View Full Version : Rating agencies, regulation, and capital

01-04-2009, 12:43 PM
Recently the WSJ ran an op-ed and an editorial relating to mispricing of risk, and noting the role to credit rating agencies.

The op-ed: Let's write rating agencies out of our law (http://online.wsj.com/article/SB123086073738348053.html)

The editorial: Credit Default Swamp (http://online.wsj.com/article/SB123094475030650613.html)

As is my Sunday afternoon tradition, I sent off a letter to the editor of the WSJ:
I agree with Mr. Rosenkranz and the editors that regulations rely too much on the Big Three rating agencies to measure the riskiness of assets. Part of the problem is in how the agencies are compensated; once, they were paid by the buyers of debt, now they are paid by issuers. The interests there are obviously divergent. To be sure, if a rating agency was too wrong too often, it would lose its reputation and perhaps its government imprimatur -- but the government moves even slower than do credit ratings.

Another obvious problem is the barrier to entry as an approved rating agency. As noted in the "Credit Default Swamp" editorial, the government does not have much incentive to recognize competitors to the current Big Three credit rating agencies. A review of what it takes to be given approval, and to lose it, as a credit rating agency may be one of the quicker regulatory fixes that could happen in the current political climate.

In light of these issues, I don't think Mr. Rosenkranz's proposal to measure riskiness by spreads over Treasuries really fixes the problem. While the market has virtues not held by regulators and credit rating agencies, with regards to structured financial products, there is not much proof that the market prices the risk well. The models used to price CDOs, CDSs, MBSs, CMOs, and other three-lettered horrors are complicated, and highly divergent parameter sets produce different spreads. We have seen recently that the models for mortgage-backed securities made certain assumptions about the quality of collateral, and the recovery given default, which have turned out to be greatly different from reality.

Moving from credit rating agencies as a basis for measuring risk, to market prices, may be a little improvement, but it doesn't fix an underlying problem: individual entity responsibility for its own risk management. Just as insurance companies and banks can point to the rating agencies to cry, "But they rated those assets AAA!", in a spread-based world the companies can cry, "But the spreads were low!"

Pushing off responsibility to third parties, whether rating agencies or the market, will not give the impetus to companies to do a hard analysis of their own positions, nor does it give incentive to fight against mispricing of risk.

I do wonder about the role of the credit rating agencies, especially given there's basically only three players in the biz for regulatory purposes in the U.S.

How has the experience been in Canada? Europe? Asia? I assume the U.S. credit rating agencies do work in other countries, too, but I was wondering the role they play in international regulatory regimes. What might be a fix here?

01-04-2009, 05:37 PM
Hmmm, I swear I didn't see this op-ed before I wrote the WSJ:
The end of the financial world as we know it (http://www.nytimes.com/2009/01/04/opinion/04lewiseinhorn.html?pagewanted=all)

OUR financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest.

The credit-rating agencies, for instance.

Everyone now knows that Moody’s and Standard & Poor’s botched their analyses of bonds backed by home mortgages. But their most costly mistake — one that deserves a lot more attention than it has received — lies in their area of putative expertise: measuring corporate risk.

Over the last 20 years American financial institutions have taken on more and more risk, with the blessing of regulators, with hardly a word from the rating agencies, which, incidentally, are paid by the issuers of the bonds they rate. Seldom if ever did Moody’s or Standard & Poor’s say, “If you put one more risky asset on your balance sheet, you will face a serious downgrade.”

The American International Group, Fannie Mae, Freddie Mac, General Electric and the municipal bond guarantors Ambac Financial and MBIA all had triple-A ratings. (G.E. still does!) Large investment banks like Lehman and Merrill Lynch all had solid investment grade ratings. It’s almost as if the higher the rating of a financial institution, the more likely it was to contribute to financial catastrophe. But of course all these big financial companies fueled the creation of the credit products that in turn fueled the revenues of Moody’s and Standard & Poor’s.

