Hey, It's Triple-A

By far, the title of this blog was the most common phrase I would when being asked to bid on some unknown piece of paper that I didn't sell to a client. Generally, my response was either A) pass-ola; B) tell me who you bought it from and I'll ask them to bid on it; C) sell it back to whomever sold it to you: or D) I'll put it out to the street and work it on a best efforts basis. Not to pat myself or my colleagues at the firm where I used to be employed on the back, but we didn't sell these CDOs, et al to our investor base (Full disclosure: the department I worked for did sell structured products to individual investors, the structures were straightforward, the risks generally quantifible by the lay person, and the buyers were subject to some serious scrutiny before being allowed to purchase such a product.). Our reasons were threefold. First, there was little liquidity in this product (even before the meltdown), particularly in the sub-$10 million amounts we would normally deal in. Each one of these instruments was basically a proprietary product of the firm that created it. That brings me to reason number two, which was that we had no way of valuing it. In retrospect, this is the crux of the problem for the market (I wish I had written this two years ago, then I could be on TV every day). Just because these items (I hesitate to call them bonds as many had non-bond like features) had an ISIN that one could type into a Bloomberg terminal didn't mean that there was any meaningful information (read: information used in generating a value) available. Finally, and I thank God (or the Securities Act of 1933) for this, most of these things were not registered in the United States, putting their purchase out of the reach of most of our primarily domestic investor base.

That brings me back to, "Hey, It's Triple-A". That nugget of information was the one thing that usually was available to us. It was probably the one piece of information available, along with expected return and purported cash flows, to the unsuspecting, yet allegedly sophisticated, foreign high net worth investor that would ask me for a bid on $100,000 face value of this stuff. This investor class had been buying triple-A bonds for years (in some places in the world, triple-A would be the only bonds available) so the thinking in general was that was no different than buying some German Landesbank paper, with an implicit or implied government guarantee. For the most part, this type of buyer doesn't have the most rudimentary notion of how the US mortgage works, and certainly has little clue of how something as complex, as these structures had become, works. (Point of Information: Mortgages and mortgage market vary widely around the world.) As it turns out, very few people understood the workings of these products.

Which brings me back to, "Hey, It's Triple-A". I would have thought that when someone sticks a rating on something, that some significant amount of due diligence was done to arrive at that rating. The pressure has been on the bond insurers, which for a fat fee, certainly more than they were getting from insuring a municipal bond, were extending their triple-A imprimatur on this stuff. However, the real problem here is the rating agencies, which grant those ratings based on thieir due diligence. The bond insurers can only operate successfully with the triple-A blessing of the raters. Unless there is a massive and conspiritorial fraud being purportrated, the blame needs to rest with the Big Two. This is just another instance in a long line of lax standards that got us into this market mess.