Tuesday, January 17, 2017

Moody's Settlement and Its Wider Implications for Finance and Beyond

This blog is provided by guest contributor Marc Joffe.  Marc also studies and writes extensively on debt issues in sovereign and sub-sovereign markets.  His recent commentary on the relative strength of US cities can be found here.  The following views are his own, and do not necessarily reflect those of PF2.


On Friday afternoon, Moody’s settled DOJ and state attorneys general charges that it inflated ratings on toxic securities in the run-up to the financial crisis. Moody’s paid $864 million to resolve certain pending (and potential) civil claims, considerably less than S&P's settlement of $1.35 billion. While the settlement appears to close the book on federal investigations of rating agency malfeasance, the episode deserves consideration because it has something to teach us all about broader institutional failures, and their implications for both the economy and news coverage.

Moody's received better treatment than S&P despite the fact that its malpractice was painstakingly documented in 2010 by the Financial Crisis Inquiry Commission. I suspect that Moody's achieved a better outcome than S&P for some combination of three reasons: (1) employees were more disciplined about what they committed to email, so DOJ lacked some of the smoking guns S&P analysts handed it (including the infamous message sent by one S&p analyst to another "We rate every deal. It could be structured by cows and we would rate it."); (2) senior management and corporate counsel took a less confrontational approach to prosecutors; and (3) Moody's carried the water for Democrats at critical times during the Obama administration. Moody's Analytics economist Mark Zandi was a vocal proponent of the 2009 stimulus bill and other Obama policies. Meanwhile, the rating agency declined to follow S&P in downgrading US debt from AAA in 2011. 

Having worked at Moody’s structured finance in 2006 and 2007 – but not in a ratings role – I recall that most rating analysts didn’t think they were doing anything wrong (although it is also true that some left exasperated). I believe this was the case because the corruption of the rating process occurred gradually. In the 1990s, ratings techniques were primitive, but appear to have been motivated by an intention to objectively assess then novel mortgage backed securities and collateralized debt obligations. After the company went public in 2001, quarterly earnings became a concern for the many Moody’s professionals who were now eligible for equity-based compensation.

As the structured finance market soared during the early part of the last decade, the pressure to dumb down ratings standards increased. As portrayed in The Big Short, analysts at S&P and Moody’s understood that the failure to give investment banks AAA ratings for the junk bonds they were assembling from poorly underwritten mortgages would place their companies at a competitive disadvantage. 

The collapse of rating agency standards is one case of a much larger set of problems that are threatening our economy and social fabric: professionals who we expect to provide objective information prove to be biased. It’s like a baseball umpire calling a strike when a batter lays off a wild pitch. While that type of behavior could ruin a ball game, the loss of integrity by financial umpires has more earth-shaking implications.

Aside from rating agency bias, the financial crisis was also triggered by a spate of dodgy appraisals. Inflated home appraisals, made at the behest of originators trying to qualify new mortgages, also contributed to the 1980s Savings and Loan crisis.

Malpractice by supposedly unbiased professionals also exacerbated the 2001-2002 recession. The values of dot com stocks were inflated when securities analysts issued misleading reports exaggerating the companies’ earnings potential. The analysts’ judgment was clouded by incentives at their investment banks, which profited from underwriting stocks issued by these overrated companies. Meanwhile, Arthur Andersen’s shortcomings in auditing Enron's books magnified the impact of that firm’s spectacular 2001 crash.

So the credit rating agency problem is part of a more generalized issue that encompasses appraisers, auditors and security analysts. It can occur whenever professionals are asked to provide objective evaluations: they can succumb to their own biases or pressure from those who have a vested interest in the outcome of the review. Because the judges usually receive less compensation and have lower social status than those who are judged, they are especially vulnerable to temptation.

And the problem is not limited to finance. Journalistic institutions which have built stellar reputations for objective, fact-based news reporting have let their standards slip, especially during the contentious 2016 election and its aftermath.  For example, the Washington Post recently embarrassed itself by hastily reporting that the Russians had hacked a Vermont power utility. Ultimately, it turned out that a computer virus created in Russia was found on a laptop at the utility’s offices. The laptop was not connected to the power system, and the virus was typical of Eastern European computer worms that proliferate across the internet. Adding insult to injury, the newspaper failed to issue a proper retraction when the story collapsed.

