Thoughts from Kansas

Last December, I called for nationalizing the securities ratings firms, companies that propped up Big Shitpile through its heyday and actively encouraged the idiotic and destructive practices which brought us to the current economic crisis. Barry Ritholz reveals that the rating agencies may just get their comeuppance at last. Calpers, the giant California public employees retirement fund, is suing the raters:

Now, here comes the fun part: Calpers doesn’t give a rat’s ass about the money. Sure, the financial instruments at hand (Cheyne Finance, Stanfield Victoria Funding and Sigma Finance) have defaulted on their payment obligations. The losses to Calpers are ~$1 billion.

But that’s not what’s going on here: These Left Coasters want their pound of flesh. They don’t care for the Ratings Agency folks, and consider them a blight on the investment landscape.
The goal of the litigation (as I see it) isn’t to make the rating agencies pay a financial penalty; rather, it is to publicly try them just as the regulatory rules are being rewritten. I also predict that CALPERS is going to attempt to not just win, but humiliate these agencies, call them out in the most embarrassing way possible, trash the senior executives, and make things very uncomfortable in general for these firms.

They don’t want them to merely suffer — they want to destroy their unique position as an Oligopoly, to remove them from having a special status under the SEC rules.

There's no reason that commercial entities should be trusted to provide ratings, especially if the only people who can pay for those ratings, and if the rating agencies also provide consultations to clients about how to game the ratings process. Many instruments are basically opaque to investors, and must be to protect trade secrets or whatever. Raters see inside, and function as regulators in many cases. Time to move that responsibility into the regulatory bodies themselves. As I said in December:

There would still be competition for the ratings, and people with private contracts could choose to rely on ratings by a private rating firm. But contracts which rely on ratings by the nationalized rating agency would still be valid (since the entity would still exist in some form), and the conflict of interest inherent in a privately-owned rating agency would be eliminated. And because the public owns the agency, there would be an incentive for raters who couldn't accurately model a security to default to giving it a very low rating, or to refuse to rate such securities altogether, until reliable data on its behavior becomes available.

This suit would give even more incentive for some company to ditch its liabilities. The legislation authorizing the purchase would set aside some money from the former owner to settle outstanding lawsuits and otherwise immunize the agency (but not necessarily employees), and the owner would move a big liability off the books, though it might still be on the hook for broader corporate malfeasance, and the companies that don't take the deal will be stuck with the suit, knowing that all the internal documents of the company just purchased will be accessible to federal investigators.