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Rating Agencies Ignored Proof of Unsafe Loans

Posted By Barry Ritholtz On September 27, 2010 @ 7:30 am In Bailouts,Credit,Really, really bad calls,Regulation | Comments Disabled

As if we need further evidence of the gross and willful malfeasance of Moody’s S&P’s and Fitch: The latest evidence of their criminally irresponsible behavior comes to us via the Financial Crisis Inquiry Commission.

This was not, as the narrative has been reconstructed, a case of good loans gone bad. Mere incompetence does not explain the ratings agency debacle. This was a Ford Pinto, a calculated attempt to maximize profits regardless fo the systemic damage it caused. So what if a few people had to burn to death in order to make our bonuses — bankrupting the global economy is merely a cost of doing business.

NYT excerpt:

“D. Keith Johnson, a former president of Clayton Holdings, a company that analyzed mortgage pools for the Wall Street firms that sold them, told the commission on Thursday that almost half the mortgages Clayton sampled from the beginning of 2006 through June 2007 failed to meet crucial quality benchmarks that banks had promised to investors.

Yet, Clayton found, Wall Street was placing many of the troubled loans into bundles known as mortgage securities. Mr. Johnson said he took this data to officials at Standard & Poor’s, Fitch Ratings and to the executive team at Moody’s Investors Service.”

The mortgage securtitizers hired independent analytical companies (like Clayton) to “sample loans and flag any that were problematic.” According to his testimony, Clayton found a large percentage of loans that failed various tests such as geographic diversity, the loan-to-value ratios, credit scores and incomes of borrowers. These findings appear to have veen routinely ignored by both the underwriters and the rating agencies.

It was a trust-but-verify approach — but without the verification that might reduce a lucrative business:

“According to testimony last week, from January 2006 to June 2007, Clayton reviewed 911,000 loans for 23 investment or commercial banks, including Citigroup, Deutsche Bank, Goldman Sachs, UBS, Merrill Lynch, Bear Stearns and Morgan Stanley.

The statistics provided by these samples, according to Mr. Johnson and Vicki Beal, a senior vice president at Clayton who also testified before the inquiry commission, indicated that only 54 percent of the loans met the lenders’ underwriting standards, regardless of how stringent or weak they were.

Some 28 percent of the loans sampled over the period were outright failures — that is, they were unable to meet numerous underwriting standards and did not have positive factors that compensated for their failings. And yet, 39 percent of these troubled loans still went into mortgage pools sold to investors during the period, Clayton’s figures showed.”

This was not a case of error or bad forecasting or poor execution. This was a reckless pursuit of profit by design. The risks, indeed probabilities of default were well known, and ignored.

If any group of firms deserve the Arthur Anderson fate of corporate execution for bring guilty of murderous behavior, it is the rating agencies. In my opinion, they should be put down like rabid dogs.

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UPDATE: October 13, 2010
Felix Salmon [1] is (belatedly) on the case of bank liability, and having entire CDO/RMBS bundles put back to the banks.

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Source:
Raters Ignored Proof of Unsafe Loans, Panel Is Told [2]
GRETCHEN MORGENSON
NYT, September 26, 2010
http://www.nytimes.com/2010/09/27/business/27ratings.html


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URLs in this post:

[1] Felix Salmon: http://blogs.reuters.com/felix-salmon/2010/10/13/the-enormous-mortgage-bond-scandal/

[2] Raters Ignored Proof of Unsafe Loans, Panel Is Told: http://www.nytimes.com/2010/09/27/business/27ratings.html

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