Editorial
Messing with the Bull
With the announcement this week of its massive $5 billion lawsuit against ratings agency Standard & Poor's, the Federal Government took a bold step to squelch any remaining independence of thought or action in the financial services industry. Given the circumstances and timing of the suit, can there be any doubt that S&P is paying the price for the August 2011 removal of its AAA rating on U.S. Treasury debt? In retaliation for the unpardonable sin of questioning the U.S. Treasury's credit worthiness, the Obama Administration is sending a loud and clear message to Wall Street: Mess with the bull and get the horns. Shockingly, the blatant selectivity of the prosecution, however, has failed to ignite a backlash. But as the move violates both the spirit of the Constitution and the letter of the law in so many ways, I can't help but look at it as a sea change in the nature of our governance. Call it Lincoln with a heavy dose of Putin.
Given the nature of the U.S. economy during the housing mania of the last decade, charging S&P with fraud is like handing out a speeding ticket at the Indy 500. Like nearly every other mainstream financial firm in the world at the time, S&P believed that the U.S. economy rested on a solid foundation of accumulated housing wealth. By 2006, the housing market was closing out one of its best decades in memory. Developers, speculators, financiers, real estate agents, bankers and even ordinary Americans had become charmed by the easy wealth of serial home purchases. The party had been orchestrated by a cadre of politicians and regulators who wanted to keep the party going and take credit for the good times.
To a degree that few Americans understand even to this day, it was not irresponsible lending, bad ratings, or excess greed that finally doomed the mortgage market, it was the simple fact that national home prices started falling. As long as prices stayed high, refinancing would have been open to borrowers, and defaults would have been manageable. Among the hordes of analysts, academics, and reporters who covered the market there were few if any standing who believed that national home prices could fall of a cliff. I know this to be true because I spent many years trying, unsuccessfully, to warn them.
From 2005 to 2008, I made scores of appearances on national television and at investment conferences around the country in which I stated that national home prices were set to decline by at least 30% and that the resulting mortgage defaults would devastate the financial sector and bring down the economy. I may have just as well been arguing that pink unicorns were about to resurrect the Soviet Union. At the 2006 Western Regional Mortgage Bankers conference I told attendees that many highly rated mortgage-backed securities, including some rated AAA, would become worthless. My debate opponent claimed that such predictions only come to pass if "an atomic bomb landed on either Los Angeles, Chicago, or New York!"
The idea that home prices could decline at all, let alone by 30% was considered beyond serious consideration. The models used by the banks, investors, government agencies, academics, and rating agencies predicted that national home prices would continue to rise, or at least stay stable. They were ALL wrong. Calls for even a 5% decline would have put S&P in the extreme minority. I know because I WAS that extreme minority and would have noticed any company joining me. Absent such opinions, the analyses put out by S&P, Moody's, and Fitch were justifiable. So why pick on S&P? Perhaps because the other two agencies never downgraded U.S. government debt.
As proof of S&P's institutional culpability, the Justice Department provided a few e-mails sent by S&P analysts during the final stages of the housing bubble. The messages contain cynical awareness that the mortgage market was built on a house of cards. So what? To avoid guilt would S&P have to prove 100% agreement among all employees? The company readily admits that it reached its opinions through a consensus and that feelings within the firm varied. Opinions are, by definition, nuanced and varied. During the years before the crash I received emails from many people who agreed with me but who said that their friends and co-workers believed that they "were nuts" for harboring such fears. I lost count of how many people told me that I was nuts. Many of these e-mails could have come from S&P analysts.
At most, S&P was guilty of a culture of complacency and groupthink. Ironically that spirit was engendered by the bizarre regulatory environment created for ratings agencies by the government itself. In 1973, in order to "protect" investors from unregulated markets, the SEC designated certain ratings firms as "Nationally Recognized Statistical Ratings Organizations." Thereafter, only bonds rated by sanctioned firms could be purchased by pension funds and federally insured banks. Before that time the ratings agencies were paid for their advice by bond investors. As the rule change limited the abilities of investors to choose who to ask, the ratings firms began charging bond issuers instead. This arrangement meant that interests of investors would be subordinated. In any event, the law may have mandated who could perform ratings, but it did not require anyone to take them seriously. Any decent portfolio manager recognized this conflict of interest and performed their own due diligence.