These oligopolies, which are actually sanctioned by the S.E.C., didn’t merely do their jobs badly. They didn’t simply miss a few calls here and there. In pursuit of their own short-term earnings, they did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it.

And some nastiness for the SEC (deserved, I think):

But this should come as no surprise, for the S.E.C. itself is plagued by similarly wacky incentives. Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become.

Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors. (The task it has performed most diligently during this crisis has been to question, intimidate and impose rules on short-sellers — the only market players who have a financial incentive to expose fraud and abuse.)

Dang. Read the whole thing. I wouldn't be surprised if someone else posted this in the Finance/Investing forum. I'm going to have to read part 2 (a proposed fix?) (http://www.nytimes.com/2009/01/04/opinion/04lewiseinhornb.html) later.

01-05-2009, 11:42 AM
The credit rating agencies are an unattural creation. The incentive structure was actually way better before the government got involved in the 70s.

Will Durant
01-05-2009, 01:25 PM
Actually, I read an article pointing out that the current incentive structure evolved as a result of Xerox ... specifically that the rating agencies could no longer protect their investor-purchased content from being circulated to non-purchasers.

Edited to add: It was Kevin Williamson in the 12/15 issue of National Review.

01-07-2009, 02:10 PM
Stop the Reform-Industrial Complex! (http://www.forbes.com/opinions/2009/01/06/sec-levitt-reform-oped-cx_jb_0107bowyer.html)

Am I the only guy in America who thinks that the Madoff scandal should discredit the regulatory state, rather than lead to an expansion of it?

Levitt was the chief cheerleader of what Larry Kudlow calls the "goo-goo" good government crowd--Financial Division. Did that stop Madoff? Heck no! Madoff was a big player in that crowd. Close to Levitt and other financial scolds, Madoff threw loads of money at Democrats who sat on regulatory oversight committees. Levitt even said that Madoff's niece married an SEC official.

Economist Joseph Schumpeter--the "creative destruction" guy--formulated another highly insightful economic principle called "the capture theory."

Schumpeter said that regulatory bodies that are created to control a specific industry will eventually be captured by the industry they're supposed to be regulating. The revolving doors, the overlapping social spheres, the pure intensity of incentive that comes when a group of individuals get to control the business dealings of another group of individuals--all of these add up to a situation in which greater regulation makes the system less honest.

09-24-2009, 04:57 PM

So there was the NAIC meeting recently and let's see what happened with rating agencies:

NATIONAL HARBOR, MD. – The National Association of Insurance Commissioners should reevaluate Securities Valuation Office reliance on rating agencies, witnesses said here today at an NAIC hearing.

The NAIC, Kansas City, Mo., should take a hard look at the rating agencies because the agencies’ poor performance helped cause the recent financial meltdown, according to New York Deputy Insurance Superintendent Michael Moriarty and Birny Birnbaum, executive director of the Center for Economic Justice, Austin, Texas.

Moriarty, Birnbaum and others were testifying at a day-long, 3-part hearing at the conclusion of the NAIC’s fall meeting.

The NAIC’s Rating Agency Working Group organized the meeting, which was chaired by Illinois Insurance Director Michael McRaith and co-chaired by New York Superintendent James Wrynn, to look at how insurance regulators came to rely on the rating agencies, what went wrong, and what to do in the future.

The SVO is an arm of the NAIC that helps insurance regulators analyze and monitor bonds, mortgage-backed securities and other investment instruments.

Earlier in this decade, the SVO responded to limits on its resources by trying to make more use of the ratings and valuations provided by third parties, such as rating agencies, Moriarty testified.

The SVO exempted insurer-owned securities rated by nationally recognized rating organizations from filing requirements, Moriarty said.

“The rationale at that time was fairly straightforward,” Moriarty said, noting that the rating agencies had a track record of reliability.

Today, however, reliance on the rating agencies should be reviewed in light of the events of the last few years, Moriarty said.

More of the story at the link.

