Criminality of bond rating agencies

[SW VandeCarr]

Can someone please tell me why the heads of the big Wall Street bond rating agencies haven't been charged yet? I don't even know if they're being investigated. We hear a lot about AIG and the banks, but not a lot about outfits like Moody's. I've called news organizations and I don't get good answers. Moody's is probably more responsible for the current economic debacle than any other single company. They rated toxic securitized assets as AAA, the highest possible rating. They knew these packages of mortgage debt were poisoned by risky mortgages, but turned a blind eye because they could be sold to banks and investors for big profits. If this isn't fraud, I don't know what is.

 

[Al68]

They knew these packages of mortgage debt were poisoned by risky mortgages, but turned a blind eye because they could be sold to banks and investors for big profits.

Blind eye? There was no blind eye, the risky mortgages were a part of the packages on purpose to please Fannie and Freddie, and the ratings simply reflected this. Is it the bond rater's fault that Fannie and Freddie insisted on packages containing risky mortgages? And the fact that packages without risky mortgages were harder to sell because Fannie and Freddie didn't want them? And they were the ultimate buyers for 80% of mortgages at one time?

Should the bond raters have rated any package that Fannie and Freddie actually wanted (containing risky mortgages) poorly? Is it the job of the raters to undermine Fannie and Freddie's stated purpose of making it easier for people with bad credit or high debt to get mortgages by insisting on "bundling" them with good mortgages?

 

[russ_watters]

They knew these packages of mortgage debt were poisoned by risky mortgages...

What is your basis for this claim?

 

[SW VandeCarr]

What is your basis for this claim?

It's the business of Moody's, Standard and Poor and Fitch to establish the credit worthiness of securities issued by public and private entities. While AIG and the banks are hardly blameless, they've borne the brunt of pubic wrath and government scrutiny. They bought these securities because they were rated AAA. It's no secret that that risky mortgages were being written. This was public information in 2006. The packaged securities were deliberately created to resell the risky mortgages by bundling them with less risky debt. The institutions that ended up holding them thought they had AAA investments when in fact these ratings were bogus.

 

[SW VandeCarr]

Is it the job of the raters to undermine Fannie and Freddie's stated purpose of making it easier for people with bad credit or high debt to get mortgages by insisting on "bundling" them with good mortgages?

It is the job of bond rating agencies make honest, professional and impartial assessments of credit worthiness. Millions of innocent workers have lost, are loosing and will continue to lose there jobs and livelihoods because these agencies didn't do their job, making huge profits in the process. And the Fannie and Freddy? They're partners in the crime. Making housing accessible to more people is a noble goal, but the simple fact is that corporate greed fueled this disaster. Certainly the people who were able to get risky loans didn't benefit. They've lost their homes.

 

[Al68]

And the Fannie and Freddy? They're partners in the crime. Making housing accessible to more people is a noble goal, but the simple fact is that corporate greed fueled this disaster. Certainly the people who were able to get risky loans didn't benefit. They've lost their homes.

I certainly agree with you here. My point was that it would be difficult for the government to accuse a rating agency of criminal activity on the basis that they went along with the government entities (Fanny and Freddie). Like you said, they're partners in the crime. As far as greed goes, the demand for the bad mortgages was artificially created by government. It was their plan for banks to try to make a profit by issuing bad mortgages to sell to Fannie and Freddie.

Some banks (including mine) refused to make these bad loans, and politicians accused them of wanting poor people to be homeless, etc. But these banks are still doing fine now, and aren't asking for any bailouts.

The simple fact is that this problem was caused by government action via Fannie and Freddie. And every bank in the country should have told them to shove it, but they didn't. They caved to the demand for the bad mortgages created by government. But the root of the problem was Fannie and Freddie. They weren't just partners, they were the instigators and the driving force behind it.

 

[SW VandeCarr]

The simple fact is that this problem was caused by government action via Fannie and Freddie. And every bank in the country should have told them to shove it, but they didn't. They caved to the demand for the bad mortgages created by government. But the root of the problem was Fannie and Freddie. They weren't just partners, they were the instigators and the driving force behind it.

