Written by Bill Harrington

October 8, 2019

Croatan Institute will convene the Croatan Forum 2020 at The Rickhouse in Durham, NC on April 27-29, 2020. As preparation, we are posting videos of Croatan Forum 2018 panels on the Croatan Institute YouTube Channel.

The 2018 Forum, the first that the Institute convened, punched WAY above its weight. The fourteen panels mined actionable steps from diverse, but interconnected, themes including “Responsible Financial Inclusion in the Age of FinTech,” “Investing in Regenerative Agriculture and Resilient food Systems,” and “The Problem of Endowments.” The format — one venue for all panels and zero break-out sessions — generated deep, frank, and ongoing dialogs on building sustainable eco- and human-made systems.

Here is a video link of “Debt and Democracy: Social Crisis and Systemic Risk a Decade After the Mortgage Meltdown” with David Sand, Tom Feltner, and me. David Sand is Chief Impact Officer at Community Capital and a member of both the Croatan Institute Board of Advisors and the Croatan Forum Advisory Board. Tom Feltner is Director of Research at the Center for Responsible Lending. I am a senior fellow at Croatan Institute and Key Expert on Structured Finance Topics for the Experts Board of Wikirating.

My post-crisis advocacy to improve US economic policy for complex finance such as derivative contracts and securitizations informed the panel premise:

“The financial sector is too large, too complex, and too dependent on government support. These attributes shortchange the country by distorting price signals, hindering useful investment, and raising the odds that another systemic melt-down will occur. Other sectors such as the legal, regulatory, and political ones also shortchange society by propping up the financial sector rather than curbing it. A combination of advocacy, whistle-blowing, and clearer ESG goals are critical to transform the financial sector into a contributor, rather than an impediment, to a more robust economy and country.“

The rigorous discussion, including rebuttals of parts of the premise by David and Tom, shows the Croatan Forum performing its mission: namely, addressing serious concerns such as the degraded physical and societal environments in clear-eyed, and sometimes unsettling, terms. Why induce discomfort? Because an important first step in mitigating a serious problem can be to take the worst of several unpalatable outcomes off-the-table.

One unsettling circumstance in the US is the inability to both (1) preserve the 30-year, fixed-rate, pre-payable home mortgage and (2) reduce taxpayer backstops of the housing market. The two laudable goals are, unfortunately, mutually exclusive because the pre-payment option of a 30-year, fixed-rate mortgage is extremely expensive for a lender to provide without government backstop. Tom Feltner described steps that the housing finance sector could take to broaden access to the 30-year, fixed-rate, pre-payable mortgage. I pointed out that the inherent flaws in the private-label housing securities at the center of the financial crisis (not least of the flaws, a poorly understood and little publicized type of derivative contract) permanently rule out the securities as a source of mortgage finance. Moreover, the same inherent flaws should also permanently rule out other types of securitized debt, such as some securitizations of student loans. David Sand offered the investor view that all assets, including housing bonds, are much more correlated with each other than cursory review suggests.

Taken as a whole, our discussion corroborated the starting premise: A financial system that nests and masks correlated risks, rather than exposes them, is neither robust nor sustainable.

Croatan Forum lands punches pulled by global media CGTN and Reuters

In contrast to the Croatan Forum, at least one global media giant is withholding unsettling views regarding the US financial system that others and I expressed as the ten-year anniversary of the Lehman Brothers bankruptcy loomed in 2018. CGTN America has so-far shelved “After the Fall,” a three-part, three-hour documentary that the company was to have aired globally this year. The failure-to-air robs potential viewers around the world of useful information that each of the 25-plus interviewees, including me, took great care to impart. Other interviewees included a former senior US legislator who figured prominently in the financial crisis response, a 95-year old philanthropist whom Bernie Madoff defrauded, and an investment banker who continues to work in the markets that imploded.

CGTN America commissioned “After the Fall” from the fellow global media giant Reuters TV. During my 90-minute interview with Reuters TV, I made similar points to the ones that I was to offer at the Croatan Forum a few months later. The Reuters TV team reacted very positively, kept in contact, confirmed that my interview would figure prominently, and then went silent. After I prodded repeatedly to fact check the information herein, the executive director emailed a response. To paraphrase: “Reuters TV completed ‘After the Fall’ upon delivering it to CGTN America and, while proud of the documentary, will not push for an airing.”

