Archive for July, 2011

“Moody’s threatens to downgrade obvious crap to crap status but doesn’t cause of a high probability of poo/fan interaction!” seems to be a common refrain in the news over the last 6 months or so. Moody’s, S&P, and Fitch (“The Big 3″) rating agencies have been in the news a ton as well over the last 3 or 4 years. Back in 2007 at the onset of the crisis they came under heavy fire for having under represented the risk on Collateralized Mortgage Obligations and the rest of the mortgage related portfolio butt penetrators that were the main reason for the downfall. The technical term here is “misrepresenting a ho as a housewife” which Mr. Kurupt has firmly proven is impossible.

"The proportion of successful Ho to Housewife conversions is not statistically significantly different from 0, which allows us to accept the null hypothesis playboiiiii"

Hindsight is 20/20 of course, but for professional, highly regarded credit analysts, seeing that something isn’t cricket when the products they are rating are based on loans from lending standards that consist of having a face doesn’t seem like too much to ask. So when they rate them as AAA then explain the rapid downgrades away as “well no one ELSE saw it coming either!”,  seems pretty bogus. An easy statistic to throw out there is that by 2006, Moody’s revenue from just structured finance (read: mortgage backed securities (MBS)) equaled Moody’s entire revenue from 2001 (USD 881M). Easy to see why they’d want to keep the MBS parade rockin eh? The ratings agency controversy actually stretches back farther than 2008 with the previous major issue being when they proclaimed “Sunshine and Boners for Enron” right up until their complete collapse for massive accounting fraud. The bulk of the criticism comes from the fact that the big 3 operate on an “issuer pays model” where the bond’s issuer pays the ratings agency to rate them . They do this instead of a “subscriber pays” model because institutions are much more willing to pay for ratings that they need to sell bonds etc than subscribers are to have someone do their analysis for them. Unfortunately, this also leads to a monster conflict of interest given the difficulty of being objective while they are being paid by the people they are in charge of rating. You don’t bite the dick that pleasures you right? That’s how the saying goes isn’t it?

No?

“Subscriber pays” isn’t perfect either though as high powered investors can pressure ratings agencies for a lower (ie. higher risk) rating in order to drive up return (higher risk bonds = higher returns), or an investor with a short interest in a bond may also rabble rabble rabble for a lower rating. So there are interest groups on both sides at play. The most important thing about how the ratings agency operates is that they are transparent with how they come up with the ratings given. I work with risk modeling frequently in my job and usually I stuff numbers into a calculator and it goes “I-AM-A-RATINGS-ROBOT-BLAAAAARRRFFFF” and spits out a rating. Someone asks me how I rated them a C I can say “well sir the giant loan you took out to finance your hooker harem in Marrakesh was considered a “non strategic asset” (there would def be air quotes there) and that triggered this specific risk gate in our model and boom, C credit.” But when it comes to the huge ratings decisions (ie. giant corporations and sovereign), there are models sure, but those are preliminary jumping off points. The real decisions are made by committees and at that level you best believe there are several oceans of politickin’ goin on leading to the uncertainty discussed above.

These ratings crises have also shown that ratings agencies can jack up overall risk in the markets and exacerbate existing cycles helping further crackify good runs and make the resulting uncrackification that much more severe. This ties back into transparency, if the market knows how the agencies rate then they can anticipate ratings changes and price them into the market, thus lowering volatility. However, if there are sudden unanticipated (this is the key) downgrades of securities then markets go “great googaly moogaly, what else is gonna happen here?” and fzam! volatility returns as markets jump all over the place trying to anticipate the unanticipatable (fuck you spell check that’s a word).

So how does this tie in with the situation these days? Well it seems as though the whole Euro debt crisis has played out to the beat of the big 3 American ratings agencies. In April 2010, when Greece was teetering on the brink of requiring a bailout, S&P’s decision to downgrade Greek debt to junk status (which is an incredibly rude euphemism if you think about it even though it just means anything under BBB rated), pretty much made it a foregone conclusion that rescue would be needed. Then when the Euro countries were trying to figure out a way to restructure Greece’s debt just a few weeks ago with private investors picking up some of the slack, S&P declared that any act of restructuring (even voluntary) would be classified as a full-on default (exactly what the Euro countries were trying to avoid). The Euro countries howled at these downgrades as well as downgrades to Portugal’s debt to junk status (July 5 ) and it has given rise to accusations of favourtism in that the agencies haven’t downgraded the US, despite threatening to numerous times.

Given the poopesque fiscal condition of the Euro nations that were downgraded, can the ratings agencies be held at fault for seemingly exacerbating a crisis? Probably not. Will that stop people from trying to use political measures to influence the ratings agencies? Definitely not. In fact EU commissioner Michael Barnier already “declared war” (hurray for sensationalist reporting!) on the ratings agencies  revealing “stiff measures to tame the[m]” and complaining again of the suddenness of the rating change with no warning (sound familiar?).

So in the end we seem to have a quagmire, where people accuse the ratings agencies of politicking both by doing stuff (see the EU) and by not doing stuff (see warning about downgrading the US below AAA but not actually doing it). There’s no easy answer out of this situation but my favourite quote that sums up the sitch the best is from a distinguished sounding fucker by the name of Sebastien Mallaby, a senior fellow for international economics and the director of the Maurice R. Greenberg Center for Geoeconomizzzzzzzzzzzzzzz…..what? He’s impressive anyways.

