“Why, more than a year into the crisis, do regulators and investors continue to rely on ratings? No one has been more wrong than Moody’s and S.&P. Less than a year ago both gave high ratings to 11 of the largest distressed financial institutions. They put the insurance giant A.I.G. in the AA category. They rated Lehman Brothers an A just a month before it collapsed. Until recently, the agencies maintained AAA ratings on thousands of nearly worthless subprime-related securities.”
Interestingly, I discovered Professor Partnoy’s work while researching Bailout Nation. Here’s what I wrote regarding his views on Derivatives, circa 1997:
Immediately after the CFMA legislation was passed, a few observers raised concerns. Frank Partnoy, a former derivatives trader at Morgan Stanley (now law professor at the University of San Diego), is the author of ”F.I.A.S.C.O.: Blood in the Water on Wall Street’,’ a 1997 book warning about the danger of derivatives. In 2000, referring to CFMA, he noted:
“The new bill’s second impact, in the swaps market, is less direct but still worrisome. The act ends an argument about whether swaps qualify for regulation by making it clear that they are not regulated if a participating company or individual has $10 million in assets. That means that the swaps activities of most companies and mutual funds are not regulated. Yet few investors know what swaps are. And there’s almost no publicly available information about specific trades in this market, now bigger than many stock or bond markets. By contrast, futures trading takes place on exchanges; an investor can find closing quotes for futures in a newspaper’s financial section.”
Even Partnoy’s prescient fears failed to anticipate exactly how devastating the results of the Act would be. It was unconscionably enormous in the scale of its potential for financial Armageddon. Either directly or indirectly, unregulated derivatives trading allowed by CFMA were responsible for the biggest bankruptcies in history. It created the monster that brought down AIG, the world’s largest insurance company.
Sources: Rated F for Failure JEROME S. FONS and FRANK PARTNOY NYT, March 16, 2009 http://www.nytimes.com/2009/03/16/opinion/16partnoy.html
Stock Gambling on the Cheap FRANK PARTNOY New York Times, December 21, 2000 http://query.nytimes.com/gst/fullpage.html?res=9C06E6D81E39F932A15751C1A9669C8B63&sec=&spon=&pagewanted=2
Originally published at The Big Picture blog and reproduced here with the author’s permission.