We have a new government now. The corruption of the Bush administration (Pitt at the SEC for one) is a whole other thread. F&F are government affiliated, but are organized and run like 'private' corporations. Their stock trades on NYSE. F&F at least are being investigated. The role of the bond rating agencies, however, is something else. They exist to rate bonds and other debt related securities. They're not bond traders. Their role is to provide information to guide investors. Without reliable rating agencies, the whole bond market (which is much bigger than the stock market) could collapse. If this happens, the entire world economy collapses. This is no exaggeration. It almost did in September, 2008. It's only being propped up by massive government expenditures which potentially endangers the credit worthiness of governments.

 

[russ_watters]

It's the business of Moody's, Standard and Poor and Fitch to establish the credit worthiness of securities issued by public and private entities. While AIG and the banks are hardly blameless, they've borne the brunt of pubic wrath and government scrutiny. They bought these securities because they were rated AAA. It's no secret that that risky mortgages were being written. This was public information in 2006. The packaged securities were deliberately created to resell the risky mortgages by bundling them with less risky debt. The institutions that ended up holding them thought they had AAA investments when in fact these ratings were bogus.

What you haven't established is that Moody's intentionally misrated these securities. Perhaps the system was flawed? Improper ratings is not a new problem.

 

[bleedblue1234]

It is the job of bond rating agencies make honest, professional and impartial assessments of credit worthiness. Millions of innocent workers have lost, are loosing and will continue to lose there jobs and livelihoods because these agencies didn't do their job, making huge profits in the process. And the Fannie and Freddy? They're partners in the crime. Making housing accessible to more people is a noble goal, but the simple fact is that corporate greed fueled this disaster. Certainly the people who were able to get risky loans didn't benefit. They've lost their homes.

Corporate greed stemmed from easy money from the FED and the implicit government 'guarantee' that everyone thought Fannie and Freddy and much of the large investment houses have/had. This is a government problem and continues to be one as we continue to bail out companies that are not fit to be in anything but bankruptcy. People love it on the way up, but we trade a large boom (bubble) for a long and drawn out painful recession/depression that everyone seems to think something has to be 'done' about it. Let the market work it out and we wouldn't have been in this mess, and it could have been averted long, long ago.

 

[SW VandeCarr]

What you haven't established is that Moody's intentionally misrated these securities. Perhaps the system was flawed? Improper ratings is not a new problem.

It's certainly not for me, or any private citizen to know the intentions of professionals and corporate executives. We can judge the results of their activity based on publicly available information. There's no dearth of such information. It's for our legal and judicial system to decide what their intentions were. I'm asking if anyone knows if such process is going forward. There are any number of news reports including a PBS documentary about what exactly happened at Moody's. If you or loved one were injured or died from a misbranded drug, is it for you to determine the intentions of the drug company?

 

[SW VandeCarr]

Corporate greed stemmed from easy money from the FED and the implicit government 'guarantee' that everyone thought Fannie and Freddy and much of the large investment houses have/had.

That doesn't change the fact that there was a broad based systematic effort to help sell risky assets by bundling them with good assets, and then giving those assets unwarranted AAA ratings. I agree that corporate greed fueled the dynamics of this debacle.

 

[mheslep]

Can someone please tell me why the heads of the big Wall Street bond rating agencies haven't been charged yet? I don't even know if they're being investigated. We hear a lot about AIG and the banks, but not a lot about outfits like Moody's. I've called news organizations and I don't get good answers. Moody's is probably more responsible for the current economic debacle than any other single company. They rated toxic securitized assets as AAA, the highest possible rating. They knew these packages of mortgage debt were poisoned by risky mortgages, but turned a blind eye because they could be sold to banks and investors for big profits. If this isn't fraud, I don't know what is.

Fraud is an intentional deception made for personal gain. What gain in particular do you believe Moody's or the other nationally recognized statistical rating organizations (NRSRO) made regarding mortgages? And while asking for ambiguous and unclear criminal charges, why not ask for the criminal charges against http://www.sec.gov/answers/nrsro.htm"

 

[mheslep]

That doesn't change the fact that there was a broad based systematic effort to help sell risky assets by bundling them with good assets, and then giving those assets unwarranted AAA ratings. ...

Those are two different things: bundling and rating. The raters did not own any of the assets.

 

[mheslep]

...news reports including a PBS documentary about what exactly happened at Moody's. ...

