Ratings agencies may have met their match

(breakingviews.com) -- Credit rating firms may finally be forced to eat their own cooking.

The $173 billion California Public Employees' Retirement System is suing the top three raters over some $1 billion in losses it incurred when three top-rated structured investment vehicles collapsed. Raters have prevailed against similar legal challenges before. But Calpers might now have them over a barrel.

The pension fund says Moody's, Fitch Ratings and Standard & Poor's should share the blame for losses in part because they helped structure the SIVs before rating them - something Moody's, at least, denies.

In fact, Calpers says, the raters were in deeper than that. They not only rated the SIVs themselves, but they rated most of the asset- and mortgage-backed securities that the vehicles purchased.

To the extent they provided guidance on what banks needed to do to obtain crucial triple-A ratings, that could be the raters' undoing. They aren't commenting on any specifics, but Calpers alleges that SIV rating fees, which it says ranged from $300,000 to $1 million per deal, were contingent on the successful sale of the SIV securities. That, Calpers says, provided a motive for the raters to bend over backwards to ensure the SIVs would get their top ratings.

More importantly, if they assisted in structuring the SIVs, that undermines the raters' assertion that their ratings constitute opinions worthy of the same First Amendment protections afforded journalists.

Fitch's then-general counsel told lawmakers investigating the Enron debacle that a rating was "the world's shortest editorial". That pretense doesn't hold up when you're commenting on something you designed yourself.

Calpers also complains that it didn't receive enough information from the SIVs or the rating agencies to adequately understand the vehicles. That's where the raters might be on safer ground. After all, Calpers didn't have to buy the SIVs' debt, and should not have done so until it was satisfied.

Such a nuance could easily be lost in arguments before a jury in California, a state on the verge of insolvency. And if the case did go against the raters and cost them big money, scores of other disgruntled investors could try their luck, too.

That in turn could open a whole new can of worms by putting the future of the ratings firms in doubt.