MIAMI HERALD: “SHADOW RATINGS” How rating agencies set stage for community bank failures


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Florida losing millions on risky investments

Three years ago, the state of Florida made bad investments that lost hundreds of millions in value. State leaders blamed the sharks of Wall Street, who they said duped Florida money managers into buying way-too-risky securities. Chief Financial Officer Alex Sink pushed the state to sue big banks, which she said dumped tainted investments on Florida. Gov. Charlie Crist demanded a no-holds-barred investigation and named four Wall Street firms that he suspected took advantage of the state.

  • The Federal Reserve Board, chastised for regulatory inaction that contributed to the subprime mortgage meltdown, also missed a chance to prevent much of the financial chaos ravaging hundreds of small- and mid-sized banks, according to a McClatchy investigation and confirmed this week by a federal report.

    In early 2005, at a time when the housing market was overheated and economic danger signs were in the air, the Fed had an opportunity to put a damper on risk-taking among banks, especially those that had long been bedrocks of smaller cities and towns across the nation.

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McClatchy News Service

NEW YORK — Billions of dollars in top-rated bonds backed by community banks have gone bust, debunking the defense offered by credit-rating agencies that wildly inaccurate ratings were limited to risky mortgage bonds that imploded and then triggered the U.S. financial crisis.

Government regulators and lawyers across the United States are examining how credit-rating agencies came to bless as “investment grade” the now-toxic bonds made up of special securities issued by community bank holding companies.

During the go-go years preceding the December 2007 start of the worst modern recession, more than $50 billion of these special securities were floated by community banks and pooled into complex instruments called collateralized debt obligations, or CDOs.


From 2000 to 2008, Moody’s Investors Service rated at least 103 of them, valued at $55 billion, issued by banks, insurance companies and real estate investment trusts. Today, many of these securities are virtually worthless.

Questioned by the Financial Crisis Inquiry Commission on June 2 in New York, Moody’s Chief Executive Raymond McDaniel insisted that “the poor performance of ratings from the 2006-2007 period in residential mortgage-backed securities and other related securities, housing-related securities, has not at all been replicated elsewhere in the business.”

Wrong. Of the 324 U.S. banks that have failed since 2008, 136 defaulted on a total of $5 billion in trust-preferred securities — called TRuPS in industry parlance — that they had issued to raise capital.

These securities were popular because their issuance didn’t dilute an issuer’s share price, unlike preferred stock. And the dividends paid on the securities were tax deductible for the issuer.

McClatchy Newspapers learned that at least 36 failed banks have transferred more than $1 billion in bonds backed by trust-preferred securities to the Federal Deposit Insurance Corp.


And with small 860 banks on the FDIC’s “watch list” as of Sept. 30, indicating risk of failure, it’s clear that even more of these toxic assets may flow to the FDIC, which is unable to find institutions willing to take them.

One failed bank, Riverside National Bank of Fort Pierce, brought a suit against Moody’s and its two competitors, alleging that Moody’s as a result of “undisclosed conflicts of interest fraudulently and/or negligently assigned inflated `investment grade’ ratings to the CDOs” that are worthless today. Riverside failed and its toxic assets fell to the FDIC, which took over as the plaintiff and continued the suit.

It’s why McDaniel’s testimony is so damning in its assertion that ratings problems were limited to mortgage bonds, and brought by outside factors.

“This (collapse in trust-preferred CDOs) has nothing to do with mortgages at all, and yet you still have had this massive impact and this massive failure,” said a former Moody’s senior analyst who alleges he was pressured to provide inaccurate ratings.

The analyst, who insisted on anonymity, said there’s a fundamental flaw in the way these securities were rated. Moody’s provided what were called “shadow ratings,” one-time ratings issued about the health of the bank that weren’t continually monitored and instead represented a snapshot in time.

Armed with these “shadow ratings,” investment banks then pooled the securities into different layers of risk, offering investors slices of the pooled securities broken down into differing risk levels. Hedge funds and big pension funds often took the portions rated highest and thus perceived to be of least risk.

6 Responses

  1. […] This post was mentioned on Twitter by USA Advocate. USA Advocate said: MIAMI HERALD: "SHADOW RATINGS" How rating agencies set stage for community bank failures: […]

  2. This is just an industry wide and Federal regulatory wide abuses by the people from the financial industry…. If you remember my comment from the last about SEC, Robert Khuzami has got caught! What a shame.

    Do not forget to watch the video.

  3. Looks like more lawsuits against the rating agencies as well. This post mentions a person who wishes to remain anonymous stating that “there was a fundamental flaw in the way these securities were rated.” I think that statement is being very kind. This is just another example of fraud on the American public because of greed.

  4. No honest enterprise can compete with the Banksters.
    dont be naive

  5. Vision Bank a small local flroida bank has almost 30% ( $180 milllion) in nonperforming loans and recieved $30 million in TARP and over $100 million in goodwill funding from its $7.1 billion parent company Park National Coropration.

  6. After reading the entire article.., I now understand why the Fla AG (McCollum) has done nothing to properly investigate the banks foreclosure practices and take action.This article is a must read for every taxpayer. I appreciate that this was posted. I found the following excerpts and quotes interesting.
    “In one of the biggest bank runs since the Great Depression, panicked city, county and school officials pulled about $13 billion from the pool. Crist, Sink and McCollum froze the fund.”

    On Dec. 21, 2007, in a conference call with SBA managers, federal securities investigators requested the names and account numbers of qualified institutional buyers.

    That same day, SBA managers revised the agency policy that barred the local pool from purchasing 144A securities. The agency changed the words ”restricted from purchasing” to ”generally restricted.”
    “The audit found a troubling combination: weak internal controls and a lack of external oversight by the trustees — Crist, Sink and McCollum.”

    “At a meeting of the SBA trustees in April 2008, McCollum promised his office’s assistance in an investigation. “I think there were judgments and controls that weren’t appropriate, and we could have done better around the margins,” he said. “But the idea that there was some action on the part of SBA to go out and buy something extraordinarily risky didn’t seem to be revealed.’

    This is the part that gtrs my goat. “The newly released documents show that just the day before, Williams sent a five-page letter to the SEC in which he said that “neither the SBA nor any of its employees engaged in any violations of the federal securities laws.”

    He wrote that his staff had made “every effort” to gain and follow “expert advice and guidance” on buying securities, and the SBA thought it was eligible to buy everything it bought.

    Williams urged federal regulators to close their investigation and “publicly remove this cloud.”

    Four months later, they did. In a one-paragraph letter March 3, 2010, Eric R. Busto, an assistant director of the SEC’S Miami office, said the agency was ending its investigation into the SBA with no enforcement action.

    He included an SEC statement that said the termination letter “must in no way be construed as indicating that the party has been exonerated or that no action may ultimately result from the staff’s investigation of that particular matter.”

    Crist, Sink and McCollum praised Williams. Said McCollum:

    “Sounds like we were cleared to me.”

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    Wow , this almost sounds like fraudulent intent.Talk about lack of clean hands or worse…….The fund managers and staff should all be behind bars.

    Read more:

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