EnglishWhen no one believed that rating agencies could possibly go even deeper in the uncharted space of financial ridicule and absurdity, Standard & Poor"s proved everyone wrong. Within one week, S&P lowered the rating of certain securities from investment grade to speculative grade and back.
Is that possible? It is, because the securities in question were eligible collateral for a Fed programme to keep the financial sector at AAA rating, but not at lower ratings. The Federal Reserve in mid-May announced intent to extend the TALF (Term Asset-Backed Securities Loan Facility) to include the CMBS (Commercial Mortgage-Backed Securities).
The collapse of the commercial mortgage market in the United States turned the CMBS into toxic assets sooner than it did the residential mortgage-backed securities. Irrespective of the new market context, these securities needed the AAA rating in order to be accepted by the Fed, which is once again regarded as the last resort for this market, too.
"After the collapse in the U.S. housing market, the non-residential property sector is now in trouble - posing a fresh threat to the banks, Dimitry Fleming, economist at ING, told Financial Times in March. Donald Kohn, Vice Chairman of the Federal Reserve, had previously stated that the banking sector was much more exposed to the collapse of the commercial mortgage market than to the collapse of the residential mortgage market, while some regional banks had especially large portfolios of commercial mortgages.
What is the size of this problem of the financial sector? Approximately 2.5 trillion USD in commercial mortgage loans at the end of last year. In order to avoid creating the impression that they would burden their balance with toxic assets, the Federal Reserve even changed their name: toxic assets became "legacy assets."
The only thing left to do was to ensure rating stability. But a small problem got in the way. Standard & Poor"s, alongside the other major rating agencies, were trying to save the "reputation" they had built during the subprime crisis and therefore were displaying belated but excessive zeal. S&P had announced in end-May that they were considering lowering the rating of CMBS" worth tens of billions of dollars, and that included securities issued by Goldman Sachs, Credit Suisse, JP Morgan and Morgan Stanley.
The S&P press release indicated that the agency was very concerned especially with the performance of the CMBS" issued in 2007, whose loss rate could reach 20% for certain AAA-rated classes, should the economy decline significantly. The uncertainty sparked by the S&P announcement prompted potential customers not to bring CMBS collateral to the first TALF bidding in June.
On 14 July, Bloomberg wrote about the reduction of the rating for several classes of CMBS", in some cases even as much as from AAA to BBB-. The result? The demand for financing amounted to some 669 million USD on the offer dated 16 July, as Reuters reported, considering that CMBS" worth 300-500 billion USD will reach maturity by the end of the year, according to market estimates.
Only a week later, Standard & Poor"s backtracked on the decision in what the Wall Street Journal called "a surprise rating flip-flop." Reuters reported that "Standard & Poor"s reversed some controversial downgrades of widely watched commercial mortgage-backed securities in a highly unusual response to investor ire." (!!!) Who might those "investors" still in denial be, if S&P was so prompt to respond to their "ire"? And where might this agency still get some credibility from?
Reuters also provided some information that is quite useful in finding the answer to that: "S&P raised ratings on the A2, A3 and A-AB classes in Goldman Sach"s 2007-GG10 transaction, considered a benchmark for CMBS, back to AAA from BBB-minus." According to the Reuters report, the same dramatic reversal also benefitted securities issued by Credit Suisse. Interestingly, Standard & Poors did not increase the rating for all the securities downgraded a week before, probably based on the idea that "all CMBS" are equal, but some are more equal than others."
"It is a stunning reversal and certainly raises questions concerning the robustness of their revised model," said Christopher Sullivan, Chief Investment Officer at United Nations Federal Credit Union in New York. His opinion is probably shared by the majority of the market actors, who will now try to find out what they could put in the basked of giveaways to S&P to "lubricate" the process of rating assessment.
In an attempt to find out Standard & Poor"s motivation, the Wall Street Journal received an email from the S&P spokesperson, who specified that the reversal to the previous ratings had been the result of "recently updated criteria." In a timeframe of one week?
The Financial Times noted that Standard & Poor"s had made that decision on the same day when proposed U.S. legislation on rating agencies was sent to Congress. Although it includes new rules on improved transparency, "the business models at Moody"s Investors Services, Standard & Poor"s and Fitch Ratings - which are paid by the companies whose debt securities they rate - remain largely intact."
Is it not a bit too soon for the U.S. politicians to forget the proletarian anger of their speeches against the rating agencies just a few months ago? With or without official support, the main opponent of the rating agencies is economic reality, which will soon invalidate the authorities" optimism.
"We are now in the early stages of a depression," Eric Sprott of Sprott Asset Management LP wrote on the company"s website, pointing out that "the economic indicators we follow to track real economic activity are signalling a slowdown of massive proportions." Under these circumstances, the Federal Reserve programmes will remain the only customers for the CMBS" on the market, as chances are no private investor will show any interest in them.
And yet, there will be growth in the near future. Growth in the losses booked to the official portfolios of CMBS", irrespective of their rating.
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