The rating agencies are not very popular on Wall Street these days. As it turns out, they were too optomistic about the credit risk associated with exotic loan products like piggybacks according to the WSJ. In 2000 S&P indicated that piggybacks were no more likely to default than prime mortgages. They reversed that opinion six years later indicating that the price run up in housing affected their historical models (thats an odd statement because it seems like these agencies didn’t understand the impact on the collateral by loosening credit back in the beginning which is the point of assuring investors that its safe).

In the WSJ’s How Rating Firms’ Calls Fueled Subprime Mess seems to suggest that the price run up of housing nationwide was a result of this decision.

Although it wasn’t just this decision:

It was lenders that made the lenient loans, it was home buyers who sought out easy mortgages, and it was Wall Street underwriters that turned them into securities. But credit-rating firms also played a role in the subprime-mortgage boom that is now troubling financial markets. S&P, Moody’s Investors Service and Fitch Ratings gave top ratings to many securities built on the questionable loans, making the securities seem as safe as a Treasury bond.

And the the majority of sub-prime bonds were rated by the credit agencies.

Also helping spur the boom was a less-recognized role of the rating companies: their collaboration, behind the scenes, with the underwriters that were putting those securities together. Underwriters don’t just assemble a security out of home loans and ship it off to the credit raters to see what grade it gets. Instead, they work with rating companies while designing a mortgage bond or other security, making sure it gets high-enough ratings to be marketable.

The markets then bet on these products, not fully understanding what the true exposure was. Here’s a good way of looking at two types of leverage investing on one of my regular reads, The Stalwart.

Update: A reporter just shared this relevant link with me about rating agencies:

WALL STREET TROUBLES [The Spine (The New Republic)]


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