10-01-2009, 04:31 AM
A congressional hearing:

WASHINGTON BUREAU -- A House Financial Services subcommittee chairman today charged that the rating agencies betrayed “their special status under our laws” through a “ask me no questions, I’ll tell you no lies” approach to grading mortgage-backed securities.

Rep. Paul Kanjorski, D-Pa., head of the Capital Markets Subcommittee, made those comments while urging passage of a draft bill that would preserve credit rating agency independence but require the agencies to comply with standards they create and police themselves.

The Accountability and Transparency in Rating Agencies Act bill draft would give the U.S. Securities and Exchange Commission power to dictate how credit rating agencies determine ratings.

At the hearing, rating agency representatives acknowledged that their firms’ ratings performed poorly, and they said they would support many of the reforms proposed in the ATRAA draft.

But the rating agencies said they would oppose some provisions, including one that would making the rating agencies responsible for each others’ ratings through collective liability.

There's more at the link. But I don't particularly like the sound of either of the bolded parts [obviously the agencies are not happy with the second]. I can think of some things that can go wrong in this arrangement, and could even make the situation worse than it is now.

11-11-2009, 06:33 AM

The National Association of Insurance Commissioners could choose a residential mortgage-backed securities modeling firm by the end of the week, a regulator says.

The NAIC plenary – the body that includes all voting members of the NAIC, Kansas City, Mo. – recently approved a measure that calls for the NAIC to develop a new model for rating the residential mortgage-backed securities held by insurers.

The NAIC will be trying to reduce its reliance on ratings from the “nationally recognized statistical rating organizations” for the purpose of determining insurer risk-based capital levels.

The NAIC is planning to set up 6 soundness designations for RMBS and establish ranges of prices for each designation, and it plans to contract with an independent firm to assist with the modeling efforts.

Matti Peltonen, a bureau chief with the New York State Insurance Department, says he expects the outside firm to be chosen by the end of the week. He says the NAIC received “about two or three dozen responses” to its request for proposals, but that the NAIC will likely not make the names of the bidders public.

The American Council of Life Insurers, Washington, called for the change in September, arguing that the current NRSRO RMBS ratings fail to distinguish between securities with a total loss and those projected to suffer minor losses.

The result, ACLI said, has been skyrocketing life insurance company capital reserve requirements.

11-19-2009, 05:31 AM
NAIC hires PIMCO to help with RMBS models

11-19-2009, 08:15 AM
The American International Group, Fannie Mae, Freddie Mac, General Electric and the municipal bond guarantors Ambac Financial and MBIA all had triple-A ratings. (G.E. still does!)

I thought GE was downgraded to AA.

12-08-2009, 11:01 AM

When the financial crisis began, few players on Wall Street looked more ripe for reform than the Big Three credit rating agencies.

It wasn’t just that Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, played a crucial role in the epochal housing market collapse, affixing their most laudatory grades to billions of dollars worth of bonds that went bad in the subprime crisis.

It was the near universal agreement that potential conflicts were embedded in the ratings model. For years, banks and other issuers have paid rating agencies to appraise securities — a bit like a restaurant paying a critic to review its food, and only if the verdict is highly favorable.

So as Washington rewrites the rules of Wall Street, how is the overhaul of the Big Three coming? It isn’t, finance experts say.

“What you see in these bills are Botox shots,” says Joseph A. Grundfest, a professor of securities law at Stanford Law School. “For a little while, everyone is going to be frozen into a grin, and then the shots are going to wear off.”

more at link

Investor beware.

12-23-2009, 12:32 PM

The House-passed rewrite of financial regulation is a disappointment for investors and taxpayers. But one portion of the bill represents significant reform—and a vast improvement from an early draft we described in October.

Congressmen Barney Frank and Paul Kanjorski (D., Pa.) have produced legislation that would likely end the credit-ratings racket enjoyed by Standard & Poor's, Moody's and Fitch. During the housing bubble, these government-anointed judges of credit risk slapped their triple-A ratings on billions of dollars of mortgage-backed securities. The consequences for investors were catastrophic.

