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FT.com / Arts & weekend / Magazine – When junk was gold –When people moan and groan about the “broken financial system” and how it needs an overhaul, they fail to realize that the mess hinged on only one factor: a corrupt rating system. This article nails the problem in great detail. This is why the Financial Times is the best.
Excerpt:
As the mortgage CDO market continued to grow, Moody’s couldn’t continue as it had. In 2004, the diversity score was abolished – a decision approved by the Moody’s credit committee. The number of mortgage CDOs rated by Moody’s rocketed.
Meanwhile, by 2006, Clarkson’s team, spread all over the globe, was delivering 40 per cent of annual income for Moody’s, eclipsing all the other parts of the business. Clarkson wasn’t involved in the day-to-day running of the structured finance unit – that was left to a network of deputies. Frederic Drevon was Clarkson’s prelate in Europe, working in cathedral-like offices in the City of London, and it was under his watch that Moody’s first came across the CPDO – a “constant proportion debt obligation”. The product had been designed by a crack team of credit experts at the Dutch bank ABN Amro and was called the “Holy Grail of structured finance” by analysts at Bear Stearns. It had been built with a view to achieving triple-A ratings, but also promised to pay investors a substantial return – more than 10 times what comparable triple-A instruments were offering. CPDOs were not mortgage-backed, but rather collections of bets on the creditworthiness of hundreds of European and US corporations.
Designing products by reverse engineering the ratings methodology was essentially beating the system, and the system did not care. There was too much money flying around. We’ve seen this kind of thinking in high-tech with benchmarks. The idea is not new.
Found by Aric Mackey.
Similarly, I think real estate appraisers are partially culpable for the housing bubble.
When the professionals who tell us the value (worth, risk, etc) are “in on it”, we are screwed.
I am honestly interested in what this article says but I think it is a little too “inside baseball”. Can anyone decipher the nuts and bolts of it? (i.e. what was “reverse engineered” and how did they do it?)
Thanks.
This will all end with crying
I don’t like realtors, bunch of overpaid underqualified inherently conflicted part timers. That said, realtors can only report/work with appraisals. Appraisals follow recent similar sales==not creditworthiness. So, realtors and appraisers will follow bubbles up, and go down when the pop==all unavoidably necessary.
NO–it is indeed the loan standards department at the front, and the securities risk analysers at the end. These “auditors” get fired when they do their jobs well–there is a constant pressure for them to perform according to desired sales.
Lots of the legal rules isolating and protecting these auditors where done away with under the “joy of deregulation.”
What did it take==about 3 generations to have the Great Depression/Reform and then forget why the rules were put in place?
Expect the same process and pull your money out of real estate in about 75 years.
During that “real estate bubble” two years ago, a friend of mine’s house was valued at $1.4M. It is now valued at $825,000.
Talk about ridiculous.
Well; that was an intersting – and depressing – article. Long have there been mumblings and grumblings about the rating services, especially Moody’s, but for the first time I now read the rather distasteful details.
Thanks for this article; it’s quite informative, at least to me.
Like I said…see you in Switzerland, John!
Let’s not forget when Arthur Andersen declared that Enron’s finances were in good shape. It’s good to have regulation and oversight but who watches the watcher?
A very sobering article. A great argument for regulations and oversight.
BUT, I’m waiting for Cow-Paddy and Lyin’ Mike to tell us this is all Clinton’s fault.
#7 – Brenda Lee
>>Like I said…see you in Switzerland, John!
Let us know when you’re leaving. You seem to hate all of America, so the mood will surely cheer up once you’re gone. We can have a “pot party” to bid you adieu.
Bush and the Repukes HIGH-FIVE THE WALL STREET CROOKS AND HAMSTRING THE FBI !!!
LINK:
http://tinyurl.com/6xoz9s
I guess it take ONE WALL STREET CROOK (BUSH – INSIDE TRADING) TO KNOW ANOTHER ….
There was corruption at every stage of the game, not just at the ratings companies.
For example, the derivatives and other “innovative” financial instruments were invented with (at least) two nefarious purposes:
(1) avoiding government regulations
(2) deliberatley masking the true underlying value (or who, in their right mind would buy them?).
Probably, the least corrupt people involved were the unsophisticated people that signed mortgages they didn’t understand. And they are the ones that will receive no help from the government.
For a great article on this subject, including much better solutions than we’ve been getting, I recommend the Vanity Fair online article:
Reversal of Fortune – Describing how ideology, special-interest pressure, populist politics, and sheer incompetence have left the U.S. economy on life support. The author puts forth a clear, commonsense plan to reverse the Bush-era follies and regain America’s economic sanity.
by Joseph E. Stiglitz, a Nobel Prize–winning economist, and a professor at Columbia University.
I occasionally like to imagine that that I’m rich. I know that I’m not, however.
These folks took their imagination way too seriously. They actually believed they were rich.
The trouble is, we’re giving them money to reinforce their fantasy! How do I get on that bus?
#12, Pagen,
A link to that Vanity Fair article.
The only thing lower than these guys in the “financial industry” are time share salespeople
Did “Big Mac” from Winnipeg have a conscious at all ?
I send them down the chute was his refrain