I mentioned in a June 29, 2011 posting titled Financial Crisis–Part III that one component of the Dodd-Frank law was to create a new regulatory structure for credit rating agencies.  Erroneous credit ratings that were given to mortgage-backed securities resulted in billions of dollars of losses, and were one cause of the financial crisis.  The SEC has not fully staffed the new office mandated by the Dodd-Frank law that is supposed to address this issue, and the provision that would hold credit rating agencies legally liable for their ratings was reported to have been tabled. Of course the government is now angry at Standard & Poors (S & P) for downgrading U.S. debt from AAA. There was a recent event involving S & P that was given very little media attention, but shocked the commercial mortgage-backed security (CMBS) world into disarray. Goldman Sachs and Citigroup pulled a $1.48 billion dollar CMBS offering hours away from settling the issue after S&P announced they would not be able to deliver final ratings on the security. A Wall Street Journal article by Al Yoon quoted a man who has worked in real estate finance since 1995 as saying “I’ve never seen this happen, to the extent where a deal was so far along, ever.”

The process of issuing a CMBS involves issuers working with the rating agencies to determine final pricing based on a preliminary rating, which has been developed after months of diligence. As was the custom, Goldman Sachs and Citigroup priced the recent issue based on the preliminary rating. No rating agency has previously failed to issue the rating when the deal is about to close, but that string has now been broken. S&P muddied the issue even more by saying “…it won’t assign new ratings to transactions based on its current criteria” (whatever that might mean). Other deals had to be recently “sweetened” to reassure investors.

What does this mean, and why should we care? The drama of watching the President and Congress thrash around with how to come up with a way of keeping the government funded followed by a stock market swoon has consumed nearly all of the news reporting. The possibility that the commercial real estate mortgage market is in limbo has been hidden behind the screen of bureaucratic ineptness of our elected officials trying to figure out how to fund overspending by the government. I fear this mostly unnoticed event instigated by what must be a nervous S&P could further cripple an already fragile economy. For those who haven’t been watching, the real estate market hasn’t been doing very well, and killing the commercial market by causing funding to dry up will be harmful. I write that believing that I have mastered the art of understatement. One analyst was quoted as saying, “This is a debacle of epic proportions.”