The Frank-Kanjorski provision that recently passed the House not only eliminates all laws that require the use of these "Nationally Recognized Statistical Ratings Organizations." The bill also instructs all the major financial regulators to remove such requirements from their rules. This is a subtle but enormously important change from the October draft, because most of the federal edicts that guaranteed profits for S&P and the gang were contained in agency rules, not laws.

The House-passed bill also repeals an exemption that credit-raters have enjoyed from the Securities and Exchange Commission's Regulation Fair Disclosure. No longer will they have access to corporate information that is denied to average investors.

Whoa. Well, I wonder if this will make it all the way through to law. Interesting.

12-27-2009, 02:02 PM
From the life insurance perspective, rating agencies are useless as a predictor of the stability of insurance companies.

Here's my take:
- companies can game the system to a certain extent
- the ratings are not indicative of the stability of a company. The rating agencies can't really tell if a company is stable. Heck, even actuaries can't tell if a company is stable. Can you?
- None of these ratings matter a whit when it really matters - 20-30 years in the future. You buy a big company, buy a small company, buy a b rated company, buy an a rated company, and there is exactly nothing these ratings companies provide that gives us an insight into the future stability of a company down the road. It's not hard to buy an AAA+++ company today that in 20 years completely blows.

I'd buy stock in Santa Claus before I'd buy stock in company that performs life insurance company ratings.

(A while ago I had suggested that I might consider reviewing rating company's performance over an extended period of time - see how many insurers had been top rated in the past before closing their doors. I had a number of people strongly suggest that such a report would not be good for my business. :) ).

12-27-2009, 07:47 PM
Heck, can the rating agencies do a good job rating government bonds?

12-28-2009, 11:52 AM
Heck, can the rating agencies do a good job rating government bonds?

In Bill Gross we trust.

09-14-2012, 04:13 PM
Heck, can the rating agencies do a good job rating government bonds?


02-05-2013, 10:25 AM
S&P being sued by federal government...

http://online.wsj.com/article/SB10001424127887324445904578284064003795142.html?m od=WSJ_article_forsub

The Justice Department sued Standard & Poor's Ratings Services late Monday, alleging the firm ignored its own standards to rate mortgage bonds that imploded in the financial crisis and cost investors billions, according to people familiar with the matter.

The civil charges by U.S . Attorney General Eric Holder against the New York company, one of the bond-rating industry's three giants, are the first federal enforcement action against a credit-rating firm over the crisis. Several state attorneys general are likely to join.

The government suit would be "entirely without factual or legal merit," said S&P in a statement earlier Monday, denying wrongdoing.

S&P said the government's allegations stem from S&P 's rating of collateralized debt obligations, or CDOs, issued in 2007 that included bundles of subprime mortgages.

The government is targeting about 30 of those deals, which plummeted in value soon after being sold to investors, a person familiar with the matter said.

In 2011, S&P , Moody's and the Fitch Ratings unit of Fimalac SA and Hearst Corp. were accused by a Senate committee of giving overly rosy ratings to CDOs and then causing an "economic earthquake" by downgrading hundreds of the bonds when the scale of the housing collapse became clear.

S&P suggested Monday it was being unfairly singled out. The CDOs under scrutiny were given the same high ratings from an S&P rival, the firm said. S&P added that it faced charges for not predicting the full extent of the housing bust, "despite [the] failure of virtually everyone to do so."

Ah, but I bet that S&P rival hasn't downgraded U.S. sovereign debt, now has it.

http://online.wsj.com/article/SB10001424127887324445904578285802822704578.html?m od=googlenews_wsj

On March 19, 2007, as the U.S. housing market weakened, an analyst at Standard & Poor's Ratings Service sent out some song lyrics to colleagues, set to the tune of the Talking Heads 1980s song "Burning Down the House."

"Housing market went softer/Cooling down/Strong market is now much weaker/Subprime is boi-ling o-ver/Bringing down the house."

