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I have traced the beginnings of the brewing Wall Street catastrophe to August 2004 and to one man's decision.
Had this ONE decision not been made, we would not be facing a 1930's scenario of a depression, when unemployment soared to nearly 30 % of America. Where getting a loan was nearly impossible. Where thousands of people applied for the same job. Where breadlines were placed throughout cities. Where campgrounds called "Hoovervilles" were full of people living in tents as they could not afford anything else.
Who made the decision? Gary Witt.
Gary Witt was the managing director for Moody's until he retired recently. He was the one who changed the rating system for C.D.O.s which led to AAA ratings on junk bonds backed by sub-prime mortgages. This made a market for these securities that otherwise would not have been possible.
S & P quickly followed suit to avoid losing business.
Here is an article on this. It's long, but good. I'll bold significant parts.
One thing to add is that in the SEC report it mentions from two months ago, it did NOT properly censure Moody's and other credit rating agencies with any real criticism. It was a very soft report. For more details, see my thread on how the SEC Chairman is responsible for failing to get C.D.O. transparency enforced, and failing to regulate Moody's and S & P here:
http://www.debatepolitics.com/econo...is-sec-chairman-chris-cox.html#post1057738947
There is also more investigation needed on who lobbied Witt to make this decision. Fannie and Freddie lobbyists are the likely suspects.
ARTICLE CONTINUES IN NEXT POST
Had this ONE decision not been made, we would not be facing a 1930's scenario of a depression, when unemployment soared to nearly 30 % of America. Where getting a loan was nearly impossible. Where thousands of people applied for the same job. Where breadlines were placed throughout cities. Where campgrounds called "Hoovervilles" were full of people living in tents as they could not afford anything else.
Who made the decision? Gary Witt.
Gary Witt was the managing director for Moody's until he retired recently. He was the one who changed the rating system for C.D.O.s which led to AAA ratings on junk bonds backed by sub-prime mortgages. This made a market for these securities that otherwise would not have been possible.
S & P quickly followed suit to avoid losing business.
Here is an article on this. It's long, but good. I'll bold significant parts.
One thing to add is that in the SEC report it mentions from two months ago, it did NOT properly censure Moody's and other credit rating agencies with any real criticism. It was a very soft report. For more details, see my thread on how the SEC Chairman is responsible for failing to get C.D.O. transparency enforced, and failing to regulate Moody's and S & P here:
http://www.debatepolitics.com/econo...is-sec-chairman-chris-cox.html#post1057738947
There is also more investigation needed on who lobbied Witt to make this decision. Fannie and Freddie lobbyists are the likely suspects.
`Race to Bottom' at Moody's, S&P Secured Subprime's Boom, Bust
2008-09-25 04:01:00.40 GMT
By Elliot Blair Smith
Sept. 25 -- In August 2004, Moody's Corp. unveiled a new credit-rating model that Wall Street banks used to sow the seeds of their own demise. The formula allowed securities firms to sell more top-rated, subprime mortgage-backed bonds than ever before.
A week later, Standard & Poor's moved to revise its own methods. An S&P executive urged colleagues to adjust rating requirements for securities backed by commercial properties because of the ``threat of losing deals.''
The world's two largest bond-analysis providers repeatedly eased their standards as they pursued profits from structured investment pools sold by their clients, according to company documents, e-mails and interviews with more than 50 Wall Street professionals. It amounted to a ``market-share war where criteria were relaxed,'' says former S&P Managing Director Richard Gugliada.
``I knew it was wrong at the time,'' says Gugliada, 46, who retired from the McGraw-Hill Cos. subsidiary in 2006 and was interviewed in May near his home in Staten Island, New York. ``It was either that or skip the business. That wasn't my mandate. My mandate was to find a way. Find the way.''
Wall Street underwrote $3.2 trillion of loans to homebuyers with bad credit and undocumented incomes from 2002 to 2007.
Investment banks packaged much of that debt into investment pools that won AAA ratings, the gold standard, from New York-based Moody's and S&P. Flawed grades on securities that later turned to
junk now lie at the root of the worst financial crisis since the Great Depression, says economist Joseph Stiglitz.
`Would Have Stopped Flow'
``Without these AAA ratings, that would have stopped the flow of money,'' says Stiglitz, 65, a professor at Columbia University in New York who won the Nobel Prize in 2001 for his analysis of
markets with asymmetric information. S&P and Moody's ``were trying to please clients,'' he said. ``You not only grade a company but tell it how to get the grade it wants.''
Presidential candidates John McCain and Barack Obama lay responsibility for the carnage with Wall Street itself. The Securities and Exchange Commission in July identified S&P and Moody's as accessories, finding they violated internal procedures and improperly managed the conflicts of interest inherent in providing credit ratings to the banks that paid them.
S&P and Moody's earned as much as three times more for
grading the most complex of these products, such as the unregulated investment pools known as collateralized debt obligations, as they did from corporate bonds. As homeowners defaulted, the raters have downgraded more than three-quarters of the AAA-rated CDOs bonds issued in the last two years.
`Cut Too Many Corners'
Facing the threat of lawsuits and tighter regulation,
Moody's and S&P now say they are adopting tougher requirements to more accurately evaluate and monitor debt. (somebody help me sue these guys ~ MC.no.spin)
``We have made significant progress in achieving these
goals,'' Chris Atkins, S&P's vice president of communications, wrote last week in a statement to Bloomberg. ``Working with policy makers and market participants around the world, we will
continue to take steps to meet and exceed the high standards for quality we have put in place.'' He wouldn't respond to specific questions for this story.