Like those working at Moody’s, I suspect that most WaPo reporters didn’t imagine that they were doing anything wrong. They may have been guided by a belief that the public needed to be more wary of the Russians, especially now that they appear to have influence within the Trump administration.  Some mainstream media reporters may honestly believe that protecting America from the Russians and from Donald Trump is more important than living up to the ideal of objectivity that had been the gold standard of 20th century news coverage. It is also possible that reporters are influenced by pundits, government sources and political power brokers: there have been many cases of journalists cycling in and out of government roles, so a victory by one’s favored party can offer career benefits.

But whether it’s Moody’s and S&P or a major news outlet, we all suffer when systemically important providers of allegedly objective information lose their bearings. Even the most primitive organisms need facts to survive. Prey that deny knowledge of the position and trajectory of predator movements become dinner. Today’s most complex social organism, American society, needs institutions that provide just the facts in a dispassionate manner. The rot destroying the foundations of these organizations should worry all of us regardless of our position in the financial hierarchy or on the political spectrum.

Wednesday, December 21, 2016

Happy-Holiday Synopsis

What a year it has been!  We sign off for 2016 with a short brief on the wave of activity that has occurred in recent weeks, wishing our readers a happy holiday season and a terrific 2017.

The main new stories of the year have been the escalation of ERISA retirement plan litigation and the unfolding conundrum that is Wells Fargo.  Meanwhile, some of the other ongoing litigation has expanded, including with FX cases being filed abroad.

But here are some of the main happenings over the last 2-3 weeks.

Actions & Settlements

Gold & Silver Fixings Class Actions [1], [2]: The court approved Deutsche Bank’s settlements of $60 million and $38 million, respectively. Meanwhile, plaintiffs’ attorneys filed documents highlighting electronic communications provided by Deutsche Bank that they argue demonstrate alleged manipulation and collusion across banks. Deutsche is the only bank to settle so far. 


  1. Goldman Sachs settled ISDAfix manipulation class action allegations for $56.5 million. (Class action claims against seven banks/brokers remain outstanding.)
  2. Meanwhile the CFTC took an enforcement action, its third in regards ISDAFIX, against Goldman Sachs -- the others being against Barclays and Citibank. The ISDAFIX penalty brings the CFTC's tally to over $5bn in fines (across 18 actions) relating to FX, LIBOR, EURIBOR and ISDAFIX misconduct.
Euribor: The European Commission fined Crédit Agricole, HSBC, and JPMorgan Chase a total of €485 million (~$520 million) for manipulating the Euro Interbank Offered Rate (Euribor).

Dark Pools: Deutsche Bank settled with New York State for $37 million and FINRA for $3.25 million over its equities order routing practices.


  1. PIMCO settled for $20 million SEC allegations that the asset manager misled investors about the performance of its Total Return ETF (ticker: BOND) by failing to disclose that a significant factor in BOND’s outperformance was its strategy of purchasing odd-lot positions at discounts and then immediately marking them up to the round-lot prices.
  2. The DOJ charged executives at hedge fund Platinum Partners with fraud, alleging Platinum fraudulently overvalued its illiquid assets to stoke high returns, as well as for other problematic practices.  The SEC filed similar civil charges.

Happy holidays!

[1] In re: Commodity Exchange, Inc., Gold Futures and Options Trading Litigation (1:14-md-02548)
[2] In re: London Silver Fixing, Ltd. Antitrust Litigation (1:14-md-02573) 
[3] Alaska Electrical Pension Fund et al v. Bank of America Corp et al (14-cv-07126)

Tuesday, November 29, 2016

Not ... Just ... Yet ... Wells, Fargo

If Wells Fargo didn't already have enough to worry about, last week things got a little bit more “interesting” with the filing, against Wells, of a class action complaint filed by employee-participants in its $35 billion retirement plan.

Wells is busy dealing with the aftermath of its fake accounts scandal.  It has paid the CFPB a $185 million penalty, but the reputational fall-out is ongoing, as outsiders seem to show more empathy towards the (former) employees at the heart of the scandal, and less with the company itself. Hundreds if not thousands of Wells' employees were let go over a period spannin years, accused of fraudulently opening 2 million customer accounts ... enough to cost former Chairman and CEO John Stumpf his job.  He fell on his sword last month. 

Much has been made of  the culture at Wells Fargo that may have enticed (or even compelled) thousands of employees to conclude that it was better to conjure up fake customer accounts than to fall short of sales quotas, especially after some of the 5,300 workers fired for the scandal decided to sue for wrongful termination that they allege was in retaliatory.  (With a nod in Wells Fargo's direction, the CFPB put out a bulletin yesterday on "Detecting and Preventing Consumer Harm from Production Incentives.")