The song lyrics are among the U.S. government's allegations against S&P in a 128-page lawsuit filed late Monday in a U.S. District Court in Los Angeles. The suit alleges that the largest U.S. rating firm "falsely" represented that crisis-era credit ratings on complex securities "were objective, independent" and "uninfluenced by any conflicts of interest."

S&P and other firms have long fought lawsuits targeting the quality of their ratings by citing the First Amendment and contending that the ratings are an opinion. In its suit, the Justice Department lawsuit tries to get around that argument by dusting off a law from the savings-and-loan crisis that imposes a relatively lower burden of proof.

The federal government is suing S&P for three types of fraud under that law: mail fraud, wire fraud and financial-institution fraud. The suit doesn't indicate how much the U.S. is seeking in damages.

oedipus rex
02-05-2013, 04:49 PM
so I'm assuming Moody's and Fitch did something completely different than S&P with respect to MBS ratings.

02-05-2013, 04:56 PM
To pull out one item:

The CDOs under scrutiny were given the same high ratings from an S&P rival, the firm said.

The main difference is that said S&P rival did not downgrade the U.S. Or maybe they were honestly dumb. There are all sorts of possibilities about why said rival isn't being sued.


S&P, Moody's Inflated MBS Ratings: Report

02-06-2013, 12:42 PM
Ah, but I bet that S&P rival hasn't downgraded U.S. sovereign debt, now has it.

The UAW doesn't bargain with all GM, Ford, and Chrysler all at once. Perhaps it is a domino theory. One after the other.

02-07-2013, 05:18 PM
The UAW doesn't bargain with all GM, Ford, and Chrysler all at once. Perhaps it is a domino theory. One after the other.

Well, it could keep Moody's in line, in terms of not threatening to change the U.S. credit rating

RR's pet coyote's cousin
02-07-2013, 05:21 PM
The credit rating agencies are an unattural creation. The incentive structure was actually way better before the government got involved in the 70s.

Isn't that always the case? Government involvement, even with the best intentions, mucks up things worse than if the government stayed away and let markets do what markets do best.

02-08-2013, 09:53 AM

S&P Lawsuit Portrays CDO Sellers as Duped Victims

Oh, the poor suckers at Citigroup Inc. and Bank of America Corp., fooled about the stench of their own garbage by those sneaky credit raters at Standard & Poor’s.
The U.S. Justice Department made some peculiar allegations in its lawsuit this week against S&P and its parent, McGraw-Hill Cos. According to the government, Citigroup was defrauded by S&P credit ratings on subprime mortgage bonds that Citigroup itself created and sold. Bank of America, too, allegedly was defrauded by S&P in the same way.
For nine of the CDOs, the government’s complaint listed Citigroup as the harmed investor -- without mentioning that Citigroup’s investment-banking division had managed the bonds’ offerings. The complaint identified Bank of America as the defrauded CDO investor in two instances, also without mentioning that its securities unit underwrote those bonds.

It’s a novel concept. If only S&P had given honest opinions to Citigroup and Bank of America -- which were paying S&P millions of dollars for ratings -- then the banks would have realized they were buying ticking time bombs from themselves. And who knows? Maybe they could have found some other hapless chumps to immolate instead, if S&P had told them in time.

01-24-2014, 01:31 PM

Jan 21 (Reuters) - Former U.S. Treasury Secretary Timothy Geithner angrily warned the chairman of Standard & Poor's parent that the rating agency would be held accountable for its 2011 decision to strip the United States of its coveted "triple-A" rating, a new court filing shows.

Harold McGraw, the chairman of McGraw-Hill Financial Inc , made the statement in a declaration filed by S&P on Monday, as it defends against the government's $5 billion fraud lawsuit over its rating practices prior to the 2008 financial crisis.

McGraw said he returned a call from Geithner on Aug. 8, 2011, three days after S&P cut the U.S. credit rating to "AA-plus," and that Geithner told him "you are accountable" for an alleged "huge error" in S&P's work.