CGTN America did not respond to multiple requests for comment on the preceding paragraphs.

Fortunately for all, 2020 Croatan Forum will pull NO punches

A logical query that 2020 Croatan Forum may pose builds on the “Debt and Democracy” discussion.

“What does success for ESG investing mean? Will it be win-win-win or, alternatively, obligate financial practitioners to pony up in unanticipated ways such as fewer resources, less remuneration, or smaller pay-outs?

From there, several logical follow-up questions can help map ESG success.

“If ESG investment is demonstrably more robust, will it pay smaller risk premiums?

“If shrinking the financial sector is important, will the result be fewer rewards?”

“If making the US financial system, and the eco-system, more robust costs more on an ongoing basis, who provides the money?”

“What other aspects of the economy may change? What other feedback loops may kick in?”

A new activist front: municipal debt investors and issuers vs credit rating agencies!

One follow-up question — smaller risk premiums for ESG investments? — points outs a plan for activism by investors and issuers.

“Push credit rating agencies to assign relatively higher credit ratings to climate mitigation projects and to the respective municipal sponsors.”

Credit rating agencies often thwart municipal issuers that seek to finance climate mitigation projects. In short, credit rating agencies do not walk their increasingly big talk on incorporating ESG considerations into ratings. Instead, the agencies generally assign an identical rating to a municipality that seeks financing to mitigate climate risk and to an otherwise comparable municipality that foregoes climate mitigation. The result? A municipality that proposes to mitigate climate exposure often cannot do so for lack of financing.

Activist investors and issuers can open multiple fronts simultaneously by calling out the void between almost any rating, announcement, or assessment viz-a-viz a governing methodology. Essentially, every credit rating agency has placed an infinite number of bulls-eyes on its own back by overworking the shallow “safe harbor” of putative First Amendment protection for “published, corporate free speech.” The self-induced vulnerability exposes a credit rating agency to compliance, legal, market, and regulatory troubles each time that it cannot reconcile a given rating, announcement, or assessment with the applicable methodology.

Any investor or issuer can “call out the rating void” simply by articulating it publicly, e.g., via op-ed in municipal or finance media, challenge to a rating analyst, or written complaint to a credit rating agency. Each communication will set off alarms within a credit rating agency because it must disclose business risks and analytical performance to equity investors, bondholders, and regulators. Collectively, investors and issuers — ostensibly the only constituencies of a credit rating agency — can ring so many alarms that they wear a credit rating agency down and obligate it to rate in accordance with methodologies.

Moody’s Investors Service is an especially big target through 2022

To up the pressure on a credit rating agency, an investor or issuer can copy regulators such as the US Securities and Exchange Commission on communication to a credit rating agency. To pile still more pressure on both the credit rating agency and the SEC, an investor or issuer can also direct the regulator make the communication publicly available. True, the SEC is generally loath to sanction credit rating agencies, but the regulator has done so when embarrassed by an overwhelming weight of publicly available information.

Moreover, one credit rating agency — Moody’s Investors Service — is subject to additional scrutiny of methodology and rating practices through at least 2022. In a January 2017 settlement with the US Department of Justice and the attorneys general of 21 states and the District of Columbia, Moody’s (1) paid $864 million, (2) admitted a Statement of Facts, and (3) agreed to undertake Compliance Commitments, including monitoring “the consistent application of credit rating methodologies.”  The parent Moody’s Corporation and affiliate Moody’s Analytics are also parties to the settlement.

With respect to Moody’s rating practices, an investor or issuer can inform the following two DOJ contacts.

United States Attorney for the District of New Jersey
United States Attorney’s Office for the District of New Jersey
970 Broad Street, 7th Floor Newark, NJ 07102

Director, Consumer Protection Branch
U.S. Department of Justice
450 5th Street NW Washington, DC 20530

Furthermore, an investor or issuer with business interests in the District of Columbia or any of the following 21 states can also inform the respective attorney general: Arizona, California, Connecticut; Delaware; Idaho; Illinois; Indiana; Iowa; Kansas; Maine; Maryland; Massachusetts; Mississippi; Missouri; New Hampshire; New Jersey; North Carolina; Oregon; Pennsylvania; South Carolina; and Washington.