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from Global Investing:

A scar on Bahrain’s financial marketplace

Bahrain's civil unrest -- which had a one-year anniversary this week -- has taken a toll on the local economy and left a deep scar on the Gulf state's aspiration to become an international financial hub.

A new paper from the Sovereign Wealth Fund Initiative, a research programme at Center for Emerging Market Enterprises (CEME) at the Fletcher School at Tufts University, examines how the political instability of 2011 is threatening Bahrain's efforts in the past 30 years to diversify its economy and develop the financial centre.

Asim Ali from University of Western Ontario and Shatha Al-Aswad, assistant vice president at State Street, argue in the paper that even before the revolt, Bahrain lagged in building the foundations of a truly international hub in the face of competition from Dubai and Qatar.

Unlike DIFC (Dubai International Financial  Centre) and QFC (Qatar Financial Centre), Bahrain insists upon local labor; currently 70% of employees in its banking and financial services industry are Bahrainis.  Bahrain’s reluctance to hire non-resident  talent  has made  Dubai...an alternative for those investors looking for a centre with more flexible labor practices such as DIFC provide...  The constraints  – a lack of formalized institutional and regulatory structure, along with an ad hoc business environment, underdeveloped infrastructure, and under-supplied skilled workforce – have negatively affected its growth and  potential to become the financial gateway in the Middle East.

Then came the crackdown of protesters.

Its ruling Al-Khalifa family unleashed  a ferocious extra-judicial crackdown against the opposition. It appeared the standard axiom of Gulf ruling families – securing legitimacy and counter-acting political opposition through redistribution of oil wealth – was sorely insufficient to address  citizens’ grievances.  These led not only to international opprobrium of  the  Bahrain government but also made foreign businesses reconsider Bahrain as a financial center – with many foreign business shifting  workers and operations to Dubai... Indeed, confidence in Bahrain as a financial hub took a major blow along with its image as a stable, tolerant and liberal state.

It remains to be seen what impact last year’s pro-democracy uprising will have on the state of Bahrain and its  ambition as a regional financial gateway– especially at a time when Dubai (DIFC) and Qatar (QFC) remain serious contenders to become dominant financial centers in the Middle East.

Bahrain had shown perseverance and strength in building its financial center, but democracy efforts and human right violations were able to  threaten the hard work of more than 30 years.

Bahrain's sovereign wealth fund Mumtalakat, which is leading the country's efforts to diversify its economy away from the hydrocarbon sector, suffered a series of ratings downgrades last year as a result of sovereign downgrades. Mumtalakat is rated triple-B.

from Breakingviews:

U.S. payroll tax fight shows faux fiscal restraint

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The fight over U.S. payroll taxes just became exhibit A in political style over substance. Republicans in Congress, who have pounded the table on deficit reduction since last summer’s bruising debt battle, have backed down on a demand that spending be slashed to cover the cost of extending the tax cut. To let it ride for another 10 months will cost $100 billion. So much for fiscal discipline.

It was bad enough when legislators leaned on seized mortgage backers Fannie Mae and Freddie Mac last December to enable 160 million American workers to keep paying a rate of 4.2 percent of their wages, instead of 6.2 percent, into the Social Security fund for a couple of extra months. Now, it’s about to get worse.

Last year, when Republicans refused to raise the nation’s debt ceiling unless future deficits were shrunk, it led to a “super-committee” tasked with finding a way to lop off at least $1.2 trillion from future deficits. The group, predictably, failed. Instead, $1 trillion was automatically cut – a figure that dips to $900 billion if the payroll tax cut is extended.

It’s easy to write this off as election-year politics, but that would neglect the deeper dogma at work. The GOP pledge not to raise taxes obviously trumps any rhetoric around the deficits that have been averaging $1.3 trillion for four years running.

Of course, the Democrats aren’t acting any more responsibly. They’re happy to extend the payroll-tax cut without paying for it, too. And though willing to slash some spending elsewhere, Barack Obama’s party is still unwilling to tackle the real problem: safety-net programs. This was evidenced most recently by the president’s budget plan on Monday.

Despite losing its AAA credit rating, the United States isn’t in any real trouble yet. Its debt held by the public is about 70 percent of GDP - well below Greece’s 160 percent. But America’s ratio is also nearly double what it was just four years ago. The payroll tax fight only goes to show just how little political will there is in Washington, just as in many other capital cities around the world, to seriously address the problem.

from Unstructured Finance:

Et tu, S&P

By Matthew Goldstein

A few weeks ago S&P telegraphed that it would soon strip the U.S. of its vaunted Triple A rating and downgrade the government's debt by a slight notch to AA+. And Friday night, the major credit rating did just as it telegraphed.

