The Mad Hatter and the Red Queen have taken over the financial system in this country and maybe the world. Standard and Poor’s downgraded the financial rating of the United States from “AAA,” the highest rating, to “AA+,” the next step down. Suddenly the sky is falling. Everybody knows that S&P, as it is called, is the be-all and know-all of how good anybody’s credit rating really is, right? Therefore,Wall Street panicked and the Dow Jones took a hit of nearly 6% in one day. It was up about 4% the next day and down the tube for another 5% the day after that. That all makes sense, right? Wrong.
Stop and think about it. When all those institutions and individuals sold off all of their stock, where could they put the money? Under the mattress seems unlikely, so where? Banks could be a choice. But the banks do not have credit ratings that are as good as the reduced rating Uncle Sam has. Bank of America’s long-term debt is rated as “A.” The only accounts at BofA that are rated “AAA” are those guaranteed by the FDIC, an agency of the Untied States. I suppose they will be rated “AA+” as well pretty soon, if that has not happened already. Bank of New York Mellon, the world’s largest custody bank, has announced that it will charge a fee to accept deposits from customers whose balances are over $50 million. Its customers are all banks with money they do not know what to do with. Giving Mellon money is not unlike putting it in the mattress. What kind of system has mattresses with $50M, stuffed there by alleged financial wizards?
They could put the money into European markets and currencies, but the concern over the state of the European financial system is worse (and perhaps more legitimate) than the concern about the U.S.
The other place those who fled the stock market in panic could put their money is into U.S. Treasuries, the very bonds that caused them to bolt from the market. The only way it makes sense to sell stock because somebody’s credit has been downgraded, then put the proceeds of the sale into a loan to the outfit that just got its credit downgraded, is if the investment in the stock market made little sense in any event. Why would an investor decide to cash in his stock in private companies because the government’s credit rating has been lowered so he can loan the money to the government with the recently “trashed” credit rating? That only makes sense if the investment in the stock market is a truly risky investment. And, of course, most are.
Take Apple Computer as an example. It used to pay a few pennies a share in dividends, but it quit doing that in 1995. In after-market trading, the day this was written, it was at $363 per share, down about $12 from the day before. I think Apple is a very good company, but it has only been good so long as Steve Jobs was at the helm. When he was gone, it nearly tanked. In spite of that, people have invested nearly $17 billion in Apple stock. Because the stock creates no income to the investor, this is all on the come. Will Steve Job’s health issues (rumored to be pancreatic cancer) lay him low? Will the company survive his departure? Is it rational to bet $375 or $363 on this situation by buying a single share? How about buying 100 or 1,000 or 10,000 shares? Even if you think it is rational, you still have to admit it is a bet.
Back to S&P, what makes it such a credit guru that it can cause such a wild reaction with the stroke of a pen? You would think it must be a completely independent organization with no ties to any significant players in the American economy and an unblemished track record. Take a closer look. S&P is a private company owned by publishing house McGraw-Hill, whose board of directors include executives or board members in oil companies, insurance companies, manufacturing, big retail, mega-agriculture, electronics, and aerospace/defense. In other words, S&P is run by bosses of the very companies that have been sucking the life out of the American economy for decades. All of their companies and their subsidiaries get credit ratings from S&P. Can you spell conflict of interest? It appears that nobody on Wall Street can.
But, perhaps I am being unduly harsh. After all, everyone in the financial industry must pay attention to S&P because its ratings have been accurate, right? Well, S&P’s analysis of the U.S. debt that led to the downgrade contained an error of $2 trillion dollars. That is $2,000,000,000,000. When that error was called to their attention, the worthies at S&P said a little thing like that did not change the analysis that led to the downgrade. So their opinions are so loose and goosey that a mistake that overstates U.S. debt by nearly 14% did not change anything? Gives you the warm and fuzzies, doesn’t it?
Do you remember some things called Mortgage Backed Securities? Sure you do. They were a hot item on Wall Street a few years ago. They had a lot to do with the housing and credit crisis we are in now. MBS, as they were called, involved taking mortgages that were a problem and bundling them together with some that were not so bad and selling the bundle as a security. S&P, with a straight face, gave these “securities” an “AAA” rating -- even when they included mortgages that, if anybody looked at them and the borrowers, were obviously never going to be paid. S&P gave these packages the highest possible rating. The same rating as the United States of America.
Yet Bank of America, which bought a bunch of these “AAA” investments (according to S&P), is now paying $207,000 a year, per package, to insure against default on each $10,000,000 worth of these mortgage packages.
In 2008, Lehman Brothers, the fourth largest investment banking firm in the U.S., declared bankruptcy; the biggest bankruptcy in U.S. history. It had been a worldwide firm with over 26,000 employees. The company no longer exists. Yet S&P gave it an “AAA” rating nearly right to the end, and never rated it at less than investment grade. It gave similar ratings to insurance giant AIG, which only avoided bankruptcy by getting a bailout from poor old bad credit risk Uncle Sam (i.e., you and me).
The stunning thing about all of this is that when the so-called leaders of S&P were called to testify before Congress, they admitted that NONE OF THE IDIOTS WHO HAD GIVEN “AAA” RATINGS TO JUNK BONDS, LEHMAN OR AIG HAD SUFFERED ANY ADVERSE CAREER CONSEQUENCES AT ALL. They were still selling the same old BS.
Only the Mad Hatter or the Red Queen would continue to pay any attention to these self-appointed idiots. If we continue to pay attention to these kinds of “rating systems” we may soon discover that it has become impossible to find the way through the rabbit hole that leads out of this Wonderland.
And as you ponder this nearly inexplicable turn of events, remember the wisdom of Mark Twain (later repeated by Will Rogers and famous economist John Maynard Keynes) when he said, “I am more concerned with the return of my money than the return on my money.”
Dugan Barr has practiced law in Redding since 1967. He has tried more than 200 civil jury cases to verdict. He is married and has five children. The offices of Barr and Mudford, LLP, are at 1824 Court St. in Redding and can be reached at 243-8008.
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