Thursday, April 23, 2009

The Rating Agency Scapegoating Catch 22

It is no secret that the administration, and especially Barney Frank, has made public enemy number one out of the rating agencies (and particularly Moody's), mostly in line with populist rhetoric and scapegoating. Of course, when the rating agencies satisfied a role that helped housing prices go higher, keep people happier and officials like Barney Frank in office longer, all was good. When things turn sour, the Franks of the world know to keep the attention away from Washington.

Well, Barney et al may want to be careful not to antagonize the RAs too much, as, in yet another twist of fate, the success of the New Economic Order plan hinges ironically on the rating agencies and their continued rating complacency, particularly with regard to that Plan Of All Plans, the TALF.

While recently perusing Moody's Weekly Credit Outlook, I came across an interesting observation from the RA regarding the most recent TALF credit card securitization deals. Moody's had this pretty standard language to say about the issuance:
Last Tuesday, two TALF-eligible credit card transactions were completed in the second round of TALF issuance. Credit card issuers Cabela’s and WFN issued $425 million and $560 million, respectively. As we had anticipated in our Special Comment of March 31,5 these early stage issuances under TALF are modest relative to the size of the market and to the TALF budget ($1 trillion). Meanwhile, however, these transactions are interesting for the information they provide on the early steps of the much-anticipated price discovery that we expect TALF to trigger.

Both credit card deals have three-year maturities and are priced comparatively wider than the Citibank TALF credit card transaction executed last month. As shown below, the estimated ROI for TALF investors ranged from a low of 14% for the Citibank transaction to a high of 24% for the WFN transaction.

So far so good - hedge funds have so much money on the side (allegedly) that they can throw it in any money pit they want, including credit card securitizations. Their problem. However, reading further down the Moody's piece and a few scary things appear. First of all, while the kinks are being ironed out in allowing any piece of floating garbage to be eligible for the TALF, for now only AAA-rated credit card securitizations are eligible for the program. Moody's acknowledges this as well "TALF requires triple-A ratings." However, and here is the rub, Moody's does not rate either Cabela's or WFN's other credit card debt AAA. Now this becomes a problem as allowing a non-AAA rating as part of the TALF structure would immediately render it ineligible. So what happens? In Moody's own brief and cryptic words: "Moody’s rates WFN and Cabela’s other outstanding credit card ABS at less than Aaa. We were not asked to rate these TALF deals."

Yup, folks - turns out the survivorship bias of the AAA-rating is back in town. If the government wants a AAA rating to peddle it garbage to "private" investors and is aware it will not get it, it simply chooses to bypass that particular rating agency which disagrees with the government's assessment on the pristineness of the collateral. Sure enough: the Cabela's deal gets a AAA rating from the three other gov't pets: S&P, Fitch and DBRS. No wonder Egan-Jones is nowhere to be included in this fray: their objectivity would royally screw with the purpose of picking the top three ratings out of the hat of four rating agencies eligible for pandering to Barney Frank and the PPIP.

Either way, this selective affirmative bias presents a new wrinkle in the rating agency conflict of interest: if there is advance information that a given RA will underrate and not provide the AAA seal of approval on any given TALF issue, the powers that be simply decide to bypass it entirely, relying on its more easily manipulated peers. Although this also means that Frank will have to be careful to focus the public anger on Moody's as he has already started, and not stray far and blame S&P and Fitch for essentially the same transgressions, as if these last two bastions of "every collateral is fabulous" opinions decide to stop playing ball, the current version of TALF will simply evaporate, and the government will be forced to redraft TALF so that even C+ rated collateral can be packaged into it.

And just as the housing bubble ended the way it did with the rating agencies' complacency, this new development will inevitably leave the naive private investors who are taking advantage of the government's TALF "benevolence" in the same boat as Iceland, who was oh-so-keen to believe that non AAA-rated RMBS is "safe". Sphere: Related Content
Print this post
blog comments powered by Disqus