For the moment, let's not debate whether S&P is engaging in politics, or should even be in the business of rating the debt of countries. The latter issue, however, is something that our nation's political leaders and regulators may want to consider at some point.

But for right now, it's worth noting that over the past decade or so, S&P has moved on downgrading corporate debt and esoteric securities as if it was still operating in the days of the telegraph.

Remember, Enron and Worldcom.

And who can forget the big role credit rating agencies like S&P played in allowing Wall Street banks to market subprime-backed CDOs as Triple A securities. In many ways, the rating agencies were Wall Street's enablers and bought into the fiction that securities built from crappy mortgages would continue to payout because a national crash in housing prices was something unthinkable. Or, at least, something the rating agencies never seemed to consider throwing into their magic default models.

Additionally, S&P was the only major credit rating agency to slap a rating--an A rating--on ACA Capital. Don't remember ACA Capital? Well before AIG took the lead in insuring flawed CDOs and other mortgage-backed securities, ACA Capital was Wall Street's go to shop for guaranteeing exotic securities. ACA could only do this because of the A rating it had from S&P.

from Alison Frankel:

Angry about possible U.S. downgrade? Don’t bother suing raters

With U.S. markets fretting Tuesday at the prospect of a downgrade in the government's triple-A credit rating, you may be wondering: Who can we sue? Litigation, after all, is practically an unalienable American right. The problem, however, is that any attempt to sue the credit rating agencies for downgrading U.S. securities will run smack into the Bill of Rights. The rating agencies, as many a disgruntled mortgage-backed securities investor has discovered in the last few years, are shielded from liability because their ratings are considered to be public opinion protected by the First Amendment of the U.S. Constitution.

The agencies' First Amendment protection dates back at least to 1999, when the U.S. Court of Appeals for the Tenth Circuit upheld a Colorado judge's dismissal of a case against Moody's Investor's Services. The Jefferson County School District had sued Moody's, claiming that the credit rating agency published an unfair assessment of the district's 1993 bond offering. (The suit alleged that Moody's was retaliating because the district hired other agencies to rate the bonds, but that wasn't important in the case's outcome.) Jefferson County, which had to re-price the bonds after the unfavorable Moody's report, claimed the rating agency had illegally interfered with its bond offering and also committed antitrust violations.

The trial court treated Moody's as a member of the media and found that the First Amendment protected its report on the school district bond offering from both state and federal claims. On appeal, the school board argued that the report was not protected free speech, but the Tenth Circuit disagreed. The appellate panel didn't even waste much time discussing the trial court's assumption that Moody's is entitled to the same First Amendment protection as, say, Reuters. Instead, the Tenth Circuit opinion analyzed the allegedly false statements in the Moody's report and concluded they're too vague to be "provably false," so Moody's was constitutionally protected.

In a similar 1999 case, a Santa Ana, California, federal district judge granted summary judgment to Standard & Poor's parent McGraw-Hill Companies, finding that a credit rating agency's opinion must be issued with actual malice to lose its First Amendment protection. (That's the same standard that applies for journalists.) In the Santa Ana case, Orange County claimed that S&P had granted too rosy a rating to county bond offerings. It sued for negligence and breach of contract, but the court held that Orange County would have to show actual malice by S&P to proceed with either claim. The County couldn't make the requisite showing, so its case was tossed.

The software outfit Compuware Corp had a stronger case for actual malice, considering that it accused Moody's of unreasonably downgrading its credit rating (instead of issuing an overly-optimistic assessment, as Orange County claimed S&P had). But in a 2005 suit against the rating agency, Compuware argued that it shouldn't have to show actual malice to proceed with a breach of contract case. The U.S. Court of Appeals for the Sixth Circuit nevertheless upheld the actual malice standard in a 2007 opinion that seems to take for granted the notion that credit rating agency products are protected by the First Amendment.

"The contract between Compuware and Moody's involves matters central to the First Amendment," the Compuware court found. "The relevant agreement, as best we can determine from the evidence presented by the parties, consists of Moody's promise to provide its opinion of Compuware's creditworthiness and to publish a report of that opinion. Moody's agreed to do no more. Moody's provided that opinion, and Compuware does not claim to the contrary. Both Moody's opinion and its publication are matters protected by the First Amendment; thus the whole of this agreement -- the very subject matter and corresponding duties -- is intimately tied to speech, expression, and publication."

