In the financial meltdown of 2008, the credit rating agencies were perhaps the most to blame. Investors rely on them to rate bonds and other financial instruments. If they give a bond a triple A rating, investors have always relied on the fact that this is a rock solid investment with a negligible chance of failure. Hence large scale institutions like pension funds, charities and city, state and national governments flock to these investments. But the fact of the matter is that the agencies, namely, Standard and Poor's, Moody's and Fitch, gave triple A ratings to investments that they knew or should have known were absolute garbage. Why did they fail to do their job causing untold suffering among large scale institutions whose purpose was to benefit vulnerable citizens in their old age among other things? The answer again is simple: they were paid by the big banks to give these investments top ratings.
You would think that an agency that was supposed to give a rating to a product that was bought and sold in the marketplace would be completely independent. You would think that there was no relationship between a company that rated a product and the the company that produced it. However, that was and still is not the case for the relationships that exist between the big banks and the credit rating agencies. Not only is it the case that there is no relationship, there is indeed a very cozy relationship. The big banks pay the rating agencies to rate their products. It's as if a company that made a toaster paid Consumer Reports to rate that toaster. How could you possibly believe the rating was any good? And what do the banks have to say about the institutional investors whose money was sucked in the process? It's caveat emptor, baby! These large investors were supposedly so financially sophisticated that they knew what they were doing. Then why even bother having rating agencies in the first place?
Goldman Sachs and other big banks paid the agencies to rate their bond issues. So when they took their subprime mortgages, sliced and diced them and reassembled them into Collateralizeed Debt Obligations (CDOs), they paid Standard and Poor's or Moody's to rate those CDOs. The agencies were under pressure to give them top ratings because, if they didn't, Goldman Sachs and others would simply shop around until they found an agency that would do their bidding. That would mean the loss of a lot of money for the rating agency if they didn't play ball. In addition the big banks paid the rating agencies a lot of money for "consultation." Using them as consultants was another way to funnel money to the rating agencies with a wink and a nod that, unless they did their bidding, these revenue streams would also dry up.
A more pernicious and corrupt system could not be set up. Talk about checks and balances. There were no checks and the only balance was the one in Goldman's account. The amazing thing was that for the most part this system worked as it was supposed to until recently. That is triple A rated bonds usually did not fail. But that was in the old days before subprime mortgages, CDOs and credit default swaps (CDSs). In other words it was before financial instruments became so "sophisticated" and when investors could merely rely on bond ratings. And if investors can no longer rely on bond ratings, you might ask, what good are they? Answer: not a lot. The banks simply used them as an adjunct to screw investors who in many cases were not simply rich people who could afford to get screwed (not that they would like it) but non-profits, charitable institutions and pension funds whose purpose was to provide aid and succor to a large segment of the population who counted on them. In other words they helped out the little guys who couldn't afford to be investors themselves. Many municipalities and state governments invested in these bonds and they were counting on them to provide health care and other benefits for their employees and retirees. The fact that these investments went belly up after having been triple A rated has a lot to do with the dire straits that many municipalities and state governments are in and why they are on the verge of bankruptcy today.
The main culprit of the whole debacle was financial deregulation.
The Gramm-Leach-Bliley Act (GLBA), also known as the Financial Services Modernization Act of 1999, enacted November 12, 1999) is an act of the 106th United States Congress (1999-2001) signed into law by President William J. Clinton which repealed part of the Glass-Steagall Act of 1933, opening up the market among banking companies, scurities companies and insurance companies. The Glass-Steagall Act prohibited any one institution from acting as any combination of an investment bank, a commercial bank, and an insurance company.
The Gramm-Leach-Bliley Act allowed commercial banks, investment banks, securities firms, and insurance companies to consolidate. For example, Citicorp (a commercial bank holding company) merged with Travelers Group (an insurance company) in 1998 to form the conglomerate Citigroup, a corporation combining banking, securities and insurance services under a house of brands that included Citibank, Smith Barney, Primerica, and Travelers. This combination, announced in 1998, would have violated the Glass-Steagall Act and the Bank Holding Company Act of 1956 by combining securities, insurance, and banking, if not for a temporary waiver process. The law was passed to legalize these mergers on a permanent basis. Historically, the combined industry has been known as the "financial services industry".
The along came the Commodity Futures Modernization Act of 2000 which deregulated derivatives. The banks' argument was that derivatives were financial instruments that were only transacted between "sophisticated" parties. Well, we've seen how sophisticated the bond investors were! They bought triple A rated garbage. The general zeitgeist of deregulation was foisted upon an unwitting public by Republican Presidents and Congresses among others. Alan Greenspan, Chairman of the Federal Reserve Bank and Ayn Rand acolyte, was an ardent libertarian who didn't believe in regulation of any kind. No wonder the SEC was asleep at the switch (after watching porn, of course). These government regulatory positions were filled with people who were philosophically opposed to regulation! It was as if George W Bush told them, "Hey you wanna $100 K government job in the SEC? All you have to do is to sit there and not regulate!" If the regulators were dedicated to regulation, they surely would have uncovered Bernie Madoff. But they were trained to look the other way.
So the question of the moment is will the financial reform bill actually reform the financial sector? The big banks are trying to drill it full of holes. They still want to play the game of privatizing profits and socializing losses meaning heads they win, tails the taxpayers lose. Their lobbyists are gathering all over Capitol Hill like a swarm of locusts trying to strip any meat out of the reform bill, trying to create loopholes so big you could drive a Brinks truck through them. But regardless of reregulation you would think that the large scale investors, having been burned once, would be very wary of ever buying these dubious financial products again. Whole countries like Greece have been brought down. What were these guys thinking? You would think that the people responsible for investing city, state and country money would be more prudent in the future. But as P. T. Barnum said, "There's a sucker born every minute."
