Some news hit late yesterday that the California Public Employees' Retirement System (Calpers) is suing the rating agencies for $1 billion for incorrectly rating structured investment vehicles (SIVs). A while back, I mentioned the possibility of suing the rating agencies for negligence. It looks like that's essentially what Calpers is doing. I wanted to break down a few of its arguments, as found in an article at CNN/Fortune, to see how they hold up.

Here's the first one, from CNN/Fortune:

To the extent they provided guidance on what banks needed to do to obtain crucial triple-A ratings, that could be the raters' undoing. They aren't commenting on any specifics, but Calpers alleges that SIV rating fees, which it says ranged from $300,000 to $1 million per deal, were contingent on the successful sale of the SIV securities. That, Calpers says, provided a motive for the raters to bend over backwards to ensure the SIVs would get their top ratings.



In other words, the rating agencies rated this stuff so highly so that would sell, and they would get paid. Generally, if deals turn out not to sell, rating agencies get paid far less than they do if the deal is successfully executed. That, however, isn't a reason for doing a poor job rating securities.

For example, the rating agencies could still have demanded that the SIVs have additional padding in order to achieve a AAA-rating. Then the banks would have been forced to issue less bond principal, based on the same collateral to achieve that rating. Those bonds still would have sold. Indeed, investors would probably have liked them even more, with more protection from losses.

But the article continues:

More importantly, if they assisted in structuring the SIVs, that undermines the raters' assertion that their ratings constitute opinions worthy of the same First Amendment protections afforded journalists.



This could pose more of a problem. But let's back up for a minute. Let's forget if they helped with structuring and just consider this supposed First Amendment protection, because I hadn't heard that one before.

The idea that ratings analysts are like journalists is hilariously absurd. Are doctors like journalists too, when they give their "opinion" on what's wrong with you? Does that mean you can't sue doctors for malpractice when they misdiagnose you because they have First Amendment protection? Of course not. That's ridiculous and so is applying the First Amendment to rating agencies. They purport to have expertise on the securities they rate, just like doctors have expertise in medicine. How could they not be accountable for their "opinions?"

But let's put that aside for a second and pretend that rating agencies do have First Amendment protection. Does it matter if they assisted in structuring the SIVs? I'm not convinced that it would. Rating agencies put out detailed (as in 100+ pages) rating criteria reports, where they explain their rating methodologies. Bond originators need to know that criteria inside out when structuring securities. I'm not sure why assisting in structuring SIVs would be any different from guidance for structuring other securities.

Finally, the article says:

Calpers also complains that it didn't receive enough information from the SIVs or the rating agencies to adequately understand the vehicles. That's where the raters might be on safer ground. After all, Calpers didn't have to buy the SIVs' debt, and should not have done so until it was satisfied.



Now Calpers is just getting silly. If it didn't receive enough information, then what the heck was it doing buying the thing in the first place? That's like buying a TV without knowing the specs and then complaining after you turn it on to find it's only black-and-white.

Does Calpers have a case based on any of these arguments? Given past court precedent, which apparently provides rating agencies First Amendment protection, I doubt it. If they helped structure the securities, that could be an interesting twist, but I still don't see how that matters, given they've long been involved shaping the way securities function. Of course, I'm not sure that the rating agencies have $1 billion to pay out anyway, even if they lose.

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