The First Amendment shield has proved to be incredibly valuable to the credit rating agencies in the wake of the 2008 economic meltdown, when court after court has dismissed MBS investors' claims that the rating agencies worked hand-in-glove with issuers to confer AAA ratings on mortgage-backed dreck. The Teflon properties of the First Amendment even attracted the attention of Congress, which attempted to impose broader liability on the credit rating agencies in the 2010 Dodd-Frank financial reform litigation. As you might expect, the rating agencies and their lawyers have lobbied hard to blunt the force of the Dodd-Frank rules as the Securities and Exchange Commission contemplates implementation.

from Unstructured Finance:

S&P as the decider?

By Matthew Goldstein

Derivatives guru Janet Tavakoli is a long-time critic of the rating agencies and in particular the role the raters played in the subprime debt crisis. And she says given the shabby job the rating agencies did in giving the green light to the subprime debt boom, it's odd to think of firms like Standards & Poor's playing such a big role in the ongoing US debt ceiling negotiations.

"Standard & Poor's lost its credibility due to a long history of misrating financial products," says Tavakoli.

The Chicago-based consultant, for now, isn't taking position on how the on-again/off-again political wrangling in Washington over raising the debt ceiling should be resolved. But she said investors would be better off ignoring what the raters--in particular S&P--have to say on the matter.

from Tales from the Trail:

Washington Extra – Cattle prod

.As market maven Mohamed El-Erian told us today "The medium term has a way of creeping up on you." That's why everyone needs a cattle prod from time to time and today it was Washington's turn to get a goading.

It came in the form of Standard & Poor's decision to slap a negative outlook on America's top-notch credit rating because of Washington's plodding pace on deficit reduction. The White House and Congress need to get in gear and start making meaningful plans to cut the deficit or else be responsible for a dreaded downgrade in debt. The chances? One-in-three over two years.

S&P took most everyone by surprise, although the White House knew on Friday. In three days, it prepared the defenses: 1) S&P is making a "political judgment"; 2) "we shouldn't overreact"; 3) actually we are closer than you think in agreeing with Republicans about the way forward.

That might be so. But El-Erian, who has lived through many a debt downgrade and default over the years, noted there are three steps to any credible adjustment and the United States hasn't even done the first one: "formulating the action plan."

Here are our top stories from Washington…

S&P move puts pressure on Congress, White House

from Financial Regulatory Forum:

ANALYSIS-After hardball, Greece gets EU solidarity pledges

By Brian Love, European Economics Correspondent

PARIS, Dec 11 (Reuters) - Reassuring noises from France and Germany suggest Greece can ultimately count on help from its euro zone partners if its debt problems get out of hand -- though its partners were content to see financial markets scare Athens for a while.

As Greek bond spreads ballooned early this week, officials in major European Union governments indirectly fuelled the panic by refraining from making clear pledges of support for Greece.

Most of the officials' public statements focused on urging Athens to face up to its problems and, like Ireland, take drastic steps such as public spending cuts to reduce its budget deficit and prevent its debt from becoming unserviceable.

But since Thursday, European officials have changed tack and indicated they are prepared, if necessary, to act to prevent the fiscal pressures on Greece from growing so heavy that the country might have to pull out from the euro zone.

Some analysts think the EU deliberately used the bond market turmoil to make the Greek government recognise the need to act decisively on its deficit -- and then calmed the turmoil before it could become unmanageable and do lasting damage to Greece.

"EU policymakers have played a game of brinkmanship and have nearly fallen off the edge," said Marco Annunziata, London-based chief economist at UniCredit bank.

from Financial Regulatory Forum:

