BLAME FOR THE FINANCIAL CRISIS




[RAW]

FALSE NARRATIVE:  Credit rating agencies allowed competitive pressures to affect their ratings, creating and adopting inaccurate rating models.

Below are some examples of this false narrative.

The New York Times reports about S.& P. and Moody’s use of inaccurate rating models.

Documents Show Internal Qualms at Rating Agencies
By SEWELL CHAN
Published: April 22, 2010

WASHINGTON —
A Senate panel will release 550 pages of exhibits on Friday — including these and other internal messages — at a hearing scrutinizing the role S.& P. and the ratings agency Moody’s Investors Service played in the 2008 financial crisis. …

The investigation, which began in November 2008, found that S.& P. AND MOODY’S USED INACCURATE RATING MODELS IN 2004-7 that failed to predict how high-risk residential mortgages would perform; ALLOWED COMPETITIVE PRESSURES TO AFFECT THEIR RATINGS; and failed to reassess past ratings after improving their models in 2006.

 

BBC reports that credit rating firms criticised over financial crisis.

 

Credit rating firms criticised over financial crisis
Friday, 23 April 2010
 
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Senators say the rating agencies’ analysis was not robust enough

The behaviour of two credit rating agencies in the run-up to the financial crisis has been criticised by US senators following an investigation.

The Senate committee said
MOODY’S AND STANDARD & POOR’S INSTILLED "UNWARRANTED HIGH CONFIDENCE" IN CERTAIN RISKY FINANCIAL PRODUCTS.

It also said that
THEY WERE INFLUENCED BY THE BANKS THAT PAID THEIR FEES.


NPR
reports about blaming the credit ratings agencies.

Economy Got You Down? Many Blame Rating Firms
Alex Blumberg and David Kestenbaum
June 5, 2009

If you’re looking for someone to blame in the collapse of the global economy, one popular punching bag is the credit ratings agencies. Firms like Moody’s, Fitch and Standard and Poor’s are supposed to let investors know whether bonds are particularly risky or relatively safe.

Ratings agencies gave their triple-A rating, the highest ranking, to many bonds backed by home mortgages — the same bonds we now call toxic assets. Grouping those bonds among the safest investments allowed trillions of dollars to flow into the housing market, which in turn created the housing bubble.

It’s hard to overstate the ratings agencies’ role in the worldwide financial system. They’ve been around for a century, assigning a letter grade to everything from railroads to school districts, even entire countries. …

Those Marvelous Ratings


Jim Finkel also wondered about THOSE COMPUTER MODELS AND THE RATINGS THEY HELPED PRODUCE. He works for a company called Dynamic Credit and helped put together complex bonds called collateralized debt obligations, which were made up of mortgages. Finkel profited from the AAA ratings, but he says the ratings agencies’ blessings seemed too good to be true.

"They should have just said, ‘You know what? We just don’t have enough information about this stuff to ascribe a rating to it,’ " he says.
"There were ratings that we saw that made no sense to us. WE MARVELED AT THE RATINGS THAT ALL OF THESE CDO PRODUCTS GOT."


FALSE NARRATIVE:
  Wall Street greed created the financial crisis and lack of oversight by the federal government allowed it to spread.

The Washington Post reports about the Culprits Who Caused the Crisis.

Calling Out the Culprits Who Caused the Crisis
By Eric D. Hovde
Sunday, September 21, 2008

Looking for someone to blame for the shambles in U.S. financial markets? As someone who owns both an investment bank and commercial banks, and also runs a hedge fund, I have sat front and center and watched as this mess unfolded. And in my view, there’s no need to look beyond Wall Streetand the halls of power in Washington. The former has created the nightmare by chasing obscene profits, and the latter have ALLOWED IT TO SPREAD BY NOT PRACTICING THE OVERSIGHT THAT IS THE FEDERAL GOVERNMENT’S RESPONSIBILITY.


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THE REALITY:
  Up until 1994, Rating agencies were extremely conservative in their estimates (ie: their estimates were accurate).  However, RTC (created to take over failing thrifts) and FDIC, in an effort to sell billions in toxic mortgage-backed securities, devised their own overly optimistic method estimating defaults.  Inaccurate rating models came straight from the federal government, and rating agencies adopted them because they didn’t have a choice.

The proof of this reality comes directly from the FDIC’s website:

Managing the Crisis: The FDIC and RTC Experience (FDIC’s website)
http://www.FDIC.gov/bank/historical/managing/



After the savings and loan crisis, the FDIC conducted a study on the challenges faced by the FDIC and the RTC in resolving troubled banks and thrifts during the financial crisis of the 1980s and early 1990s.  The result was a two book publication, Managing the Crisis.

