The real reason Moody's and S&P fear #Debtmageddon

Anybody who knows much about the housing bubble, not on the fradulent mortgage end as much as the finished-sausage-product end of CDOs and stuff knows that the ratings agencies were $2 financial whores, full of shit, or a bit of both. (They're not mutually exclusive.)

For Moody's, S&P and Fitch, the bottom line is the bottom line. Not the U.S. government's bottom line, their bottom line.

If there's a default, the economy in general slows down.

Not just the real economy, for those of us working real jobs, but the fake financial sector economy. That means less wheeling and dealing. That means fewer financial issues to be rated by these folks.

Besides whoring themselves out to Countrywide, numerous hedge funds, etc., in the last decade, did the ratings agencies say a word as George W. Bush put more and more war spending "off budget"?

Nope, not one damned word.

So, as you hear Moody's and S&P bleat and squeal in days ahead ... remember why.

More stupidity from Moody's, the bubble inflator

Mark Zandi, chief economist at Moody's Analytics (yes, technically not the ratings side of the company, but nonetheless), shows how either economic stupidity, kowtowing to Wall Street, or both, has infected the whole damned company.

How's that, you ask?

His argument to extend the Bush tax cuts for the wealthy. He even admits the economy did fine in the 1990s with higher tax rates, then claims raising the taxes on the upper end now would hurt job growth.

That said, I know conservatives invented "death tax" to replace "estate tax." On the countervailing side, the first phrase that pops into my head is "parasite tax" for the rich who only produce money, especially folks like hedge fund managers who don't want their income taxed as, well, INCOME!

Help me out, folks, if you've got more ideas.

Speaking of, I have an idea to trump Zandi. Let's tax both corporations, on the corporate side, and CEOs and board members on the individual side, for each job outsourced overseas!

How Moody’s contributed to the subprime crunch

When you have a better operating margin than ExxonMobil and your CEO is trying to improve it, you’re probably going to be a soft touch for creative new financing vehicles.

Even though the standards at many lenders declined precipitously during the boom, rating agencies did not take that into account. The agencies maintained that it was not their responsibility to assess the quality of each and every mortgage loan tossed into a pool.

Then what the hell were you rating? Or why were you in this business?

The full story, which focuses on Moody’s in the last decade, probably could apply to Fitch’s and S&P about as well.

Moody’s as financial manipulation enabler put in the dock

If there’s a person, creature or corporation more to blame for the subprime crunch, the credit-derivatives crunch, and everything else FUBAR about today’s finance situation, it’s Moody’s the not-so-humble bond-rating service.

Having branched beyond bonds into larger credit ratings, it’s quite arguable, as one person puts it in the story, a preview of a New York Times Magazine story for this coming Sunday, that Moody’s, along with Standard & Poor and Fitch’s, moved from “gatekeepers” to “gate openers.”

Arthur Levitt, the former chairman of the Securities and Exchange Commission, charges that “the credit-rating agencies suffer from a conflict of interest — perceived and apparent — that may have distorted their judgment, especially when it came to complex structured financial products.”

No shit. The next couple of webpages of the story read like the financial-world equivalent of politics’ infamous “sausage making” process of legislation.

Here’s stuff Moody’s ignored on one special-purpose vehicle, or SPV:

Moody’s learned that almost half of these borrowers — 43 percent — did not provide written verification of their incomes. The data also showed that 12 percent of the mortgages were for properties in Southern California, including a half-percent in a single ZIP code, in Riverside. That suggested a risky degree of concentration.

And more fun on this same bundle:

In the frenetic, deal-happy climate of 2006, the Moody’s analyst had only a single day to process the credit data from the bank. The analyst wasn’t evaluating the mortgages but, rather, the bonds issued by the investment vehicle created to house them. A so-called special-purpose vehicle — a ghost corporation with no people or furniture and no assets either until the deal was struck — would purchase the mortgages.

In other words, a single guy just spent a business day playing the equivalent of the lotto with a $430 million bundle of papers.

Ironically, if you will, increased federal regulation of things like pension and mutual funds gave Moody’s more things to rate, setting the stage for the dereg hothouse of the late 1990s and on.

Issuers thus were forced to seek credit ratings (or else their bonds would not be marketable). The agencies — realizing they had a hot product and, what’s more, a captive market — started charging the very organizations whose bonds they were rating. This was an efficient way to do business, but it put the agencies in a conflicted position. As (Frank Partnoy, a professor at the University of San Diego School of Law), says, rather than selling opinions to investors, the rating agencies were now selling “licenses” to borrowers. Indeed, whether their opinions were accurate no longer mattered so much. Just as a police officer stopping a motorist will want to see his license but not inquire how well he did on his road test, it was the rating — not its accuracy — that mattered to Wall Street.

Problem is, even before the bubbles started bursting, CDOs were defaulting at a rate higher than traditional bonds, as page 5 notes. But, because a lot of these CDOs were coming from high-volume repeat customers, Moody’s kept the rubber stamp hot.

The Securities and Exchange Commission refused to look at the incestuous nature of the modern credit-rating agency after Enron blew up, despite a directive from Congress. And, of course, in both the House and Senate versions of housing bailout legislation, nobody in Congress is proposing a serious oversight reform bill, not just a nudge to the SEC.

More financial “sausage making” on page 6, from a subprime package called XYZ:

Moody’s monitors began to make inquiries with the lender and were shocked by what they heard. Some properties lacked sod or landscaping, and keys remained in the mailbox; the buyers had never moved in. The implication was that people had bought homes on spec: as the housing market turned, the buyers walked.

