russia’.

Of particular interest, though, is the historical perspective provided by Lawrence White of New York University:

‘A major change in the relationship between the credit rating agencies and the U.S. bond markets occurred in the 1930s. Eager to encourage banks to invest only in safe bonds, bank regulators issued a set of regulations that culminated in a 1936 decree that prohibited banks from investing in “speculative investment securities” as determined by ‘recognized rating manuals’.

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In the early 1970s the basic business model of the large rating agencies changed. In place of the ‘investor pays’ model that had been established by John Moody in 1909, the agencies converted to an ‘issuer pays’ model, whereby the entity that is issuing the bonds also pays the rating firm to rate the bonds.

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Regardless of the reason, the change to the ‘issuer pays’ business model opened the door to potential conflicts of interest: A rating agency might shade its rating upward so as to keep the issuer happy and forestall the issuer’s taking its rating business to a different rating agency.’

So what does all this boil down to?

Essentially, the story goes like this:

1) A crazy, technology-based stock trading bubble driven by the desire for quick profits on the part of the new ‘high finance’ part of the ruling class brought about a massive crash in 1929, and millions of the working class suffered.

2) The investment banks were allowed by a compliant US state to outsourced their credit rating operation in 1936, thus providing a temporary ‘fix’ in public.

3) Over time the credit rating agencies empowered by the 1936 decree came to be so far in league with the ruling financial class that they became a prime mover in the crazy, property-based stock market bubble of the 2000s, legitimizing ever stranger structures of finance in order to make ever higher profits themselves.

4) A massive 1929-style stock market crash ensued, billions of dollars were used to bail out financial institutions who had caused the crisis, but a massive bonus culture soon returned to the financial ruling classes and states worldwide  that the best way to restore financial balance was to attack the living and working conditions of the working classes by allowing unemployment to soar and reducing public services.

As a result of what the credit rating industry did, between 28,000 and 50,000 babies in Sub-Saharan Africa will die this year.

5) International credit rating agencies, which were complicit in the making of this latest financial disaster, thought it perfectly in order to issue stern warning to governments that they must reduce public spending and impoverish the working classes or risk losing the trust of their investor colleagues, and their moves were welcomed warmly by governments and wanabee governments acting in happy complicity with the ruling financial classes.

6) Meanwhile, the credit rating industry is unfettered and is right now assigning corrupt credit ratings to new structured finance products, so that both they and the issuers of these products can make large profits until such time as the next bubble bursts.

You couldn’t make it up.  But capitalism did.

But perhaps there’s a crack in the façade.  Even Newsweek has noticed what’s going on and is complaining.

Why, I wonder, is the report on international credit rating corruption a headline in the Guardian, or the Mirror.  Where’s Jon Pilger when you need him?