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Chapter 16.Securitizations
www.FDIC.gov/bank/historical/managing/history1-16.pdf

Securitization Process and Participants

The rating agencies have developed loan loss models to estimate the required level of loss protection for a securitized mortgage loan pool. They use the Great Depression as a benchmark to estimate the level of losses that may occur if a mortgage pool is subjected to stressful economic conditions. Cash flow scenarios are run that subject a pool of mortgages to “stress tests” for which losses and delinquencies are assumed to be two to three times greater than the losses experienced in the Great Depression. The rating agencies monitor the performance of the transaction over time and adjust credit ratings as appropriate.

Securitization

During the structuring process for the first RTC securitization transaction, the issue of whether to include delinquent loans (loans for which payments were more than 30 days late) in the pool arose. The industry standard is to exclude delinquent loans when forming a collateral pool for any new offering of mortgage securities. … the RTC decided to include loans that were up to 89 days delinquent in the sale pool. THIS WAS THE FIRST TIME MORTGAGE-BACKED SECURITIZATION TRANSACTIONS HAD INCLUDED DELINQUENT LOANS.


Commercial Securitization

The RTC has been credited with EXPANDING AND EDUCATING THE MARKETPLACE BY CREATING UNIQUE AND COMPLEX SECURITIZATION STRUCTURES TO SELL ITS COMMERCIAL MORTGAGE LOANS.The commercial securitizations that were completed before 1990 were private placements issued by commercial banks and life insurance companies. STRUCTURES WERE SIMPLE, … Because the collateral involved only a few properties, the analysis of these transactions was very detailed and “property specific.”

The RTC’s commercial loan portfolio was originated by savings and loan institutions in the 1980s… Consequently, the quality and integrity of the mortgage loans suffered. … The loans were originated by multiple lenders, loan documents were missing, and, in some cases real estate taxes and insurance premiums were in arrears … These characteristics, coupled with generally lower quality real estate, resulted in the highest CREDIT ENHANCEMENT levels ever assessed by rating agencies for commercial loan securitized pools.


Many of the early RTC transactions DID NOT ALLOW THE SERVICER MUCH FLEXIBILITY TO WORK OUT DELINQUENT LOANS.

In response to this scarcity of information, the RTC created the Portfolio Performance Report (PPR) to provide monthly information to investors… The report became an industry standard… Although HIGH NUMBERS OF DELINQUENCIES AND LOSSES WERE INITIALLY ANTICIPATED BY THE RATING AGENCIES, these transactions have performed better than expected because of the high level of prepayment activity (many loans were paid in full before their scheduled maturity date). The successful performance of the RTC securities WAS A SIGNIFICANT FACTOR IN THE FURTHER DEVELOPMENT AND STANDARDIZATION OF THIS MARKET. Large commercial banks are now underwriting and originating commercial mortgage loans specifically for securitization.


The collateral security agreements, which govern the administration of the cash reserves, contain language that automatically allows a reduction in the reserve fund if the rating agencies … confirm that … such a reduction would not adversely affect the rating on the certificates. As of June 30, 1997, THE NEGOTIATIONS WITH THE RATING AGENCIES under that alternative HAD RESULTED IN THE RETURN OF $709 MILLION OF CREDIT RESERVE FUNDS TO THE FDIC.


In December 1991, to accurately assess the risk exposure for securitization transactions, the RTC established a loss allowance for credit reserve funds for each transaction on the basis of Moody’s actual loss experience for similar types of transactions. This approach provided a good initial methodology for calculating realized losses. From 1992 through 1994, actual losses were compared to estimated losses; IT WAS DISCOVERED THAT LOSS ESTIMATES NEEDED TO BE REVISED because Moody’s methodology had no mechanism for changing estimates and no provision to incorporate actual loss experience. …

Given … the need to accurately determine risk exposure, the RTC devised a method to project each transaction termination date and to estimate realized losses. A MODEL WAS DEVELOPED

At the time of the closing, loss estimates for each securitization were provided by the RTC-FDIC financial adviser and by the rating agencies. … In May 1996, the FDIC compared actual and expected loss estimates from the various sources. The comparison showed that THE RATING AGENCIES WERE EXTREMELY CONSERVATIVE IN THEIR ESTIMATES… For example, rating agency-expected losses AVERAGED APPROXIMATELY 29 PERCENT, the FDIC model loss estimates AVERAGED 12 PERCENT;


[/RAW]

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