That's a government supported media outlet giving its take on how everybody but the government caused the credit crisis.

 

[SW VandeCarr]

Fraud is an intentional deception made for personal gain. What gain in particular do you believe Moody's or the other nationally recognized statistical rating organizations (NRSRO) made regarding mortgages? And while asking for ambiguous and unclear criminal charges, why not ask for the criminal charges against the government that set them and a couple others up by law as the only entities legally entitled to rate securities?

Moody's ex-executives have already stated that they were pressured to set up a way of evaluating these securities, which they knew were tainted, so as to give them AAA ratings. As a result, Moody's took a lot new business from Standard and Poor's and Fitch. I really don't think there's much debate about this. A lot of details are known. Moody's made a lot of money from this. I already said the government during this period, 2005-2007 in particular, is a part of the problem.

 

[SW VandeCarr]

That's a government supported media outlet giving its take on how everybody but the government caused the credit crisis.

Right. PBS was a tool of the Bush Administration. Besides, how does this make the government look good given the abject failure of the SEC? You could also blame Congress, but most of them really don't really understand finance.

 

[mheslep]

Moody's ex-executives have already stated that they were pressured to set up a way of evaluating these securities, which they knew were tainted, so as to give them AAA ratings. As a result, Moody's took a lot new business from Standard and Poor's and Fitch. I really don't think there's much debate about this. A lot of details are known.

Then let's see some.

Moody's made a lot of money from this. I already said the government during this period, 2005-2007 in particular, is a part of the problem.

The NRSRO laws were setup decades ago.

 

[Al68]

F&F are government affiliated, but are organized and run like 'private' corporations.

No private corporation wanted to buy bad mortgages on purpose, except to sell to F&F. They're not run like private corps, they have a government mission.

As far as a new government, the politicians that supported the idea of F&F creating demand for bad mortgages have more power now. Why do you think it's not being properly investigated?

 

[edward]

The mortgage ratings situation went much deeper than F&F. It involved billions of dollars in profits for the ratings agencies for helping to design the structured finance deals such as the CDO's

On October 22, 2008, the Congressional Committee on Oversight and Government Reform held a hearing on the role of the credit rating agencies in the Wall Street crisis. In his opening statement, Chairman Henry Waxman referenced an October 2007 presentation by Moody’s CEO, Ray McDaniel: “Analysts and MD’s are continually pitched by bankers, issuers and investors,” as McDaniel described in a confidential address to the Board of Directors, and admitted that sometimes we “drank the kool-aid.”

The problem is compounded when rating agencies are paid consulting fees to help to design the structured finance deals in the first place. “Everyone is sitting on the same side of the table at that point,” says Graham Henley, a director at LECG who formerly served as director of mortgage-backed securitization at Societe Generale. “The fox is in the henhouse!”

Faulty Models

Garbage in, garbage out. When models are based on erroneous or insufficient data, they produce misleading results. One of the stumbling blocks for rating securitized instruments was the dearth of long term data for extrapolation. Although the ratings analysts assumed defaults would increase during an economic slowdown, recent history offered no such modeling data for innovations like CDO’s.

Indeed, many CDO’s were simply unratable on the basis of the home loan characteristics in the reshuffled pools of mortgages. In his testimony Chairman Waxman refers to exchanges between S&P employees describing the pressure on analysts to devise shortcuts, based on guesswork, for coming up with some rating, any rating at all. “It could be structured by cows, and we would rate it,” one analyst wrote.

Emphasis mine.

http://www.realclearmarkets.com/articles/2009/03/drinking_the_rating_agencies_k.html

 

[Astronuc]

It might be difficult to prove criminal intent. It might be easier to demonstrate negligence.

It was known in 2007 through 3Q2008 that there were significant problems with the subprime mortgage industry and the plethora of derivatives based on securitized mortgage bundles.