EU ratings register would boost competition-banks

    By Huw Jones    LONDON, Aug 12 (Reuters) - Financial firms said European Union plans for comparing credit rating agencies would boost competition and increase investor power, documents from the bloc's regulators showed on Wednesday.    However, some agencies expressed concerns at having to provide data covering periods before the register is set up.    Just three agencies, Standard & Poor's <MHP.N>, Moody's <MCO.N> and Fitch <LBCP.PA>, dominate the global sector.    They were slammed by policymakers for failing to warn investors about the risks in highly-rated products such as mortgage-backed securities that sank in value as the global financial crisis unfolded, forcing banks to make huge writedowns.    The EU has just adopted a law requiring authorisation of ratings agencies in the 27-nation bloc and includes a provision for setting up a central ratings repository.    The Committee of European Securities Regulators (CESR) is finalising the plans for a repository which would store details of ratings so that investors can compare their accuracy over time.    "As users of ratings, banks welcome improved tools to assess the accuracy of ratings and to make comparisons between rating agencies in this respect," the European Banking Federation said in its submission to CESR and made available on Wednesday.    "Importantly, the repository is expected to be helpful when considering the use of an additional and lesser known rating agency. As such, it might help to increase competition on the ratings market," the EBF said.    AFG, the French investment management body, said a central repository would help enhance transparency, investor power, consistency and comparability in ratings.    But some agencies criticised a requirement to provide data covering periods before the new law comes into force.    "Specifically, we believe that CESR's suggestion that data should be presented for each of the 10 years preceding the date of entry into force of the regulation would undermine legal certainty and erode Moody's legitimate expectation relating to our obligations under EU law," Moody's said.    "If retroactive, it will not be possible for Moody's to comply in some instances, as we will not have data available in the requisite format," the company said.    However, Companhia Portuguesa de Rating of Portugal said the EU plans would fail to increase choice for investors.    "It is useless and greatly misleading to have statistics that are not valid and which only favour the big CRAs, by excluding small CRAs from the CRAs central repository," the company said.    "This will increase entrance barriers in the CRAs industry, avoiding competition from small CRAs and perpetuating the oligopoly that was one of the causes for the problems that happened with the big CRAs ratings during the present crisis," the company said.    CESR should require agencies to supply it with standardised data about ratings issued, changed, withdrawn and respective defaults, the Portuguese company said.    (Reporting by Huw Jones; Editing by Victoria Main)    ((Reuters messaging: huw.jones.reuters.com@reuters.net; + 44 207 542 3326; huw.jones@thomsonreuters.com))  Keywords: EU RATINGAGENCIES/    Wednesday, 12 August 2009 13:25:04RTRS [nLC549170 ] {C}ENDS

from Commentaries:

Debt leaves Reed a lot of digging to do

    Crispin Davis wanted to bolster Reed Elsevier's risk management business when as chief executive he spent $4.1 billion on ChoicePoint.     Last year's acquisition was not a bad one -- it's a ray of light in Thursday's otherwise largely depressing results for his successor Ian Smith -- but the debt taken on to fund the deal is looming over him after the failure to sell the RBI magazines business.     Instead, he has been forced to raise around $1.65 billion in a large, unpopular share placing to keep on top of the $8.4 billion debt pile. A failure of risk management, then. It suddenly seems a long time since Reed handed some $4 billion from the sale of its education business back to shareholders at the beginning of 2008.     Reed is not alone in having to take such drastic action -- drinks can maker Rexam needed a rights issue to keep the credit markets onside -- but the 15 percent fall in Reed's shares reflects the nasty surprise.     Reed and its advisers can expect some flak from the Association of British Insurers (ABI) which hates these big share placings because they threaten the first-refusal rights of existing shareholders.     Reed has stretched the 10 percent new share concession to the limit, adding 9.9 percent to its existing issued capital.     It protests that debt repayments are comfortably far into the future, but the move still smacks of "needs must" and Reed admits that its credit metrics are "too stretched" given the economy and its business cycle.     Add that to a retreat from its profit guidance for the year, and it's no wonder shareholders are spooked.

from Financial Regulatory Forum:

U.S. Treasury sends credit-rating regulation bill to Congress

WASHINGTON, July 21 (Reuters) - The U.S. Treasury Department sent a draft bill to Congress that would prevent credit rating agencies from consulting for the companies they evaluate, and said it hoped new disclosure and conflict-of-interest rules will curb the agencies' power.

Under the measure the Securities and Exchange Commission would have new powers to regulate the industry and companies would have to disclose when they go "ratings shopping" in two other provisions of the plan.

"In recent years, investors were overly reliant on credit rating agencies that often failed to accurately describe the risk of rated products," the Treasury said in a statement.

The reform is meant to help reduce reliance on credit rating companies, the government said. Still, the plan does not tinker with the basic business model that has ratings agencies relying on fees from the companies that they evaluate.

Officials concluded that there was no way to eliminate conflicts and the best approach was to identify and regulate problem areas, said Michael Barr, Treasury assistant secretary for financial institutions.

"Look at the investor-pay models -- investors would still have a conflict because they own these securities being rated," Barr told reporters on a conference call.

"Our basic approach is to say we understand the potential for conflict in this area and we need tough rules to regulate conflict of interest."