Investors Are Being Misled About The Real Values Of Their Subprime Securities Holdings
Many investors are being provided with grossly inflated valuations of their subprime securities holdings because Standard & Poor’s and Moody’s have failed to cut the ratings of many AAA-rated securities even though those securities do not meet the criteria to be classified AAA. The bulk of these securities are believed to be held by banks and insurance companies.
A recent study by Bloomberg concluded that 80 of the AAA securities in the ABX indexes fail to meet S&P’s criteria for AAA-rated securities. The study concluded that, if the ratings standards were accurately applied, at least $120 million in AAA bonds would be downgraded. According to Credit Suisse Group, record home foreclosures have caused AAA debt to fall to 61 cents on the dollar, but those same bonds would be worth only 26 cents if downgraded to AA. If Credit Suisse is correct, investors in just these securities currently rated AAA have an undisclosed loss of at least $42 billion.
Kyle Bass, chief executive officer of Hayman Capital Partners, was blunt about the situation when he said, “The fact that they’ve kept those ratings where they are is laughable. Downgrades of AAA and AA bonds are imminent, and they’re going to be significant.”
The failure of S&P and Moody’s to downgrade these AAA-rated securities is just another on their long list of failures in dealing with subprime securities. First, the ratings agencies had conflicts of interest in rating subprime securities, were closely involved in structuring such securities and granted excessively high ratings to such securities. Second, the ratings agencies reacted much too slowly in downgrading subprime securities when conditions in the subprime mortgage market worsened and defaults soared. Now, the ratings agencies are ignoring their own guidelines and maintaining ratings that have no basis. As Janet Tavakoli, president of Tavakoli Structured Finance, said, “It will take years for the ratings agencies to fix their problems.”
The ratings agencies know full well the impact of their inflated ratings and what will happen when they make widespread downgrades. The inflated ratings have given many investors a false sense of security about the limited extent of their losses. Downgrades will definitely force those investors to accept a more realistic view of their loss exposure. Many investors may be forced to sell their subprime holdings because their internal requirements or guidelines limit their holdings to AAA-rated securities or place limitations on the amounts of non-AAA securities that can be held. Other investors in subprime securities may liquidate their holdings when they see the dramatic drops in the reported values of their holdings (reported values are based in part on the ratings the subprime securities have) and the real losses they have sustained. Of course, it is possible that such selloffs could precipitate further losses in the market.
Page Perry, LLC is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing individual and institutional investors regarding their subprime investment problems. For further information, please contact us.
