In another outstanding development in the new normal of the post-GFC world, a bad actor has been brought to task:
The ruling in the Federal Court of Australia on November 5th held Standard & Poor’s (S&P) jointly liable with ABN AMRO, a bank, for the losses suffered by local councils that had invested in credit derivatives that were designed to pay a high rate of interest yet were also meant to be very safe.
What in effect does this mean? If you put your name on something as good, then you have to carry the consequences of it being bad. And the courts will hold you to it, or, they did in this case. As shareholders held Deloitte accountable in at least one Auditor case recently.
This is one of the essential, unavoidable causes of the GFC (marks I and II) -- that powerful players may take the upside of profitable participation in risky trades, but declare themselves non-liable for the downsides.
Was, in this case, S&P just caught out by a statistical bad apple, or was it raking it in? The Economist goes on to report:
The derivatives in question were “constant proportion debt obligations” (CPDOs). These instruments make even the most ardent fans of complex financial engineering blush: they are designed to add leverage when they take losses in order to make up the shortfall. S&P’s models, which the court said blindly adopted inputs provided by ABN AMRO, gave the notes a AAA rating, judging they had about as much chance of going bust as the American government.
That's a slam dunk. Adding that local councils are unsophisticated investors (and generally can't tell their elbow from their posterior) it is no surprise that they routinely invest in AAA ratings, and only AAA ratings. Hence, they rely on AAA.
Hence, S&P must be held liable for their good word on the meaning of AAA, assuming of course that the Economists' reporting is fair representation of the evidence presented.
Further, as S&P clearly did not do the diligence due to a statement with the gravitas of "as safe as the American government," the question of gross or criminal negligence looms large.
Posted by iang at November 13, 2012 05:01 PM | TrackBackThe Economist -- Credit-rating agencies came under more fire, this time in Italy, where prosecutors from the town of Trani asked a judge to order seven employees from Standard & Poor's and Fitch to stand trial for allegedly violating market rules when they announced downgrades on Italian sovereign debt. The two-year investigation was sparked by complaints from consumer groups and involved a police raid on the companies' offices in Milan. The employees haven't been charged. S&P dismissed the allegation as "baseless".
Posted by: The Economist at November 16, 2012 05:06 AM