"My economics weiner is THIIIIIIIIS big"

He says “the more government has power and is meddling with ratings agencies, the more the rating agencies will be brow-beaten into giving a generous rating to the sovereigns…. The reason why the subprime bubble could happen, or the reason why the Euro sovereign debt crisis can happen is, largely, that very blind investors bought bonds relying on ratings, and [didn’t do] their own homework about what the real credit risk was in the bonds.” Boom. Nailed it Mallaby. The ratings agencies have become a crutch for those unwilling to do their own research or unwilling to pay for independent research. As long as they are politically motivated, less than perfectly transparent, and funded by the people who they rate, they will never be unbiased and perfect. The only way to fully solve all these crises is to do your own research or hire independent researchers. Lacking that you’re always going to have to look behind the scene that’s already behind the scene and try and deduce for yourself what’s hard finance and what’s fluffy “soft factors”.

Sometime soon I’d like to expand on this by studying how the markets/currencies/yields actually moved with the downgrades in the EU and the threats in the US, cause anecdotally…. It totally seems like the markets said “jerk jerk jerk pshhhhhhh” (that was the fake jerk off semen throw motion) to some of the announcements indicating that they may be starting to put a lower emphasis on these downgrades.

Till next time.

Stay classy

The SRB (appreciator of the Triple B)

So the ECB is going to drop a second bailout package all up in Greece’s grill worth an estimated 70 Bn Euros. If the EU and the IMF don’t release the next tranche of this (12 Bn Euros) by mmmm…. NOWish then Greece will default on its government debt. This is on top of the 110 Bn Euros that have already been mostly used up by Greece during this debacle. People had compared Greece to Lehman Brothers in 2008 in that “oh snap if we let this fail then it’s gonna spread to everywhere else and we are double secret probation fucked” so it was unlikely that they would be allowed to default on those obligations.

In order to get access to this 12Bn that they so desperately needed, Greece needed to pass ANOTHER austerity package cutting more government jobs/spending and further raising taxes… this was met with 500,000 protesters and a government revolt in mid June . So they tried again with a mildly watered down version June 29, passed it, got their moneyz, the international stock markets took off, supermodels clothes spontaneously combusted into rose petals and everything was great. Article over.

 

"oh hey Mo...m..... HEY WHAT THE FUCK!"

 

Just kidding, that 12Bn just papered over what is a monster problem that a lot of very smart people don’t seem to realize: You can’t solve a solvency issue with a liquidity solution.

The idea behind this is as follows: say you have a cocaine dealer (Greece) and they have a bigger cocaine dealer who is threatening to jook them for real (their sovereign debt holders) if they don’t pay them the scrilla they owe them. Now if Greece has a bunch of dope they can definitely sell (good future GDP growth and solid future tax revenues) and they are just in trouble because they don’t have the money to pay now then THAT is a liquidity issue and something that can be fixed with a loan from the ECB to tide them over till they can sell their dope/grow their GDP and collect taxes.

 

"AND TAXXEEESSSSSSSS"

Herein lies the rub though, Greece is dopeless. Greece. Is. Dopeless. Also, these “bailouts” aren’t bailouts in the true sense of the word, the ECB isn’t just saying “here is some cash” or “hey don’t worry bout that debt son(s)”, they are lending them money at a low rate so they can pay off their current obligations.

Greece’s debt to GDP ratio will reach 165% by the end of 2012 (Canada is at 34% now and even the US and its disaster of a balance sheet will only be at 94% by end of the next year) so it’s interest bill is already straight nuts. The austerity programs they have put in place, rather than decreasing the government’s deficit have actually increased it by 13% because, while yes they have dropped spending, they have stifled their economy so much that tax revenues have dropped by more than the spending drop so the austerity is actually self-defeating. Further to this, usually when a country is in trouble they can cut interest rates and devalue their currency to stimulate exports and spur growth…. But not Greece cause their part of the EU and that decision is not in their hands (interest rates may actually end up rising soon in the EU). So why don’t they just peace out of the EU and drop their currency? Well for the final bit of deep dickin’: all their debts are denominated in Euros and so would become that much more expensive to pay off with a lower domestic currency.

This picture is surprisingly appropriate for so many situations.

In short Greece is insolvent and has no way to remedy that situation other than defaulting on their debt and restructuring down to a more sustainable 80%-100% of GDP debt load. Slangin’ money at them via more loans won’t help because it will just increase the debt load and interest payments. In the end someone is going to have to lose a buttload of moneyz to make this work.

 

"uh... ma'am that is not a quantity of moneyz"

The most sensical plan out there to me to employ the capital that is clearly there and willing to be used to insulate this crisis, was proposed by the Institute of International Finance (they should probably know whats up right?). It is to first have Greece repurchase its own debt from the current holders at market value (which is dirt cheap right now) thus lowering their debt load. Then employ the capital on the table to the banks/nations who took writedowns when the Greeks bought their debt back from them cheap.

Ireland was downgraded today and Italy is starting to make news as well. More on them as they develop for this Eurozone sovereign crisis is a loooong way from sorted out.

Till next week.

Stay classy

The SRB. A.K.A. The Skillsbury Flow-boy