"He said that 'you have done an enormous disservice to yourselves and to your country,'" and that S&P's conduct would be "looked at very carefully," McGraw said. "Such behavior could not occur, he said, without a response from the government."

The U.S. Department of Justice, which brought the civil fraud lawsuit, did not immediately respond to a request for comment. New York Fed spokesman Jack Gutt declined to comment.

In its lawsuit, the U.S. government accused S&P of hurting banks and credit unions by inflating ratings to win more fees from issuers, and then failing to downgrade debt backed by deteriorating mortgage-backed securities fast enough.

S&P has claimed that the lawsuit was filed in retaliation for the downgrade, and should be dismissed. Its main rating agency rivals, Moody's Investors Service and Fitch Ratings, were not sued.

06-16-2014, 04:17 PM

Pension fund investors lost billions of dollars trusting the rosy credit ratings stamped on troubled mortgage securities before the 2008 crisis. In its aftermath, they have spent years and many dollars suing Moody’s and Standard & Poor’s, the main purveyors of those dubious grades.

That these funds and other plaintiffs are trying to hold the ratings agencies to account is a good thing.

And yet, there’s a mystifying disconnect in some of these disputes. On one hand, pension funds or state officials are telling the courts that Moody’s and S.&P. were negligent and their ratings marred by flawed methods and conflicts of interest. On the other hand, when the professionals who manage state funds buy bonds or mortgage securities, their investment policies require them to rely on the assessments of — you guessed it — the very same ratings agencies.

Mr. Kelleher suggested that ratings agencies be held liable for malpractice as accounting firms and other experts are. Moody’s and S.&P. contend that the grades they give bonds and securities are opinions that carry free-speech protections. As such, they are not subject to legal liability. Some courts, alas, have accepted this argument.

Investors could also effect change by relying on ratings firms that were not part of the problem in 2008.

Even though 10 ratings agencies of varying sizes are currently recognized by the S.E.C., the market is still dominated by Moody’s, S.&P. and Fitch. The S.E.C.’s 2013 report to Congress shows that in 2012 the big three controlled 94.7 percent of their industry’s total revenue, up from 94 percent in 2011.

Such a share might decline if pension fund investors either did their own credit analysis or stopped relying solely on the big three for ratings. Either action could have a much more meaningful impact than their lawsuits by eliminating the agencies’ hold on determining creditworthiness.

Even if they prevail in the courts, investors are unlikely to recover more than a small fraction of losses they have incurred. And payments made by the ratings agencies to resolve these matters would amount to a rounding error on their financial positions.

The continued reliance on agencies that failed so many investors with their ratings might not be a problem if securities regulators had forced the raters to overhaul their operations. Among the problems: Companies pay the agencies to grade the securities, and that sets up a potential conflict of interest. States, too, pay the agencies to assign grades to their own debt.

Still, little has been done.

All three agencies have said in the past that they can manage these conflicts and that they have tightened their procedures to eliminate the potential for another fiasco involving overly optimistic ratings.

Nevertheless, the Dodd-Frank law of 2010 directed the S.E.C. to increase its oversight of these agencies and to issue new rules. The commission proposed rules three years ago that are still not final.

It’s passing strange for large investors to require that their holdings carry ratings from the very firms whose grades, they say in court filings, were negligent. But what’s even worse is that these investors are helping to maintain the troubling status quo.

01-11-2016, 05:56 PM

Ratings Agencies Still Coming Up Short, Years After Crisis

The mistakes that led to the 2008 mortgage crisis can’t happen again, right?

Not so fast, particularly if you’re talking about credit ratings agencies like Moody’s Investors Service and Standard & Poor’s. Eight years after these companies were found to have put profits ahead of principle when they assigned high grades to low-quality debt securities, some of the same dubious practices continue to infect their operations. That’s the message in the most recent regulatory report on the companies from the Securities and Exchange Commission.

