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November 7th, 2012, 22:01
Originally Posted by dteowner View Post
By "back testing", do you mean putting historical trials into the model and see if the prediction matches the historical result? If that's the case, wouldn't it be hard to do historical checking on a mechanism that had no real history? The bundling scheme was a new approach at the time.
Back testing is taking the actual results (day to day market value changes for instance) and testing them against what your model predicted. Nothing is 100% of course, but the model results should show some level of correlation with the actual results. Additionally, they should have been doing stress testing. The Big Bank Stress Tests were all the rage a few years ago, but I assure you that risk departments have been doing them for decades. We spent a significant amount of time every month doing stress scenario analysis, as did they, but as I said, they missed the credit bubble aspect. The bundling scheme wasn't entirely new. MBS have been around for decades, even CDO's have existed in various forms. The real new item was the idea that you could diversify amongst different piles of crap and turn it into gold. At best, you can turn it into bronze.

Big difference between a poor short-view business plan and illegal, though.
There is, but what they were doing violated their fiduciary responsibility, which was illegal.

Impartial does not equal infallible. Besides, wouldn't the whole thing be covered by that generic "investments can lose value" disclaimer that's on everything? Caveat emptor, and all that?
There is a difference between infallible and simply prudent. They played fast and loose with their obligations because the times were good.
The defense of "I didn't" know doesn't hold up when you SHOULD have known.

Think of it like this. You want to buy a house. You know virtually nothing of electricity outside of how to flip a light switch, so you hire an inspector to inspect the house. He gives the house a clean bill, so you buy. The first night you are there, you turn on the TV and the house goes up in flames due to faulty wiring. Upon inspection afterwards, its determined that the electrician was in fact an actual drunken monkey and wired the house so badly that it was not to code and was a fire waiting to happen.

You're going to sue the builder and the electrician of course, but what about the inspector? Well if it was just some buddy that said he knew what he was doing, you're shit outta luck. But as a licensed inspector, this guy claimed he knew what he was doing, represented himself as such and gave your place the A-OK. He is held to a higher standard because he presented himself as such. He can't just say "Well really I don't know a damn thing about electricity." He's going to lose his license, get fined by the state and sued into the ground by you. He wasn't the only one at fault, but he WAS the guy you paid to protect from the other people at fault because he said he could do that.

I guess the real question is, is the financial industry itself pissed off at these guys for what they did (as opposed to, for the end result of losing a ton of money in the crash), or does the industry see them as scapegoats? Seems to me like the latter, but I'm no investment banker. If people in the industry see the ratings guys as crooks, I'd certainly have to correct how I'm reading the tea leaves from the outside.
Mostly we see them as incompetent. When I was a Portfolio Manager, ratings on bonds was extremely important to how we allocated assets. I'm not a PM anymore, but most of the ones I know at best take it with a grain of salt, and at worst either use alternative agencies or largely ignore ratings all together.

However, there is one additional factor here. Many bonds are insured. You often hear the expression on Muni's as AAA Insured. The number of defaults cost the insurers BILLIONS and nearly put many of them out of business. Now you can say "well they should have done their due diligence" and while that is true, the long term theory had always been the ratings agencies know better than anyone else. That's essentially fraud on agencies against the insurers.


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