The complaint filed last week  alleges that Wells Fargo enriched itself at the expense of its employees by engaging “in a practice of self-dealing and imprudent investing of Plan assets by funneling billions of dollars of those assets into Wells Fargo’s own proprietary funds.” The plaintiffs argue that Wells Fargo’s proprietary funds, specifically its target date funds (which were a default investment option), charged higher fees than, and under-performed against, comparable funds. 

It is a familiar tune that we have heard from employee plaintiffs at other financial services firms, such as Morgan Stanley and Putnam Investments, two of several financial services firms recently accused of self-dealing through its employee retirement plans. Similar cases have already been settled (e.g. Ameriprise for $27.5 mm and Mass Mutual for $31 mm). Self-dealing asset managers are not the only alleged culprits – 2016 has seen at least two dozen lawsuits over retirement plan fees and offerings, including twelve by university employees.

Pat Bagley, Salt Lake Tribune; licensed by PF2

A primer on the ERISA litigation can be found here.

The case is: Meiners v. Wells Fargo & Company et al (16-cv-03981) 

More on issues of corporate culture at financial institutions, here

Friday, November 18, 2016

FX Settlements Up and Up-dated

It has been a little over a year since we last visited the state of currency markets litigation.

For the main benchmark rigging allegation issue, overall settlements have now surpassed $12.2 billion, primarily in fees imposed by global supervisory authorities.  North American private actions account for over $2 billion, but many of the defendants are yet to settle.  Since our last update, we have seen three, albeit relatively small, settlements by defendants in the Canadian class action.

Outside of the main case, there have been settlements by custodians State Street ($530 mm) and Bank of New York ($714 mm) in cases alleging they failed to provide, as promised, "best execution" on FX conversions on standing orders.  Separately, Barclays has settled with regulators and a private litigant over issues concerning its backing away from live quotes, implementing a potentially one-sided "last-look" approach.

Here is the current status of the settlements in re potential benchmark rigging.  It is noteworthy that counselors representing the class actions have pursued, and often exacted large settlements from, parties that have escaped regulatory fines.

Friday, September 16, 2016

The Influence of Short-Termism on Corporate Culture

Our first piece on corporate culture at financial firms is up and ready (click here).

We managed to grab the first bit of news in the ongoing Wells Fargo saga, but there should be further developments next week Tuesday, when Wells' CEO, John Stumpf, appears before a Senate Banking Committee hearing.  He will face some tough questions.

(Meanwhile the House Financial Services Committee announced today that it too will be investigating the allegedly illegal activity by Wells Fargo employees, and says it too will summon CEO Stumpf to testify later this month.)

We don't want to give it away, but here's a short blurb, enticing you to read the piece.  We hope you'll dig in!


Bank of America is cutting costs. Its headcount has decreased by roughly 15,000 employees annually over the last three years. Things are moving fast. CEO Moynihan recently explained that: "We're driving a thing we call responsible growth. You've got to grow, no excuses." 

Meanwhile, it has become known that numerous Wells Fargo's employees have been creating unauthorized accounts for their clients. Millions of accounts. More than 5,000 employees are said to have been fired. 

Perhaps growth has its costs. 

Short-Termism and its Potent Influence on Corporate Culture at Financial Firms tries to frame the issue: how and to what extent can short-term thinking patterns hurt the long-term goals of a firm?

The financial firms are under pressure, including from increased regulatory oversight (and non-compliance risk) and the renewed focus on cultural issues within financial firms.  

We analyze some of the problem zones and propose a framework for tackling short-term thinking patterns and the associated cultural concerns -- appreciating that the mindsets, incentive structures, and personality types at financial firms can make matters all the more challenging. 

In addition to Wells Fargo, we include examples and thought-pieces from: 
  • Credit Suisse Citigroup 
  • Green Tree Financial 
  • JP Morgan 
  • Platinum Partners 
  • Société Générale 
  • Visium Asset Management
As always, all feedback is welcome and appreciated!


Monday, August 15, 2016

Buy-Side Pricing Alerts

The money center banks have for years been heavily criticized for their pricing operations going awry. 

Many of these issues occur in the fixed income or over-the-counter (OTC) markets, where transparency is limited, secondary market liquidity near invisible, and pricing discrepancies sometimes easily and innocently explained away.

