Rating structured bonds is impossible

By Felix Salmon
December 16, 2010
regulatory arbitrage with negative economic value -- you take a bunch of bonds , and then spend lots of money on bankers and lawyers and ratings agencies in order to transform them into other bonds.

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Re-remics are a regulatory arbitrage with negative economic value — you take a bunch of bonds , and then spend lots of money on bankers and lawyers and ratings agencies in order to transform them into other bonds. The financial-services industry gets lots of lovely fee income, which ultimately comes out of the pockets of the beneficial owners of those bonds. And no one makes out more handsomely than the ratings agencies, without whom none of this would be possible: it’s their precious triple-A ratings which make the arbitrage attractive in the first place.

The problem is that the ratings agencies, as we saw in the crisis, have no idea how to rate structured debt. And they also have no idea how to learn their lesson: the first big re-remic downgrades happened almost immediately, and then they just kept on trickling out — there were 224 in September, and another 129 have just arrived.

S&P is the big villain in this story, both rating and downgrading many more re-remics than anybody else. They emailed their press release to the FT, where Tracy Alloway reprints large chunks of it, but if you Google the headline on the release, the only way you can find it is by paying $100 to Alacra. Just because you’re releasing something to the press doesn’t mean you want it to be public, I guess, and neither does it mean that you want to talk about it:

“Our written statements are what we are providing,” Ed Sweeney, a spokesman for S&P, said in an e-mail. He declined to comment further and didn’t answer an e-mailed question about the principal balances of the securities under review.

The business of structured-finance ratings broke so badly during the financial crisis that it cannot easily be put back together again. The ratings agencies have no business rating structured bonds: they’ve proved that many, many times, and there’s zero indication that they’re any better at it now than they were before the crisis. Indeed, it might well be something which is impossible to do — these things are just too complex to be able to assign a risk-free rating to. Somebody should stop the ratings agencies from even trying.

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