Moody's spokesman Anthony Mirenda declined to comment after Bloomberg submitted questions in writing and by phone.
``The rating agencies' models were too flawed and cut too many corners, and the raters got pressured by the bankers,'' says Tonko Gast, the chief investment officer of the $5.1 billion New York hedge fund Dynamic Credit Partners LLC. He reverse-engineers the raters' models as part of his investing strategy.
``That's how the race to the bottom was kind of invisible for a lot of people,'' he says.
Favoring Diversity
Starting in 1996, Moody's used a framework known as the binomial expansion technique for rating CDOs, structured funds consisting of aircraft leases, franchise loans, high-yield bonds, hotel mortgages and mutual-fund fees. On the theory that diversification reduced risk, the BET formula rewarded balanced portfolios and punished concentrations of assets, using a proprietary measurement Moody's called the diversity score.
On Aug. 10, 2004, Moody's Managing Director Gary Witt
introduced a new CDO rating method that dispensed with the diversity test and made other adjustments to the evaluation of structured-finance products.
``People were just starting to do deals that were all
residential,'' says Witt, 49. He retired from Moody's this year and is now an assistant professor of statistics at Temple University's Fox School of Business in Philadelphia. The BET model ``is not as well suited for the highly correlated portfolios that were becoming common in 2004,'' he says.
The emphasis on diversity turned into an obstacle after the 2001 recession, when some assets plummeted in value. Home mortgages, auto loans and credit-card receivables offered higher returns for CDO managers. As mortgage rates fell and the market boomed, investment firms argued the risks in housing were small.
`Moody's Obliged'
``I know people lobbied Moody's to accommodate more
concentrated residential mortgage risk in CDOs, and Moody's obliged,'' says Douglas Lucas, 52, the head of CDO research at UBS Securities LLC in New York. The former Moody's analyst says he invented the diversity score in the late 1980s.
A statistical tabulation appearing in the appendix of Witt's paper represented the new formula as more rigorous in calculating risks than the BET. A side-by-side comparison showed that the new model projected losses that were 24 to 165 percent higher than forecast by the old, on a hypothetical investment pool.
Bankers ``could put together a deal with greater
concentrations in one area or another,'' says Jeremy Gluck, 52, a former Moody's managing director, who worked with Witt at the time.
Fewer Defaults Projected
In September 2005, Witt and colleagues published a follow-up analysis. Compared with the BET, the new model now projected that the likelihood of collateral defaults affecting CDO bonds rated at least Aa could be 73 percent lower at the extreme, in a range
of possibilities.
The new comparison was based on a hypothetical investment pool in which 75 percent of the assets were residential mortgage-backed securities, including 30 percent that were subprime.
Moody's could produce a lower default rate by incorporating a decade of ratings stability for structured finance into its assumptions. The average five-year loss rate on U.S. structured finance products between 1993 and 2003 was 1.9 percent, compared with 6.3 percent for corporate bonds, the company had said in September 2004. A drawback was that raters didn't have data going back to the 1920s, as they did on corporate bonds.
In a press release on the report, Moody's said ``structured-finance ratings are broadly comparable in quality to the ratings of corporate bonds.''
`More Aaas'
Philippe Jorion, 53, a finance professor at the University of California, Irvine, criticizes the Moody's decision to factor ratings stability into its evaluations.
``This uses the output of their model as input into their models,'' Jorion says. ``This type of model is totally out of touch with the underlying economic reality.''
Witt declined in an e-mail exchange to discuss the September 2005 findings or his earlier projections from August 2004.
``The effect that had on structures was to create more
Aaas,'' says Thomas Priore, 39, chief executive officer of Institutional Credit Partners LLC in New York, which oversees $13 billion of fixed-income investments.
The Moody's share of the market for rating CDOs was falling before the change, to 76.8 percent in 2004 from 91.5 percent a
year earlier, according to the industry publication Asset-Backed Alert in Hoboken, New Jersey. It climbed afterward, to 85.1 percent in 2005 and 96.8 percent in 2006. S&P had 97.5 percent that year, the publication said. Underwriters made obtaining a top grade from one or both raters a condition for the sale of the
investment pools.
E*Trade's CDO
The value of asset-backed CDOs tripled to $30 billion in the fourth quarter of 2004, according to the London-based monthly journal Creditflux. The yearly total increased 87 percent to $104.3 billion in 2005. Subprime mortgages came to account for about half the collateral on all asset-backed CDOs issued that
year, according to a Moody's estimate.
In December 2005, New York-based E*Trade Financial Corp. raised $300 million to fund E*Trade ABS CDO IV Ltd. It followed the formula Witt and co-authors outlined in the September paper.
Moody's assigned Aaa grades to three-quarters of the CDO's rated bonds, which invested 73.5 percent of the fund's assets in mortgages backed by loans to homeowners with bad credit and limited income documentation. As the subprime market deteriorated, the company in June 2008 lowered $137.3 million of the bonds initially rated Aaa to Baa2 and the rest to speculative.
ARTICLE CONTINUES IN NEXT POST