By the spring of 2007, 13 percent of Subprime XYZ was delinquent — and it was worsening by the month. XYZ was hardly atypical; the entire class of 2006 was performing terribly. (The class of 2007 would turn out to be even worse.)

But, although Moody’s started re-rating individual mortgage-based bonds by soon after this time, it still didn’t do anything about collateralized debt obligations, or CDOs. And, was using a different set of ratings analysts, and giving ratings without knowing what bonds a particular CDO would buy!

A CDO operates like a mutual fund; it can buy or sell mortgage bonds and frequently does so. Thus, the agencies rate pools with assets that are perpetually shifting. They base their ratings on an extensive set of guidelines or covenants that limit the CDO manager’s discretion.

One misrated CDO was estimated to have a loss potential of 2 percent at the time it was rated triple-A. Latest estimate? At 27 percent; a 16 percent slice of triple-A bonds downgraded all the way to single-B.

It’s clear that only major federal regulation can put this horse back in the barn and keep it there.

If Moody’s et al can’t be trusted on rating subprime mortgages, what about things like school district financial ratings?

It reminds me a bit of credit card companies

As I recently blogged, financial rating agencies like Moody’s have apparently “pumped” the subprime mortgage market by rating subprime mortgages, for investment purposes, of being of higher investment grade than they really actually are.

Well, this got me to wondering: what if Moody’s and other folks do something similar for local governments, like cities and school districts?

At both my current newspaper and the previous one, the local school district had its rating upgraded after floating a bond issue. Arguably, that’s a temptation to do a number of things, whether urging voters to float a new issue at lower rates or cheaper bond insurance costs, borrow off maintenance and operation funds in the school district equivalent of certificates of obligation (as the current school district did when hurricanes Katrina and Rita blew its original cost estimates out of the water), or otherwise look at additional debt ideas.

Moody’s doesn’t do its work for nothing or in any way out of the goodness of its corporate heart. I’m no financial guru at all, so I don’t know who pays Moody’s (or anybody else) for rating services, but somebody does. Depending on who, I’m sure there’s some sort of conflict of interest floating around here.

Subprime loans: why they should be a serious economic concern

Pension funds could be up shit creek, that’s why

These subprime loans became financial “instruments,” then were rated by Moody’s and other folks trading on mutual back-scratching, is why. It’s just like at the start of this decade, when folks like people at Merrill Lynch were touting certain stocks in exchange for “considerations” from the relevant companies.

As Kevin Drum says:

Fortune notes that a big factor in the recent success of the subprime lending market has been the ability to repackage subprime loans into clever little bundles of asset-backed securities that are then traded on the open market. But there’s more. An even bigger factor is the fact that these debt instruments (called collateralized debt obligations, or CDOs) have generally received investment grade ratings even if the mortgages underlying them were highly risky.

Sniff those class-action lawsuits getting even bigger?

Wait. Here’s more from the actual Fortune story:

To appreciate the role that the rating agencies play in today’s housing market, you have to understand a piece of Wall Street alchemy: the process by which mortgages are combined, carved up, recombined and carved up again in almost endless permutations to create new forms of debt (which usually go by three-letter abbreviations).

A bank or brokerage bundles up hundreds of mortgages and sells investors debt that is backed by mortgage payments and secured with homes. These asset-backed securities — ABS’s, in Street parlance - are sold in slices, each of which carries its own theoretical level of risk, ranging from the supposedly invulnerable (AAA) all the way down to the bottom rung of investment grade and even past that, to a highly speculative unrated slice.

It's possible to create a AAA-rated asset out of somewhat shaky collateral, because the first dollar of income goes to the securities with the highest rating, while the first dollar of loss is assigned to those with the lowest. The bottom layers provide a cushion that supposedly protects the higher-rated securities.

Lately much of the bottom rung of investment-grade ABS’s has been snapped up by another Street creation called a collateralized debt obligation (CDO), which, like an ABS, is sold in slices. A large chunk of a CDO that consists of barely investment-grade securities can still secure a coveted AAA rating — again, because any losses have to eat through the bottom layers.

In other words, subprime loans are a big Ponzi scheme, to put it less politely. No wonder we get zero-down balloon-note mortgages. And it’s no wonder cookie-cutter homebuilders build crap, if they’re building for a Ponzi scheme.

These products exploded in popularity in recent years because investors — including pension funds and insurance companies, which must mostly buy investment-grade-rated debt — had a voracious appetite for them. That in turn encouraged a historic increase in subprime lending.

So, if these subprime loans ever WERE to be rated at below investment grade, a bunch of pension funds could be up shit creek, along with insurers, mutual funds, etc.

How potent has this nectar of financial temptation been?

The amount of subprime mortgages issued shot up from $35 billion in 1994 to $625 billion in 2005, says Josh Rosner, a managing director at research firm Graham Fisher. Brokerage firms, which packaged, sold and traded these creative instruments, made big
profits. And so did the credit-rating agencies.

At Moody’s (the only one publicly traded), net income went from $159 million in 2000 to $705 million in 2006, in large part because of increases in fees from “structured finance,” the umbrella under which this mortgage alchemy falls.

WOW.

NOTE THAT: A 2,000 percent increase in subprime loans in a decade. Moody’s has an almost five-fold earnings increase in just six years. Anybody with a brain knows there HAS TO BE envelope-pushing (to put it mildly) wheeling-dealing, swap-outs, quid pro quos with stuff like that. And, the small mutual fund investor, etc., will probably wind up holding a large share of the bag.