The credit ratings agencies played an enormous role in generating billions of dollars in losses during the debacle. Internal emails that emerged in congressional investigations were especially revealing of the problems at these companies. “We rate every deal,” one Standard & Poor’s employee famously wrote. “It could be structured by cows and we would rate it.”

There’s an entertaining — and illuminating — scene in the movie “The Big Short” that perfectly captures the pathology. As a Standard & Poor’s employee played by Melissa Leo replies when asked why the ratings agency didn’t insist on higher standards: “They’ll just go to Moody’s.”

Ten credit ratings agencies are currently registered and operating in the United States. As their overseer, the S.E.C. must conduct examinations of them every year and issue an annual report of its findings.

The most recent such report came out on Dec. 28, easily missed in the holiday crush. But its contents are a potent reminder that absent strong enforcement of the rules, questionable behavior is not likely to change.

The S.E.C. report doesn’t identify which agencies ran afoul of what rules. That’s unfortunate. But it does separate the companies into two groups based on size. So when the regulator describes a problem at one of the “larger” credit ratings agencies, you know it means one of the big three — Fitch Ratings, Moody’s or Standard & Poor’s.

Some of the problems uncovered by the S.E.C. are frighteningly basic. For example, two of the larger companies “failed to adhere to their ratings policies and procedures, methodologies, or criteria, or to properly apply quantitative models.” These failures occurred on numerous occasions, the report noted.

Errors seem common. Because of a coding mistake, a structured finance deal made by one larger ratings agency didn’t reflect its actual terms. It took some time for this error to be detected and when it was, the transaction’s rating took a substantial hit.

In another example, a larger ratings agency employee noticed an error in the calculations used to determine certain ongoing ratings, but in subsequent publications, the company disclosed neither the mistake nor its implications. This ratings agency also inaccurately described the methodology it used to determine some of its official grades, the S.E.C. said.

Then there were the analysts at one larger ratings agency who learned of flaws in outside models used to determine ratings. But no one at the company assessed the impact of the errors or told others about them as required under its procedures. The S.E.C. also identified instances where substantive statements made by this agency in its rating publications directly contradicted its internal rating records.

Even more alarming, policies and procedures at one larger credit ratings agency did not prevent “prohibited unfair, coercive or abusive practices,” the report found. As a result, the agency gave an unsolicited rating to an issuer that was “motivated at least in part by market-share considerations.” Such a practice would allow an agency to gain an issuer’s business by offering a better rating than a competitor.

01-14-2017, 10:40 AM

Moody's pays $864 million to U.S., states over pre-crisis ratings

Moody's Corp (MCO.N) has agreed to pay nearly $864 million to settle with U.S. federal and state authorities over its ratings of risky mortgage securities in the run-up to the 2008 financial crisis, the U.S. Department of Justice said on Friday.

The credit rating agency reached the deal with the Justice Department, 21 states and the District of Columbia, resolving allegations that the firm contributed to the worst financial crisis since the Great Depression, the department said in a statement.

"Moody's failed to adhere to its own credit-rating standards and fell short on its pledge of transparency in the run-up to the Great Recession," Principal Deputy Associate Attorney General Bill Baer said in the statement.

S&P Global's (SPGI.N) Standard & Poor's entered into a similar accord in 2015 paying out $1.375 billion. Standard and Poor's is the world's largest ratings firm, followed by Moody's.

Moody's said it would pay a $437.5 million penalty to the Justice Department, and the remaining $426.3 million would be split among the states and Washington, D.C.

As part of its settlement, Moody's also agreed to measures designed to ensure the integrity of credit ratings going forward, including keeping analytic employees out of commercial-related discussions.

The rating agency's chief executive also must certify compliance with the measures for at least five years.