The problem was when it came to housing mortgage bond buyers who were just as clueless as the ratings agencies. In fact, even those few buyers who knew the party would end badly, decided for themselves to keep dancing until the music stopped. It's completely hypocritical to sue the band after-the fact. Given that the SEC required investors to use these ratings agencies, should not the Justice Department be suing them instead?
The 2011 downgrade came as the government passed a weak and inconclusive patch to the debt ceiling crisis. Now, a year and a half later, we see that they have slithered out of that poorly constructed straight jacket. With the new debt piling up faster than ever, and the government showing itself to be blatantly incapable of making hard choices, it should be clear to anyone with a half semester of accounting that the Treasury debt should be downgraded. Yes the government has a printing press, but that only means that the value of the bonds will disappear through inflation rather than default. S&P was far too lenient.
Smaller ratings agency Egan Jones (which never had the official sanction of S&P) issued harsher reports about government debt, and they have also been duly punished for their candor. In 2011 the other major ratings agency, Moody's, argued that the fiscal cliff deal agreed to by Congress and the President improved the country's fiscal position and forestalled any need to downgrade Treasury debt. However, since we never actually went over that conveniently erected fiscal cliff, why has Moody's not responded with a downgrade? Perhaps they want to stay out of court?
Let's hope that it is still possible to get a fair hearing in a U.S. court of law, even when squaring off against the biggest and most powerful opponent the world has ever known. But even if S&P wins, we have all already lost. If it survives it will only do so after incurring huge legal bills and seeing its share price slashed. It's a foregone conclusion that no more downgrades will be coming.
Peter and Euro Pacific Metals are the subject of a Daily Bell Special Report: "To Survive the Coming Financial Hurricane, Physical Holdings of Gold and Silver Are a Must. This Solution Provider Can Help You Now – Without Leverage or High Pressure Tactics."
Peter Schiff is CEO and Chief Global Strategist of Euro Pacific Metals.
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Posted by amanfromMars on 02/10/13 05:23 AM
Thanks for that clear explanation of the current expanding and catastrophically spontaneously self-defeating mess/meme, Bischoff, which is just being kicked further on down the road by Sysadmin guaranteeing unbelievable pain that will suddenly overwhelm them and disempower them?
Or is the System being/Or has the System been fixed with a New Lead Programming ... ... Click to view link ?
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Posted by Bischoff on 02/09/13 10:19 PM
After the divorce of any relationship between the connection of the USD to the gold standard through Nixon's direction to the U.S. Treasury Department to suspend the sale of gold at a fixed price to foreign banks, it should not have come as a surprise that credit ratings had to become bogus as time went on. To issue credit ratings regarding instruments denominated in irredeemable central bank "managed" currency is bogus.
The fallout of Nixion's suspension of the bullion standard was a real estate speculation boom in the mid-1970s that got so out-of-hand that the voters in California passed Proposition 13 to change their constitutional land value assessment procedure. What people didn't anticipate was that Prop 13 shifted the real estate tax from commercial real properties onto residential real properties.
For commercial real properties, the real estate tax is a business expense recovered in revenue from commercial business. On the other hand, residential real estate tax comes out of the earnings of the residential real estate owner.
While California residential real estate owners thought that they had gained an advantage by passing Prop 13 in 1979, they didn't anticipate that the constitutionally fixed increase in the valuation of real property ignited a residential real estate boom in California which spread up and down the West Coast and extended into the North East and South East of the United States. This bubble finally burst with the default on MBS held by a Scottish bank as well, as a French bank. The rest is history. Read some of Frank Partnoy's writings, "FIASCO", etc. on how credit reatings were obtained for bond issues, i.e. MBSs... .
When you write mortgages involving residential real estate transactions, i.e. "flipping houses", and those mortgage contracts are denominated in irredeemable central bank currency, then all you are doing is selling the same piece of dirt back and forth, each time rasing the price. This worked in Caliifornia, because of Prop 13. The movement of talent between California and the North East, i.e. between Silicon Valley and the Boston Corridor, spread the real estate speculation across the U.S. to the East Coast.
