A major test case has pointed the finger of GFC blame squarely at the ratings agencies who told bare-faced lies about the quality of exotic financial instruments that turned out to be toxic.

Standard & Poor’s and investment bank ABN Amro have gone down in the Federal Court for, respectively, rating and selling this rubbish to gullible local councils who were looking for high but safe returns for their ratepayers’ money.

Amro put together a bunch of CPDOs (Constant Proportion Debt Obligations) and had them rated AAA by S&P, then sold them on to the councils. After only six months the councils had lost 90% of the value of their investments, about $30 million.

What the court said

Both Amro and S&P were found liable for negligence and misleading conduct. Basically, they owed a duty of care to the investors and didn’t come even close to fulfilling it, on top of which they simply lied about the safety of the CPDOs.

Interestingly, S&P aimed to refute that it did not owe a duty of care to the investors because the rating was not provided directly to the investors but to Amro, and that was the extent of S&P’s liability. The Court said S&P was aware that the rating would be published to the prospective investors and that it would be relied upon them in deciding whether to purchase the product.

What’s next

S&P will appeal the decision but this judgment is important as it constitutes a world first adverse finding against a rating agency. Many many billions of dollars went south in the GFC on worthless products like CPDOs, and the ratings agencies were involved in every deal. Their potential total liability is incalculable. What comes sharply into focus is the inherent conflict the ratings agencies have when they are providing ratings they know investors will rely on, while being paid by the financiers who need them to give high ratings so they can sell the products to the punters. It’s a recipe for exactly the type of disaster the GFC has been. A bit like paying off the ref.

We can’t see why this isn’t exactly the right outcome, but won’t be surprised if it gets overturned on appeal. Hopefully not.