On Friday S&P downgraded U.S debt from AAA to AA+, the first such downgrade in the nation's history resulting in grave concerns over the outlook for the U.S. economy. Yet simultaneously they must have been popping champagne corks in Newport Beach, California, home base of Pacific Investment Management Co. (PIMCO) one of the worlds largest investment funds with a focus on bonds with some $1.2 trillion under management and an affiliate of the Insurance giant Allianz SE of Munich.
Back in April of this year Pimco let it be known that they were betting billions against U.S. Treasuries. Since that time there has been a relentless media blitz by Bill Gross who runs the fund and most particularly his CEO Mohamed El-Erian and co-Chief Investment Officer appearing in front of any microphone and television camera that would have them to bemoan the state of the American economy and predicting, whenever the questioning led in that direction, that a rating agency downgrade of U.S. Treasuries was in many ways inevitable. To quote El-Erian, "High, persistent unemployment, sluggish growth, balance sheet issues and the failure of politicians to deal with deep structural problems... " as he would put it.
When the rating agencies were slow to react, their credibility was put into question as well. El-Erian called for "some kind of process to evaluate the performance of the agencies" much in the tradition of "I'm Shocked, I'm Shocked." Rarely did El-Erian's interlocutors pin him down as to whether such a downgrade would help or hurt his book, leaving most listeners with the impression that they had received the accumulated wisdom from high on the hill unaware that the sermon being delivered was from atop a mount built upon billion dollar bets against U.S. Treasuries/U.S. Debt instruments.
Given the steadfastness of the other two rating agencies -- Fitch and Moody's -- one wonders, given its enormous size and connections, whether Pimco had some influence on S&P's downgrade. To quote Paul Krugman:
...it's hard to think of anyone less qualified to pass judgment on America than the rating agencies. The people who rated subprime-backed securities are now declaring that they are the judges of fiscal policy? Really?
Just to make it perfect, it turns out that S& P got the math wrong by $2 trillion, and after much discussion conceded the point -- then went ahead with the downgrade...In short S&P is making stuff up-and after the mortgage debacle, they really don't have the right.
So this is an outrage- not because America is A-OK, but because these people are in no position to pass judgment.
But pass judgment they did and one need ask why and at whose behest. Did Pimco's ubiquitous and powerful influence have sway?
Far fetched you say? Then let me take you back to September 2008. There was this billion dollar moment when the very same Pimco turned a massive about face on its much vaunted investment strategy of quality only, making huge investments in what was then widely recognized as quintessential junk, namely Fannie Mae and Freddie Mac subordinated debt. Carrying a higher coupon, it was at significantly higher risk than regular bond holders, representing but 1% of the company's debt, thereby being hardly critical to the functioning of Fannie and Freddie given the disastrous straits in which they already found themselves.
With the seriously deteriorating situation in the financial markets in September 2008 investors fully expected a subordinated debt wipe-out at Fannie Mae and Freddie Mac, or at the very least a massive restructuring calling for a significant haircut. Yet Pimco piled in, loading up on the subordinated debt for pennies on the dollar. Certainly the beaten down status of Fannie and Freddie sub-debt was well outside the parameters of Pimco's broadcast policy of dealing only with high quality products. Why this sudden shift? Perhaps the following played a crucial role.
-Then, much as Gross and Mohamed El-Arian have today, Gross had almost unlimited access to CNBC and other broadcasters, permitting them to endlessly lecture listeners and those with authority about the systemic dangers of a Freddie and Fannie collapse, or currently to goad the rating agencies to bring about a ratings downgrade. In 2008, the coziness with the broadcasters was such that Pimco never had to answer a query of whether they would, and how they would benefit from a Fannie and Freddie bailout.
- Gross and Pimco are incredibly well connected, into the highest reaches of government. This extends to offering revolving door employment to high government staffers such as Neel Kashkari, the former head of the nation's TARP Program. In 2008 Gross availed himself of his close relationship with Treasury Secretary Hank Paulson to confer regularly. At the time, according to Gross, he was not out of line pushing for a bailout from which Pimco would benefit outrageously because, as he would say, "Pimco had no official role in formulating the plan..we want safe agency guaranteed mortgages. We don't want to take a lot of risk in subprime space". Huh? Fannie and Freddie subordinated debt safe and guaranteed in September 2008 when Pimco piled in? Maybe he was watching the wrong movie.
And then, abracadabra, the Treasury without thought of renegotiation or shared risk, paid out Fannie and Freddie sub-debt at 100 cents on the dollar. It thereby set the standard for covering Wall Street speculation and all that was to come thereafter. Others could bet and lose, but Wall Street would be given a pass.
At the time, the Wall Street Journal with rightful outrage penned an editorial, "Bailout for Billionaires", suggesting that the sub-debt bailout enriched "some of the world's richest people and largest financial institutions". Both Pimco and Goldman Sachs were mentioned, as was a reference made to Treasury Secretary Hank Paulson's prior Goldman ties, "where Mr. Paulson used to work."
For Pimco it was the biggest one day pay-day in their history, an outrageous and unconscionable $1.7 billion dollars lifted from the pocketbooks of Americans throughout the land and into coffers of the Pacific Investment Management Co.
Given Pimco's current booked positions on U.S Treasuries/U.S. Debt Instruments, given the intensity of El-Erian's and Gross' sightings as talking heads on myriad television programs and op-eds, one need wonder if some version of the Fannie/Freddie rip off is taking place now. After all, the last act was shamefully successful and they got away with it without having to look back once.
Should this hypothesis prove to be correct, that it was Pimco pressure on S&P that brought about a downgrade, we are beyond the cusp of a serious dysfunction in our society and financial system. It bespeaks of a system that can be rigged for private gain at the expense of the well being of the nation at large. All of us will have to live with the consequences of the downgrade in terms of higher interest rates, lost jobs and a seriously slowing economy while those who stacked the deck become ever richer. That is not what American capitalism was ever about. It is a total perversion of what we once respected as a level playing field and a magnificent meritocracy. And if so, we must stop the financial engineers who add nothing to our society in terms of goods and services other than financial hocus pocus rendering unto themselves egregious private gain through their financial tricks while the rest of society endures massive financial loss and places the entire economy at risk.