Friday, February 8, 2008

Rating Agencies as Fools, or Worse?

"Here, seduced by the fees that securitization offered and turning a blind eye to the fact that the models were in many cases untested or based only on a few years of benign economic data, the raters were only too happy to grant AAA-ratings to the top (senior) tranches. The alchemy in the equation was the realization that the mere securitization process was enough to grant higher ratings overall. ... This might appear contrary to the laws of nature, similar to a perpetual motion machine. Indeed, many sceptics suggested that the securitised whole could not be worth more than the sum of the parts. If the risks appeared lower, they said, then it was because they were being hidden in the structure. Such views remain heretical: securitization has been a money machine for the banks for over twenty years, and has been the lynchpin of the enormous expansion of the global credit market. Yet in recent years the technique might be described as an all-devouring monster, as it was applied to debts of lower and lower quality. ... Nevertheless, to date Moody's and [S&P] have stubbornly refused to downgrade the bond insurers and their AAA rating remains. ... The Basle-II accord, which sets bank capital adequacy requirements on the basis of credit ratings, and depends on discredited financial risk models such as value at risk (VaR), will probably have to be scrapped or rewritten. ... [T]he credit rating scandal has reminded us that we cannot trust a system where the raters are paid by the issuers", my emphasis, Paul Amery (PA) at, 2 February 2008.

Amen PA. I used the term alchemy on 23 August and 1 December 2007. "[T]he securitised whole could not be worth more than the sum of the parts", amen. That's arbitrage, see my 8 November 2007 post. Any "third-party payer system", like the way CPA firms are paid, will show the "classical agency problem". That's why we need lawsuits. Under my most charitable interpretation, the financial engineers never understood microeconomics, or under a less charitable interpretation, they understoood all too well! Were they fools or knaves? Mike Garcia, get on the stick and find out.

No comments: