CalPERS appears to be a willing victim














Most of these structured pools were created by banks desiring to take mortgages off their books. In the investment world this was deemed to be a positive because if anything went wrong with the pools, the banks supposedly would have the liquidity to stand behind them.

CalPERS' SIVs weren't that kind of SIV. Their sponsors were a hedge fund and a couple of investment firms that specialized in marketing exotic paper to sophisticated investors -- such as CalPERS.

In fact, the investments were so risky that by law they could be marketed only to investors as sophisticated as CalPERS, which is always looking for "alternative" investments to even out the ups and downs of stocks and bonds.

In some businesses, this is known as seeing the mark coming a mile away.

CalPERS says it had no way of knowing what assets were owned by the structured investment pools -- "no access to any information on which to base a judgment of an SIV's creditworthiness," it says in the lawsuit. Consequently, it says, it had no choice but to rely on the rating firms, which did get to peek inside.

Unfortunately, the firms were paid to provide the ratings not by the investors such as CalPERS, which want objective judgments, but the promoters, who want anything but. Did this give the firms an incentive to rate every investment pool as gilt-edged whether it held gold or garbage? You make the call.

CalPERS' SIVs, in any case, held garbage. Naturally it's claiming that the rating firms were complicit in the debacle.

Let's pick this story apart.

First, the rating firms’ unholy alliances with the people they rate have been widely exposed, not least by the Securities and Exchange Commission and Congress, which released a pile of damning documents last year.

Even before then, the situation was no secret. CalPERS states in its lawsuit that in 2005 Moody's pocketed $715 million, or 41% of its revenue, from rating "structured" investments. The pension system didn't have to dig deep for this news: It's in the Moody’s annual report.

How about the issue of what CalPERS knew or didn't know about the assets held in the pools? CalPERS says "no amount of diligence" could have given it "actual knowledge" of what the pools contained.

This is slicing the baloney pretty thin. CalPERS knew its SIVs held mortgage assets. It knew that a bank's incentive would be to keep good mortgages on its balance sheet and dump the rest -- say, by offering them to an SIV.

In July 2007, a JPMorgan analyst reported that Cheyne Capital Management, the sponsor of one of the CalPERS pools, had the highest known concentration of real estate assets in the business. If JPMorgan knew, how come CalPERS didn't know?

More fundamentally, why would CalPERS put any money into an investment pool whose defining characteristic is that its investors can't know what it owns?

Many investors and financial analysts figured out the truth about these shady credit evaluations. The e-mails released by Congress and the SEC feature numerous investment executives telling Moody's and its cousins in mid-2007 that they didn't trust their ratings on exotic paper -- conclusions that had plainly originated months earlier, conceivably by late 2006.

Yet CalPERS claims to have been blindsided by the wave of credit downgrades the firms issued on the pools after mid-2007. It was then too late to extricate itself, as all three of its pools were headed for extinction.

The rating firms' complicity in the mortgage and financial meltdowns is a scandal -- that's true. But big investors including CalPERS played along.

They reasoned that no one would care that they had outsourced their due diligence to raters in cahoots with the ratees, as long as everyone was making money. If the money machine stopped, they figured, the rating firms would be convenient whipping boys.

The CalPERS lawsuit pulls the curtain back on this charade. Sure, CalPERS was a victim. The pension fund says it doesn't think the rating firms should be allowed "off the hook" and says it has "a duty to recover losses on behalf of our beneficiaries." But its case reminds me of a line by the great Russian author Nikolai Gogol: "There's no point blaming the mirror if it's your own mug that's crooked."


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