Discredited: How Australia exposed creditor predators
Australians have a tendency to feel small and insignificant on the global stage. But it’s time to take a bow.
It has taken an Australian court to expose and bring to justice the despicably lax moral standards of investment bankers and credit ratings agencies that helped create the global financial crisis which destroyed jobs and retirement nest eggs the world over.
Ever felt bamboozled by the world of high finance, that it’s all too complex to understand? Well, don’t worry. It’s not you, it’s them.
In a world first, the Federal Court of Australia ruled on Monday that one of the world’s biggest credit rating agencies, S&P, was guilty of negligent conduct when it gave its highest credit rating –AAA – to a financial asset created by an investment bank ABN Amro and sold to 13 local Australian councils in 2006. The councils lost $16 million when the asset proved worthless within two years. They stand to recoup about $30 million in costs and damages. S&P has announced it will appeal.
The landmark decision opens the way for a global wave of copycat litigation by other angry investors sold financial duds disguised as top notch investments in the run up to the GFC.
Credit ratings agencies are supposed to be the trusted gatekeepers of financial markets, assigning a rating to financial institutions and financial products depending on how risky they are.
Turns out ratings agencies are often just rubber stamps, guns for hire. They are paid to rate particular financial assets by the creators of those assets. And worse, they are paid not on the quality or accuracy of those ratings, but according to the volume of ratings they produce. In the debt-fuelled heady days before the GFC, these agencies rushed to write as many ratings as possible. They became overstretched and completely out of their depth to understand the products they were rating.
If you think about it, having investment banks pay ratings agencies to rate their products is a bit like a used car salesman paying a magazine to write reviews his or her cars. Basically, the ratings agency had no idea what was happening beneath the bonnet. But that didn’t stop them writing glowing reviews on some particularly toxic financial investments.
These, by the way, are the same credit ratings agencies that rank the Australian government AAA and our banks some of the top AA rated banks in the world.
State governments contort their budgets to satisfy their demands.
Remember that the next time you hear some politician arguing budget cuts are necessary to maintain a certain credit rating.
So how have they got away with it?
In the United States, ratings agencies have avoided law suits and deflected blame by pleading the right to free speech. They argue it’s just an opinion to say a financial product is AAA rated. Buyer beware!
Sorry. Not good enough, according to federal court justice Jayne Jagot.
“The very purpose of a rating is to provide investors with independent information by persons expert in assessing the creditworthiness of an investment so that, by a simple system of letters, an investor can know and compare the creditworthiness of investments,” she wrote in her damning 1459 page judgment.
Justice Jagot found S&P had been “negligent” and “misleading and deceptive” in assigning its AAA rating to the financial asset sold by ABN Amro (which has since been taken over by Royal Bank of Scotland). The asset was “grotesquely complex” and S&P failed to undertake basic fact checking which could have revealed it was in fact a risky and highly leveraged investment.
Incredibly, S&P used a financial model created by ABN Amro to assess the riskiness of the asset. Into this model it inserted data supplied by ABN Amro which a simple check could have revealed was completely wrong. A key measure of market volatility was entered at 15 per cent, when it was in fact much higher at about 28 per cent.
But any higher and the asset wouldn’t have been eligible for a AAA credit rating. And that suited neither ABN Amro nor S&P.
Justice Jagot found ABN Amro “sandbagged” S&P and “simply bulldozed the rating through”. For its part, S&P failed to act in a “reasonably competent” way.
As a result, local councils were sold AAA rated assets that turned out to be worthless in less than two years. Some councils were left unable to finance upgrades to critical community infrastructure like pools, parks, public toilets and footpaths.
The follies of high falutin finance came crashing down on local communities.
No where near enough has been done to ensure sure this can’t happen again, although this week’s decision is a major step forward.
Global authorities have been enforcing a higher a degree of transparency in the way ratings are assigned. But that’s just not good enough.
The real problem is the pay structure for ratings agencies.
As long as ratings agencies are paid for their ratings by the sellers of financial products, and not the investors who end up buying them, ratings agencies will always lean towards outcomes that are in the interest of their clients, not investors. He who pays the piper gets to pick the tune.
It’s time these guys were held to account for their ratings. And it is encouraging that Australia that is leading the way.
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