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Default 6NOV: The Apocolypse Cometh

November 7th, 2012, 20:02
Originally Posted by dteowner View Post
What do you fine them for? There was certainly (and still is) a huge conflict of interest in the ratings biz, but that's not illegal under the laws of the time nor the laws of today. I'm not sure how you can penalize companies for following the rules that are presented to them. Sure, the rules were stupid and destructive, but the companies didn't make them.
The setup of the business is bad, but the agencies that have only taken money from clients have always had issues with solvency.

The reason they should be fined (and stripped of their status as Nationally Recognized Statistical Rating Organizations) though is not due to that inherent conflict of interest. The reason is that they were at best negligent and at worst fraudulent in their ratings of MBS and CDO securities.

They were required, but statute, to do certain amounts of back testing to validate the models they were using to value those securities. They generally didn't and where they did, they often didn't have people in place to adequately understand the results. There was an article shortly after the debacle titled something like "Part-time MBA's vs PhD Rocket Scientists: How the ratings agencies were outmanned and outgunned". The gist of it is that they hired some really, really smart people back in the 90's to build the ratings systems for their securities. Those guys got hired off by hedge funds and I-banks for massive raises. They replaced them with people that, while smart, weren't up to the task of modeling these types of securities. It all came down to cost, they didn't want to pay what it would take get the right people, and even if they did, they didn't want to lose the revenues from the Ibanks for rating these securities.

If you want a short synopsis of why the MBS world blew up, it goes like this:

1) Package up a bunch of crappy mortgages from different locations into one security because "there is no national real estate market" (just ask any realtor)
2) Divide it up such that roughly 80% of the buyers will have a 99% chance (based on the model) of getting paid on time and in full. Sell the other 20% at a big discount to reflect the increased risk.
3) Get the rating agency to slap a AAA rating on that 80%
4) Now buy up the bottom 20% of 5 MBS's and start back at 2 again. and again and again

While its true that there is no national real estate market (not in terms of how the economy is doing or people migration trends), the model completely ignored the fact that almost 100% across the country, housing prices were rising due to the easy credit afforded by the above scheme.

Now there is nothing wrong with the above scheme (outside of the ratings), SO LONG AS IT IS DISCLOSED TO BUYERS WHAT THEY ARE GETTING INTO. That is where the ratings agencies come it. They are supposed to impartial 3rd parties.

Well guess what, there are emails, memos, etc. of the few really smart people there, raising questions about the models lack of credit risk accountability! And those people being told to shut up and be a team player. That is at best a serious breech of ethics and at worst outright fraud.

Those ratings enabled pension funds, money markets, etc. to buy those securities when they otherwise would have been prohibited to do so. And they wanted to buy them, because everyone has been yield crazy (who hasn't complained about the yields on their savings or checking accounts, even when they were a few percent?).

The ratings agencies had a fiduciary responsibility that they completely punted on, and no one has held them accountable.

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