This is a few months old, now, but ithe New York Times magazine has a pretty detailed account of some of the problems of the credit ratings agencies that helped lead to the global credit crunch.
It’s easy, with the benefit of hindsight, to shake one’s head at the flaws in the risk modelling that they did. Using the example of a real (but anonymized) block of subprime mortgages Moody’s rated, one of the many flaws in the process becomes clear:
A month after Zandi’s report, Moody’s rated Subprime XYZ. The analyst on the deal also had concerns. Moody’s was aware that mortgage standards had been deteriorating, and it had been demanding more of a cushion in such pools. Nonetheless, its credit-rating model continued to envision rising home values. Largely for that reason, the analyst forecast losses for XYZ at only 4.9 percent of the underlying mortgage pool. Since even the lowest-rated bonds in XYZ would be covered up to a loss level of 7.25 percent, the bonds seemed safe.
Hanging around on American blogs, around this time I began to hear about property flipping – the same sort of behaviour that was familiar from the dot-com boom of the late 1990s. When people are buying property (or shares) on the basis that they’ll be able to sell it immediately for more money, it’s a pretty good sign that there’s a bubble that will pop sooner or later. It does amaze me that this wasn’t starting to ring alarm bells.
But beyond that, the article points to some more evidence of the view that the ratings-agency model provided incentives for the agencies to tell the story that their customers – the people trying to sell financial instruments – wanted to head:
And it seems to have helped the banks get better ratings. Mason, of Drexel University, compared default rates for corporate bonds rated Baa with those of similarly rated collateralized debt obligations until 2005 (before the bubble burst). Mason found that the C.D.O.’s defaulted eight times as often. One interpretation of the data is that Moody’s was far less discerning when the client was a Wall Street securitizer.
There were endless points in the chain where destructive behaviour was rewarded. Amongst the justified clamor for more regulation of the financial markets, one thing that might be looked at is whether regulation can prevent some of these incentives for stupidity.
Yes, and look at them all go crying to the state after it flops.
Pathetic. Bring back national insurance.
Btw, a fairly reliable little birdy tells me Monash Uni is highly exposed – and has lost a PACKET today.
Plenty of people have been shaking their heads for a long time, but no-one that was considered “credible” by the mainstream. I mean, Marc Faber and Bill Fleckenstein have predicted imminent global financial catastrophe for a long as I can remember, but no-one wanted to listen to the permabears while the giant Ponzi scheme was working …. even though a lot of what they were saying made a lot of sense.
Marc Faber has started making sense ?
That he gets any media time at all is more a function of his manner and his funky dress sense than the contenst of his spiel.
Dr Doom since the 80′s and still going strong but at times like these suddenly the professional contrarian sounds so smart.
Only in hindsight mind you .
Michael West in the SMH ( this reporter has done plenty of work on the background to the current problems )today has an artcile featuring the failures of the regulators.
Calls for regulations are fine but if they aren’t enforced they aren’t going to make any difference.
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http://business.smh.com.au/business/who-can-you-trust-20080918-4j12.html?page=fullpage#contentSwap1
Robrt Merkel and All:
Isn’t it absurd?
That thousands of millions of dollars can be shovelled into the furnace because of fairy-tales about creditwothiness of firms and “products” cooked up by lazy, ignorant or just plain gullible screen-jockies.
And yet the credtworthiness of ordinary citizens can be destroyed because of a dodgy credit report based on incorrect, misleading, misunderstood, manifestly incomplete or cover-your-backside data. Of course there are some appeal mechanisms, just bring your own Charted Accountant and your Senior Counsel …. in other words, if you could afford to hire such eminent advisors, you would be driving a Jaguar and you wouldn’t have to be applying for a loan to buy a barely-registerable $3000 rust-bucket. Credit reporting? GIGO: garbage in, garbage out.
Time for a really severe crackdown on the operations of all credit reporting mobs.
Once there has been a thorough clean-out of this credit reporting cess-pit, it will be safe again for ordinary citizens to borrow money and to invest their savings.
Carbonsink: Murph does have a bit of a point about professional contrarians.
At any given time you can find people who will predict financial markets are about to boom, bust, or go sideways. Depending on what happens, one of these three groups ends up looking like a genius and the best TV talent out of the group becomes a featured interview guest until the next gyration, where they get it wrong.
Is the US “AAA” credit rating at risk?
Reality or overcompensation?
From what I understand, if it was any nation other than the USA it would have lost its triple A credit rating a while ago.
But I suspect that the US would be the ultimate “too big to fail” global instituteion…
Sure, Faber et al have predicted 10 of the last 3 recessions — we all know that — my point is, the permabears were pointing out very real risks in the financial system, which were completely ignored by the regulators.
My view is the permabears were going to be right eventually, and they’d get the reasons for the crash spot on, its the timing they got wrong. Bubbles always last longer the the doomsayers expect.
Robert,
The US has the luxury of having its debt denominated purely in its own currency. In extremis it could satisfy the debt just by resorting to the printing press. A US default would be as unlikely as them running out of paper to print it on.
That said, any resort to the presses would result in massive inflation, which may be a technical default.