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Ratings Agencies - It’s Time to Shine the Light

Posted on | October 22, 2008 Time: 7:07 pm |

The heads of major credit ratings agencies S&P, Moody’s and Fitch are testifying today before Congress’s House Oversight and Government Reform Committee. I don’t know if today’s testimony will reverberate in the face of so many potential sources of blame in this crisis, but in my mind they deserve more singular blame than any other group, including (and I can’t believe I’m saying this) regulators and investment banks.

While investment banks are in the business of making greed profitable, credit ratings agencies should be in the business of evaluating the aggregate risks in the credit products they evaluate. Their excuse that they use “historical models” isn’t sufficient or even accurate, and many employees of S&P, Moody’s and Fitch new full well that their models weren’t capturing the tail risks involved with MBSs, CDOs, and other securitized products. We count on these agencies to evaluate what we - the individual investors - cannot readily obtain, which includes the specific covenants, terms, and collateral for specific credit-based securities.

Always Delete Your Stupid Emails

Will You Take Milk as Collateral?

Will You Take Milk as Collateral?

The perfect soundbite came out of an internal message between two execs at S&P; back in April of 2007 an exchange between the two culminated in the following:

Exec 1: “We shouldn’t be rating these (structured finance products)…Our models don’t even capture half the risks involved”

Exec 2: ” I know. But it doesn’t matter, we rate every deal. It could be structured by cows and we would rate it”

People have to give you quotes like that, you can’t write ‘em…It was a dangerous game of alchemy they were playing with mortgage-backed securities, and any one of them with the experience required to do their job knew that. It was their job to rate them as they were: sub-investment grade securities. But AAA and A+ ratings led to more MBSs being created by the investment banks, which meant more money for the ratings agencies. I discuss this concept more fully in my piece on The Fuel that Fed the Subprime Meltdown, which many people are shocked to find out was written well over a year ago.

It’s not that I had information not privy to the public, although I will admit that sourcing the article at the time was quite a task. I kept realizing that everyone was printing information about the returns, yields, and high ratings of MBSs and CDOs, while nobody was printing information on what was inside them, or the break-even points on bad loans that would cause massive layers of investor tranches to get their cash flows (interest payments) wiped out. The lack of transparency was only one of many dangerous signs, and I’m glad that the damning email today has been widely distributed by the media. It’s time for the agencies to be gutted out and restructured, as they will not retain any credibility coming out of this terrible credit cycle.

Ryan Barnes

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Read more on Investment Banks, S&P 500 (SPX), Credit Ratings Agencies at Wikinvest
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