Subprime Mortgage Derivatives Extend Drop on Moody's Reviews (Feb 22, 2007)
http://www.bloomberg.com/apps/news?pid=20601087&sid=avTR8S7Yr5Kw&refer=home

Ratings agencies 'put system at risk,' CEO says (Oct 22, 2008)
Testimony shows watchdogs were 'Kool-Aid drinking' lapdogs
http://www.marketwatch.com/story/ratings-agencies-put-system-at-risk-ceo-says

An interesting overview with references
Rating Agencies: Moody’s, S&P, and Fitch (REVISED VERSION)
http://www.ritholtz.com/blog/2009/02/rating-agencies-moodys-sp-and-fitch-revised-version/


Triple-A Failure (April 27, 2008)
http://www.nytimes.com/2008/04/27/magazine/27Credit-t.html

In 1996, . . . . Moody’s was then a private company that rated corporate bonds, but it was, already, spreading its wings into the exotic business of rating securities backed by pools of residential mortgages.

Obscure and dry-seeming as it was, this business offered a certain magic. The magic consisted of turning risky mortgages into investments that would be suitable for investors who would know nothing about the underlying loans. To get why this is impressive, you have to think about all that determines whether a mortgage is safe. Who owns the property? What is his or her income? Bundle hundreds of mortgages into a single security and the questions multiply; no investor could begin to answer them. But suppose the security had a rating. If it were rated triple-A by a firm like Moody’s, then the investor could forget about the underlying mortgages. He wouldn’t need to know what properties were in the pool, only that the pool was triple-A — it was just as safe, in theory, as other triple-A securities.

Over the last decade, Moody’s and its two principal competitors, Standard & Poor’s and Fitch, played this game to perfection — putting what amounted to gold seals on mortgage securities that investors swept up with increasing élan. For the rating agencies, this business was extremely lucrative. Their profits surged, Moody’s in particular: it went public, saw its stock increase sixfold and its earnings grow by 900 percent.

By providing the mortgage industry with an entree to Wall Street, the agencies also transformed what had been among the sleepiest corners of finance. No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and — their capital thus replenished — wrote new loans at a much quicker pace.
. . . .

 

[Al68]

It might be difficult to prove criminal intent. It might be easier to demonstrate negligence.

Well, since negligence isn't a crime, but fraud is, it might be difficult. But we should at least investigate fraud suspects. But since the root of the problem was politicians and their fraud, and they have even more power now, I don't see it happening.

They're laying low, trying to shift the blame, until they will start up the same programs that caused the mortgage problems. They're certainly not going to investigate or admit they caused the problem (even to themselves).

The biggest problem I have with politicians getting by with causing the problem is not only that they will do it again, but that, unlike the rating companies and banks involved, the politicians were supposedly acting on behalf of the public. And everyone is downplaying the real cause of the mortgage problem, government creation of the artificial demand for "bad" mortgages. None of the bad mortgages would ever have been issued to begin with if not for government. The government, via Freddie and Fannie, made "bad, toxic, risky" mortgages profitable on purpose to encourage them.

None of the "bad" mortgages were ever issued for any other reason than for resale to Fannie and Freddie.

 

[mheslep]

The mortgage ratings situation went much deeper than F&F. It involved billions of dollars in profits for the ratings agencies for helping to design the structured finance deals such as the CDO's





Emphasis mine.

http://www.realclearmarkets.com/articles/2009/03/drinking_the_rating_agencies_k.html

Interesting article, especially where the SEC considers:

The second June proposal, also rejected, was “the most revolutionary”, Herring says. It attempted to remove the use of ratings from all SEC regulations, which would have defrocked the hegemony of the NRSRO’s. No longer would their ratings have enjoyed a sanctified governmental status.

That's unfortunate, as that's the crux of the problem to my mind.

 

[Tibarn]

Most politicians don't have the knowledge necessary to understand the complexity of today's financial markets. One practically needs a Ph. D for that. Even if they could, little things like poverty, healthcare, crime, national defense, and upcoming elections also require their time. That's where an army of experts and regulators come in. That's why regulatory agencies were set up in the first place and given the power to create regulations within their scope of authority. The knowledge required is so specialized that debating all these regulations on the open floor in Congress would be a disaster.

So, we're left with a Congress that's theoretically in charge but doesn't quite understand all the details and regulators that have to somehow balance pressure from Congress with the reality of the market. Throw in industry lobbyists and a variety of models featuring lots of mathematical gymnastics, and I'd be surprised if anyone knows what's really going on in the resulting quagmire.

It would work well enough if everyone were completely honest, but shortsightedness, greed, and letting pressure overcome your good sense lead to disaster. Trying to pin all the blame on one or two organizations is a fool's game.