Yes let’s (really) kill the NRSROs
February 6, 2013, 9:34 am
Filed under: Uncategorized

Barry Ritholtz headlines this post Why the Ratings Agencies Deserve the Death Penalty, and I was ready to agree!, only, unfortunately he doesn’t really fully stake out that position. That’s because in my book the ‘death penalty’ for rating agencies would be to eliminate the concept of “NRSROs” altogether and let them all just become Consumer Reports Magazine for bonds. Evidently Ritholtz just wants to get them in (bigger) trouble or pay bigger fines or something, but still keep the whole “NRSRO” thing intact:

But the major ratings are not just any business — these firms were all “Nationally Recognized Statistical Rating Organization” (NRSRO) — which the SEC allows other firms to rely on for regulatory purposes.

Here’s a thought: if you’re mad at ‘the ratings agencies’, because you think they misbehaved so severely, I’m totally on your side!, but maybe you oughta also question how wise it was to set up a system in which the SEC ‘allows other firms to rely on them for regulatory purposes’ in the first place. Do you want to treat the symptoms or the disease? Just saying.

If you don’t kill the NRSRO concept, then I don’t really see how you can ‘give rating agencies the death penalty’. Under the NRSRO system, let’s face it, rating agencies are (effectively) deputized parts of the government. Is the government going to give itself the death penalty? Are they going to send in the FBI to raid and shut down literally all NRSROs, yet keep in place all the ratings-based capital rules, ratings-based regulations of what such-and-such funds can buy, etc.? How would that even work?

Obviously, mostly, I’m on board with the criticisms in that post as they’re self-evident. I will however quibble with this claim:

I do not want to excuse the bad purchase decisions made by the buyers of this junk…

He may not want to, but that’s exactly what he does, in saying:

However, the complexity of these products required they use third party analysts and agencies to facilitate the purchase decision. That is why the bad pourchases is merely lousy investing but the payola-like ratings are actual fraud.

‘Required’? I cannot agree. FACT: No financial actor, anywhere, was ‘required’ to buy, consider buying, or even look at any of these structured securities in the first place. You can’t, logically, be ‘required to use third party analysts and agencies’ to analyze something you are not even buying or going to buy. (Yachts are probably complex purchases, but I’m not ‘required to use third parties’ to analyze them, since I ain’t buying one anytime soon.)

What he must mean (if it makes any sense at all) is that, given that someone had chosen to play in this space (why is this a given exactly?), then they were ‘required’ to rely on third parties (e.g. ratings). That is also FALSE.

Seriously, if you’re too lazy or unable to read (or, perhaps more commonly, at least get a trusted subordinate to read) the Prospectus, Portfolio Management Agreement, Credit Support Annex, Total Return Swap Agreement, Collateral Management Agreement, Initial Portfolio Annex, etc., etc., etc. and whatever other docs these deals depended on, and translate the information there into a reasonable sense of its value and risks, you shouldn’t be even thinking about putting down tens of millions on it. I know these docs are painful and boring to read –  believe me. But come ON. That’s the job!

At best, I would say that feel free to use third parties (including rating agencies) – but then that’s a conscious decision on your part (your time being oh so way too valuable, etc. so you outsource) that you need to own, so don’t come around whining afterwards that those third parties messed up. They messed up, sure, but you messed up too, and worse. That’s because, in this hypothetical, you’re the one who’s supposed to be the big fancy smartypants money manager, not some schlub at S&P.

RELATED UPDATE: Where can we sue bank regulators for having empowered Standard and Poor’s too much?

3 Comments so far
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your final 4 paragraphs are the key to the difference in understanding of financial responsibility between “civilians” and “professionals”

I completely agree with what you wrote in those 4 paragraphs

Comment by Kid Dynamite

[…] Sonic Charmer at Rhymes With Cars and Girls offered up his own view of this concept, as he replied to a recent post from Barry Ritholtz.  Barry writes: […]

Pingback by "But It Was Too Complicated" Is NEVER An Excuse - Kid Dynamite's World | Kid Dynamite's World

A lot of organizations found it convenient to farm their judgment out to the NSRSOs. Why not, since it ultimately wasn’t their capital at risk? They knew the GSEs would buy up all the garbage in the end; they just skimmed a little off the top at each stage as the garbage worked its way down the pipeline. The AAA rating was a stamp of approval that let them say “Huge risk? I don’t know what you mean. A blue-ribbon panel gave them a clean bill of health.” I don’t buy the argument that either the buyers or the sellers didn’t know exactly what they were doing: they were all relying on the “greater fool” theory, the greatest fool being the taxpayers, ultimately.

You think people in the industry all the way down the line — from mortgage originators to bank managers to investment bankers to government bureaucrats — didn’t know what the risk was? How many of them put their personal capital at risk on the strength of a belief that all those liar loans would be repaid some day? I knew that all those slice-and-dice securitizations of mortgage-backed packages were nonsense the first time someone explained them to me and urged me to go into that hot new transactional field. Ditto for the first time I sat through a little seminar on why I should be investing in that stuff. Of course I didn’t know exactly when the bubble would pop or how abruptly, or I’d be rich now, having shorted everything in sight just before the collapse. But not knowing exactly when it would collapse is not the same as not knowing how crazy it was, and I’m hardly more clear-sighted in these matters than the average investment banker.

Comment by Texan99

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