How the Dirty Deed Was Done or The Fleecing of America

Did rating agencies like Standard & Poors, Moodys and Merrill Lynch conspire with the financial industry to lie and bleed America dry? Yes, rating agencies played an important role at various stages in the subprime crisis. They have been highly criticized for understating the risk involved with new, complex securities that fueled the United States housing bubble, such as mortgage-backed securities (MBS) and collateralized debt obligations (CDO).

The ratings of these securities was a lucrative business for the rating agencies, accounting for just under half of Moodys total ratings revenue in 2007. Through 2007, ratings companies enjoyed record revenue, profits and share prices.

The rating companies earned as much as three times more for grading these complex products than corporate bonds, their traditional business. Rating agencies also competed with each other to rate particular MBS and CDO securities issued by investment banks, which critics argued contributed to lower rating standards.

Interviews with rating agency senior managers indicate the competitive pressure to rate the CDOs favorably was strong within the firms. This rating business was their "golden goose" (which laid the proverbial golden egg or wealth) in the words of one manager.

Author Upton Sinclair (1878-1968) famously stated: "It is difficult to get a man to understand something when his job depends on not understanding it." This competitive pressure and the resulting profits gave a personal financial incentive to management to lower standards.

Internal rating agency emails from before the time the credit markets deteriorated, discovered and released publicly by U.S. congressional investigators, suggest that some rating agency employees suspected at the time that lax standards for rating structured credit products would produce negative results. For example, one email between colleagues at Standard & Poors states "Rating agencies continue to create an even bigger monster--the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters."

Impact on the crisis

Credit rating agencies are now under scrutiny for giving investment-grade, "money safe" ratings to securitization transactions (CDOs and MBSs) based on subprime mortgage loans. These high ratings encouraged a flow of global investor funds into these securities, funding the housing bubble in the U.S.

An estimated $3.2 trillion in loans were made to homeowners with bad credit and undocumented incomes (e.g., subprime or Alt-A mortgages) between 2002 and 2007. These mortgages could be bundled into MBS and CDO securities that received high ratings and therefore could be sold to global investors.

Higher ratings were believed justified by various credit enhancements including over-collateralization (i.e., pledging collateral in excess of debt issued), credit default insurance, and equity investors willing to bear the first losses.

Economist Joseph Stiglitz stated: "I view the rating agencies as one of the key culprits...They were the party that performed the complicated process that converted the securities from F-rated to A-rated. The banks could not have done what they did without the complicity of the rating agencies." God Bless them, everyone.

Without the AAA ratings, demand for these securities would have been considerably less. Bank write downs and losses on these investments totaled $523 billion as of September 2008.

*Wikipedia, The Free Encyclopedia