Friday, March 15, 2013

Are Credit Ratings Opinions?

The Justice Department's lawsuit against S&P made us reconsider whether the ratings provided by S&P were "opinions."

Let's quickly look at the concept of an opinion: one often relates the word "opinion" to a judgment (which may be factually supported) but may not be "provable."  A fact, however, is closer to being provable.

Of course, the rating agencies have long argued that their ratings are opinions, but there's probably more to it than that.

At the very beginning, many rating agencies have the ability (and they exercise it) to assign a rating of "D" to defaulted issuers or assets.  Many (but perhaps not all) issuer or asset defaults, relative to their defined terms, are directly provable - in other words, at least certain ratings may be more fact, and less opinion.

Now let's dig deeper into the DoJ's argument.  One core argument alleged throughout the complaint was that S&P maneuvered its models/methodology to achieve the rating levels desired by the structuring bankers (the issuers).
"As set forth in detail … S&P's competition for ratings business, that is, its desire to maintain and increase market share and profits, and its resulting desire to maintain its relationships with issuers who drove its ratings business, improperly influenced S&P to favor issuers in its ratings of RMBS and CDOs. In particular, as alleged in detail … to maintain and increase its market share and profits, S&P limited, adjusted, and delayed updates to the ratings criteria and analytical models S&P used to assess the credit risks posed by RMBS and CDO tranches, thereby weakening those criteria and models from what S&P analysts believed was necessary to make them more accurate."
The argument could therefore be that the resulting rating wasn't the "opinion" formed as part of the ratings process: the required rating, known upfront, caused the determination as to which ratings process/model to apply.  In such a case, the rating would be the fact, and the process (to be used) is the judgment.

In other words, an argument may be that the resulting ratings were not the result of the ratings process.  The ratings processes used were the result of the rating required!  

(Think of this relative to the structuring process itself, one of the goals of which is to achieve a certain rating.  Thus it may be inferred -- if the DOJ's allegations hold true -- that both the banks and S&P were playing the role of engineering their analyses in such a way as to achieve the desired rating.)


inquirer_esquirer said...

Not to nitpick but to add to the conversation here.

In defamation and libel law we often look at statements of opinion. Some of these can be proven to be false, in which case the statements are not considered "pure opinions" and may constitute the basis of a defamation claim. There's a difference between a claim that "he is dumb" versus "he is crooked". The latter may be proved false and therefore loses certain First Amendment speech protections.

What you may be on to here is a case that the rating is an (impure) opinion that can be proved by the proper application of the public methodology.


As we saw in the housing bust. Securities were rated AAA+ that were really junk. Its amazing but nobody was ever charged with anything.