As market for asset-backed securities rebounds, ratings shopping resumes

In yet another sign that zero genuine financial reform has occurred since the beginning of the financial crisis, Bloomberg reports that as the market for asset-backed securities rebounds, credit ratings shopping has returned.

Regular readers will recall that in the run-up to the financial crisis, rating firms were willing to put a AAA-rating on securities that the firms admitted they did not have adequate information monitor prior to issuance of the securities and after the securities traded in the secondary market.

In fact, structured finance securities developed a nickname: opaque, toxic.  Where the opacity of the security hid its toxicity.

Here we are almost 6 years after the financial crisis began and policymakers and financial regulators have done nothing to bring transparency to the structured finance market.

As regular readers know, the only way to bring transparency to structured finance securities is to require that they disclose on an observable event basis all activities like payments or delinquencies that occur with the underlying collateral before the beginning of the next business day.

It is only with observable event based reporting that investors know what they own and potential buyers can know what they are buying.

Here we are almost 6 years later and policymakers and financial regulators have not brought observable event based reporting to structured finance.

In fact, policymakers and financial regulators have gone out of their way to keep these securities opaque.  For example, the ECB puts its blessing on a data warehouse that provides disclosure on the same frequency as opaque, toxic subprime mortgage-backed securities.

Almost six years after the start of the worst financial crisis since the Great Depression, bond issuers are again exploiting credit ratings by seeking firms that will provide high grades on debt backed by assets from auto loans to office buildings considered inappropriate by rivals. 

Fitch Ratings isn’t grading a deal linked to a Manhattan skyscraper after saying investors needed more protection. The securities won top grades from Moody’s Investors Service and Kroll Bond Rating Agency Inc. 

Blackstone Group LP’s Exeter Finance Corp. got top-tier ratings from Standard & Poor’s and DBRS Ltd. in the past 15 months on $629 million of bonds backed by car loans to people with bad credit histories, even as Moody’s and Fitch said they wouldn’t grant such rankings.

Borrowers are finding more options than ever to get the top ratings that many investors require after U.S. regulators doubled the number of companies sanctioned to assess securities to 10 since 2006.... 

Issuance of bonds linked to loans and leases are staging a comeback as the Federal Reserve (FDTR)’s unprecedented stimulus, including a pledge to keep benchmark interest rates close to zero into a fifth year, pushes investors into riskier assets. 

Banks have arranged $31.5 billion of commercial mortgage-backed securities this year with issuance poised to climb 50 percent from 2012 to $70 billion, according to Credit Suisse Group AG. Issuance of bonds tied to subprime auto debt of $7.7 billion this year compares with $5.7 billion in the first four months of 2012, according to Wells Fargo & Co.... 

“Nothing’s really changed” in the ratings business, David Jacob, former head of structured finance at S&P, said in a telephone interview. Regulation “changed some of the processes that they do, but what led to a lot to this bad behavior hasn’t really changed.”

The only way to bring about true change is to require the structured finance securities to provide observable event based reporting.

With this information, market participants can assess for themselves the risk and value of these securities.  Market participants can either do the due diligence themselves or hire third party experts to do the due diligence for them.

This ends any reliance on the rating firms.  With transparency, rating firms become just another third party expert offering an opinion.

Debt graders led by S&P and Moody’s helped ignite the credit seizure that began in August 2007 by lowering their standards to win business before defaults soared on home loans to subprime borrowers, the Federal Crisis Inquiry Commission said in a January 2011 report. 

“My plea today is that you take action,” Franken, a Democrat from Minnesota elected to the Senate in 2008, told participants at the SEC roundtable today. “If we maintain the status quo we are leaving ourselves far too vulnerable to another catastrophe.”...

Where the status quo is opacity.  Bringing transparency to opaque securities like structured finance reduces our vulnerability to another catastrophe.