05-16-2018, 02:37 PM

Mortgage-Backed Securities and the Financial Crisis of 2008: a Post Mortem
Juan Ospina, Harald Uhlig
NBER Working Paper No. 24509
Issued in April 2018
NBER Program(s):Asset Pricing, Economic Fluctuations and Growth, Monetary Economics
We examine the payoff performance, up to the end of 2013, of non-agency residential mortgage-backed securities (RMBS), issued up to 2008. We have created a new and detailed data set on the universe of non-agency residential mortgage backed securities, per carefully assembling source data from Bloomberg and other sources. We compare these payoffs to their ex-ante ratings as well as other characteristics. We establish seven facts. First, the bulk of these securities was rated AAA. Second, AAA securities did ok: on average, their total cumulated losses up to 2013 are 2.3 percent. Third, the subprime AAA-rated segment did particularly well. Fourth, later vintages did worse than earlier vintages, except for subprime AAA securities. Fifth, the bulk of the losses were concentrated on a small share of all securities. Sixth, the misrating for AAA securities was modest. Seventh, controlling for a home price bust, a home price boom was good for the repayment on these securities. Together, these facts provide challenge the conventional narrative, that improper ratings of RMBS were a major factor in the financial crisis of 2008.

05-21-2018, 12:40 PM
Interesting conclusion(s)...

I have to wonder if they controlled for or quantified benefits of the mortgage assistance programs put in place post 2008-2009, the billions of dollars from UST used to recapitalize banks and mortgage lenders (directly via UST infusion or indirectly via M&A by other banks), and the balance sheet support offered by FRB interest rate and yield curve management during the period in question.

05-21-2018, 01:46 PM
You can take a look at their data appendix....

https://www.nber.org/data-appendix/w24509/OspinaUhlig_MBSPostMortem_v21%20online%20appendix. pdf

They're pretty thorough in showing how they found their data. ...and that it's all based on the bonds themselves, and not on the stuff outside the bonds.

Here's part of the appendices:

B Database Description

For this paper we have constructed a database that contains detailed information on a comprehensive
collection of Non-Agency Mortgage Backed Securities. Our database has data for
almost 9,000 MBS deals which translate into 147,606 unique mortgage backed securities issued
between 1987 and 2014. These securities were issued by more than 200 firms and have a notional
amount of $6.1 trillion, out of which 65% was issued between 2004 and 2007. See Table
DA1 for a brief description of the quantities in our data year by year.

In this paper we have focused our attention on private residential MBS. These non-agency
MBS make up bulk of our data and are the ones that we restrict our attention to. However,
given the broad search that we have conducted, our full database contains some other securities
including more than 3,400 CMBS with notional amount of $426 billion. In the collection process
some information on Agency MBS was collected. Including the VA (Veteran Affair) loans, which
are partially backed by the Government through the U.S Department of Veteran Affairs, only
about 1% of the bonds in our data are Government-related, which leaves us with 146,000
private-label MBS. It is also worth noting that our data is not a comprehensive collection of
CDOs. Finally, about 10% of the data corresponds to re-securitizations, which became more
common after the financial crisis. Table DA2 presents figures on the number of deals, number of
bonds and notional amounts for different classification criteria of the securities in our database.
Many of the variables related to MBS vary over time. For example, one can talk about the
average loan size at issuance or the average loan size at any other point in time; or one can
talk about the credit rating given upon issuance and the current credit rating of a security. For
most variables we were able to obtain the values upon issuance. For some of these variables we
may have gathered also current information (current meaning the value of the variable at the
time we collected the data). For some of these variables the time series information may exist,
for some it may not. We are uncertain about the benefit of the “current” value of a variable
if we do not have access to the time series. We did not collect information on all the existing
time series due to constraints in the amount of information that can be extracted from the data
sources in a given month. If needed, these time series could be potentially obtained.

This was purely a look-back at how these securities performed. But they do acknowledge missing data.

05-21-2018, 05:40 PM
Thanks for the additional info campbell. I am not an NBER subscriber so I am unable (and unwilling to pay) to see the full report.

A concern could be that the entire "cause and effect" premise - and conclusion - of the study is flawed by its not fully considering or modeling the effect on MBS/RMBS deals of the extraordinary state and federal stimulus in response to the liquidity, financial and economic crises ostensibly heralded by Bear and Lehman.