The banks have had their troubles and issues with consistent pricing across different divisions.  The "London whale" saga at JPMorgan was one of the big ones.  

Anybody who watched The Big Short recently will remember the palpable frustration in the air as the "shorts" waited anxiously for RMBS and CDO price depreciation, which lingered endlessly, much to their frustration, despite the obvious downward change in fundamentals.  In the book, Scion Capital’s Michael Burry is quoted as saying: 
“Whatever the banks’ net position was would determine the mark,” ... “I don’t think they were looking to the market for their marks. I think they were looking to their needs.”
Pricing Concerns ... Coming to a Fund Near You

In the Big Short, the focus on pricing was on banks' failure to lower prices quickly enough.  But pricing concerns are more typically focused in the other direction: asset price inflation. And nowadays the buy-side is taking the brunt of the investigative interest ... with the focus being drawn on their valuation of private companies.

First, let's step back.  Everybody who owns a computer (even a smartphone) can see where Apple's stock trades.  Yes there are off-exchange venues (including dark pools) but generally there is plenty of price transparency for liquid large-cap stocks.  

Importantly, all institutions would hold Apple stock at the same value on their balance sheets, whether they're long or short, expecting it to rise or fall.  Each institution's opinion doesn't matter: the market dictates.

In OTC and private company's equity valuation worlds, there isn't necessarily a ready market...so instead of marking-to-market the world more generally marks-to-model.  Each firm can hold the same security at a different price.

But the problem is, well, funds charge fees based on performance.  Higher asset prices translates into better performance.  Ergo, mark your assets higher and you'll make more money.  Voila!  Next, funds advertise their performance.  Higher marks therefore means better performance; marketing of stronger performance can translate into higher capital inflows from investors, which means more money under management, which means more fees.  Brilliant!

So that's the problem (the incentive/motivation is too compelling!).

The news pieces are coming in thick and fast.

On Friday, Reuters published a piece called: U.S. mutual funds boost own performance with unicorn mark-ups which explained that:
"The Securities and Exchange Commission (SEC) has been asking mutual fund companies how they value their stakes in companies like Uber, Pinterest Inc and Airbnb...  The regulator is worried investors could get hurt in case of a sharp tech downturn, according to two people familiar with the SEC's queries."
The WSJ had written a similar piece back in November 2015: Regulators Look Into Mutual Funds’ Procedures for Valuing Startups, noting that:
"According to a Journal analysis of data provided by fund-research firm Morningstar Inc. of startups worth at least $1 billion, there were 12 instances over the past two years in which the same company was valued differently by more than one mutual fund on the same date."  
And BloombergBusinessweek, back in March 2015, had put together perhaps the most entertaining read of all:  We Tried to Re-Create JPMorgan’s Mutual Fund Returns and Gave Up: "The bank’s impressive mutual-fund-group performance figures come with little explanation ."


We're keeping a close eye on asset pricing issues, especially in the credit space.  If you notice anything we're missing, let us know.  Click here for a compilation of pricing issues we have seen recently, including specific investigations.

Tuesday, July 5, 2016

Student Loan ABS Update & Ratings Mismatches

We've kept a look-out on the National Collegiate Student Loan Trust (NCSLT) shelf we inspected more fully in January this year.

At the time, we commented on the nature of all outstanding notes, originally rated AAA by Fitch or S&P, being currently rated junk (sub investment grade) -- and often in deep junk territory.  

In January, S&P had some of those notes on watch for upgrade, but those have since been attended to by S&P.  As we revisit these notes, none of those notes on watch for upgrade was upgraded by S&P into investment grade territory (BBB- or above).  And, due to a technical dispute having arisen in respect of a servicing agreement, some of the Moody's-rated investment-grade notes were placed on downgrade watch.

This shelf really shows the difference between rating agencies' approaches.  The ratings performance may say more about the viewer than the viewed.   

Just have a look at the currently ratings for each note outstanding that was originally rated AAA by Fitch/S&P or Aaa by Moody's.  For each rating agency, there are roughly 55 notes described in the table below. Moody's has roughly half of their outstanding notes, originally Aaa still in investment grade territory.  Fitch and S&P have none.

Meanwhile the following, originally AAA, note successfully paid off in full in November 2015, at a time that it was rated C by Fitch, CCC by S&P and Aa1 by Moody's. (Moody's subsequently upgraded it in December, after it had been paid off, but this was probably just due to an administrative or technical shortcoming on their side.)