California is stuck with Prop 13. However, the rest of the states in their wisdom refrained from changing their constitutions. In order to get out of the mess, the other states can revert back to proper value assessment. However, California is stuck and will have to default on their obligations, unless the voters see the light and vote to change their California constitution back to full valuation of real property.
The rating agencies were just playing their part in this whole central bank currency regime. On the one hand, they are liable for failing fiduciaries when they go "light" on the risk projection, and on the other hand, the central bank and their political bosses get upset when the credit agencies reflect the central bank currency expansion by lowering the quality of the debt instruments peddled by the central government.
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Posted by chapprg1 on 02/09/13 03:49 PM
Laughing hysterically on my way to a failing bank. To bad I am too hysterical and lacking in knowledge to add anything intelligent to the dialog. Observing with total disbelief the workings of the government, Wall Street ,the body politic, the international banks... Peter, where shall we turn?
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Posted by 1776 on 02/09/13 11:37 AM
I Can't Believe We Made It
If you were a kid in the 50's,60's,70's or early 80's this is a salute to you from radio station 107.9 WSRZ in Sarasota, Florida. I grew up in the 70's and early 80's and have fond memories of many things that today would be considered unsafe for kids. The high dive at the local YMCA pool is just one example not to mention jumping the Big Wheel and my bike off make shift ramps without a helmet. Congratulations to all those who survived!
Click to view link
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Posted by dave jr on 02/09/13 10:00 AM
"... I stated that national home prices were set to decline by at least 30% and that the resulting mortgage defaults would devastate the financial sector and bring down the economy."
With all due respect Mr. Schiff, this may sound like nit picking, but I think it is relevant.
A home owner whose income was unaffected wouldn't voluntarily default on his mortgage because the market value of his home dropped. 'Upside down' or 'under water' aside, it is still his home. And then he wouldn't quit his job because he no longer had a mortgage payment, helping send the economy into a tail spin.
Lets put the horse in front of the cart.
Since the late seventies; mergers, aquisitions and leveraged buy outs have run rampant in a world captured by a cabal bent on monopolizing global trade, their version of globalization; offshoring US industry being part of the plan. In the later stages, the US economy was proped up by lowering interest rates, a wide open credit window and cheap fuel which spurred the housing boom as well as many other construction projects. It ran its course, and then interest rates were raised slightly, credit was shut off and the price of fuel increased. Americans then got to see the economic devestation. Lay offs, downsizing, stagnant wages and general economic contraction ensued. First the subprime then mainstreet began defaulting because wages wouldn't keep up with inflation and there was no way out, being 'upside down' or 'under water'. The US economy, purposely destroyed, was the cause not the effect.
It is relevant because I don't believe the origin of the problem lay with a few greedy Wall Streeters in the mid 2000's. I believe it goes much deeper and earlier than that.
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Posted by amanfromMars on 02/09/13 02:21 AM
Libertarian Jerry, Hi,
Regarding .. "There is no rule of lawful justice in America today. Only the rule of a few powerful men." ... .. as the world and his dogs of war get ever wiser and better informed about the nature of their existence, and how everything is so easily controlled with such as may be chaos, would you like to be in any way identified as being one of those few powerful men or even be recognised as being an avid supporter of their inequitable policies?
The smarter ones at the top of those pyramids though, if they have any smarts at all, will be changing their spots and engaging with thinkers and tinkerers from a new age, for a New World Order Program in a New Orderly World Projects, to ensure that they survive the near future rather than perish in the exchange of power to ITs new rulers in realms with remote virtual control of reality.
If one considers the millenium and the exponential rate of progress and fantastic change in Man's development as chronicled in history and technology, will the future of Mankind in the near future be like nothing ever before ... ... so fundamental radical change is only natural and unstoppable and any and all who would be opposed to it will be swept away as easily as the tide sweeps away all on the foreshore.
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Posted by Libertarian Jerry on 02/09/13 01:32 AM
Peter,To paraphrase George Orwell,"Speaking the truth in times of deceit is a revolutionary act." In the end,the Federal Kangaroo court monster will do to Standard & Poors what they did to your father. There is no rule of lawful justice in America today. Only the rule of a few powerful men. Sad to say the Republic is dead.
