Guest Column: Serious Concerns Regarding Bond Credit Ratings

Richard Lawless
Special to Historic City News

Fifty-nine million American’s and millions of businesses rely on the credit ratings issued by rating agencies Moody’s Investors Service, Fitch Ratings, Inc, and Standard & Poors.

These credit rating agencies make billions issuing credit ratings on investments while major banks make billions selling those investments to investors.

According to the web sites run by these agencies, the definition of a BBB+ rated bond is:

“An obligation rated BBB exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.”

In other words, “adequate protection parameters” means it is currently a safe investment. In general, any rating from AAA to BBB- is considered an “investment grade rating”.

In 2007-2008 America went through a massive financial crisis precipitated by thousands of Commercial Mortgage Backed Securities (CMBS) that were fraudulently and misleadingly rated as safe investments.

Trillions were lost, millions of jobs vanished and six million homes were foreclosed on. One person from Wall Street was prosecuted.

A review of BBB rated bonds revealed that more than half of the bond issuers were technically bankrupt at the time safe “investment grade ratings” were report about them by the rating agencies.

The rating agencies and Wall Street’s biggest banks reflect the best and brightest in the industry. Are we supposed to believe that they all made these simple mistakes accidently and independently or should common sense prevail? It may all depend on our legislator’s political will.

In most cases, the issuing Agency failed to provide sufficient debt service coverage for the payments on the debt. In fact, in some cases the Agencies only had 60 cents on the dollar for the payments promised to the investors. Remarkably, many of the offering memorandums site that the Agencies would need to utilize bank lines of credit and other borrowings to make the payments.

This is the same strategy that Bernie Madoff went to jail for. Using new investor money to pay off the old investors. Basically a Ponzi Scheme where the last to invest will take the most significant losses. By any reasonable definition, financial fraud and a crime.

Most of the Agencies had significantly understated pension obligations that would be impossible to meet, a negative net worth, numerous violations of bond covenants, material lawsuits and regulatory violations.

All of which, on a standalone basis would give anyone pause. In combination, they reflect very troubled, incompetent leadership at the Agencies, an investment criterion that is as critical as any other benchmark.

In this multi-trillion-dollar industry we may be talking about a fraud that will rival the 2007-2008 financial meltdown.

Just like in 2007-2008, we know exactly what individuals issued these bonds, knowing they could not be paid back, we know exactly who issued the unjustified credit ratings and we know exactly who sold these investments to unsuspecting investors.

All this information was shared with the FBI, U.S. Attorney and many of the States, Attorney Generals. To date, I am not aware of any material action being taken to protect the American people or punish those responsible.

Common sense would dictate that bond holders start reviewing their bond offering memorandums and get out of the troubled bond issues before this whole house of cards collapses.

Our government did not protect us in 2007-2008 and they are not likely to protect us this time.

-Richard Lawless is a former senior banker who has specialized in evaluating and granting debt for over 25 years. He has a Master’s Degree in Finance from the University of San Diego and Bachelor’s Degree from Pepperdine University. He sits on a number of Corporate Boards and actively writes for a number of finance publications. Mr. Lawless is currently working with the SEC and FBI on uncovering financial fraud in the bond industry.