The next one is a good example, too.  Originally AAA it was downgraded to CC by Fitch in 2013 and has remained there since.  Then in 2014 Moody's upgraded it to Aa1 and then in December 2015 back to Aaa, its original rating.  But in May 2016, while Moody's had just upgraded this note to Aaa, S&P took it off watch for upgrade, and left it at CCC.

Your AAA, is my CCC, is my CC...

Ratings history snapshots, above, courtesy of Bloomberg LP.

Friday, July 1, 2016

A Rocky Start to Q3

It's been a week since the Brexit vote.  And silver, not gold, has been taking off.

Usually in lock-step with gold, silver has outperformed gold by roughly 9.2% over the last 4 days.  Gold has been up 1.3%.  Silver, on relatively high volume, has gone up more than 10%.

This graph shows silver in green, each day adding to its gains over gold, in white (both were normalized at 100 for the comparison).  And we're again pointing out the suspicious volume, in red, at roughly 3:33 pm yesterday in SLV, which we commented on yesterday, almost a half hour before the day's close, (which was importantly also quarter-end).  

By yesterday, silver had moved 4.5% relative to gold.  Today, it moved another 4.5%, after opening again far higher on high volume.

Silver futures, too, show similar patterns to the ETF, and volume spikes.  Our hunch is that a bigger play was at large here behind the scenes, possibly involving or culminating in the squeezing our of some silver shorts.  Certainly, if it were a drive purely to protect against economic concerns, pertaining for example to Brexit, we would have expected to see the gold markets move in similar fashion.

Thursday, June 30, 2016

Silver is Golden ... or Gold has Lost its Luster (for today)

The last 2 days have been pretty good to silver's ETF (SLV) and pretty ordinary for gold ETF (GLD).  
Gold and silver, often joined at the hip, have disconnected from a price perspective ... and there's some interesting trading at the center of it.  Overall, silver is showing gold who's boss, disconnecting from gold for a 4.6% gain over the last two days.  

Is somebody (or some firm) keen on silver and not so keen on gold, or might a barrier have been tested on an option expiring at quarter-end?

We just moved into quarter-end, and both GLD and SLV moved slightly higher into the 4 pm close, on some synchronized, high volume (right around 3:59 pm).  

But perhaps the 3:33 pm move, unique to silver, (on high volume) is interesting.  Silver hits a peak at 3:33 pm, so perhaps a barrier was tested, say on a knock-in knock-out option.

You can see the additional volume spike in the lower silver graph -- but not in the gold above -- just before the close.

And this graph zooms in on the price movement (up) on the very short infusion of interest in the silver market at 3:33 pm today. It then losing some of its gains before pushing higher again into the close at 4 pm.

Graphs courtesy of Bloomberg LP.

Thursday, June 23, 2016

Bank Stress Tests and the Problem of Ignoring Reality

“Too large a proportion of recent "mathematical" economics are mere concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.
                                                                                        - John Maynard Keynes

The 2011 European Bank stress tests were largely held in disregard.  They had managed to assume away the implications of a chief risk held by the banks being tested – that countries within the EU could default – culminating in several banks easily passing the tests, only to fail soon thereafter.

The results were released in July 2011, with Dexia and Bankia and the Cypriot banks passing and sometimes easily passing the tests. Dexia failed in October 2011. Bankia survived a little while longer, before being nationalized in May 2012. The Cypriot banks never triggered any kind of concerns among the key monitoring agencies, the EU, EBA, IMF or BIS, well, not before the Cypriot banking collapse.

The editorial board at Bloomberg View just put out a piece on why the US Fed's bank tests lack credibility.  Same problem, here: a lack of basis in reality:
"...the simulation [being run] is a far cry from what happens in a real crisis. It doesn't fully capture how contagion can afflict many of a bank's counterparties at once, magnifying losses many times over. It also assumes that a thin minimum layer of equity capital -- just $4 per $100 in assets -- would be enough to maintain the market's confidence in a bank's solvency. These flaws make a passing grade almost meaningless."
Reality is very different, and modeling behavior in a stressed environment is necessarily a different process from modeling a normal environment, as what was previously uncorrelated or even inversely correlated can suddenly become correlated ... as the economic principles break down and legal rules change.

We're not saying this is easy – but there's little comfort to be gained in performing a test if that test fails to capture the harsh reality that, in times of crisis, our (joint) behavior itself will compromise the predictive value of the theoretical process we're modeling.  

Perhaps a picture will say it best: