Thursday, October 23, 2008

Do You Yahoo? Moody's Employees Did...

The folks at the ratings agencies are (in my mind) the culpable party behind this debacle. The investment banking community was just misled by blind overconfidence in a model. The ratings agencies that issued AAA ratings on bundles of crap securities are the group who really need a flashlight shone in their direction. And that is happening. Yesterday, the government began a public hearing regarding the ratings agencies role in the mess. A great post at the Financial Times' Alphaville blog shows how the hearings are must see TV (even more so than Mark Maguire and Raphael Palmeiro's perjury).

A conversation via instant messenger:

Thursday, April 05, 2007 3:58:42 pm EDT Shah, Rahul Dilip (Structured Finance - New York): btw that deal is ridiculous

Thursday, April 05, 2007 3:59:05 pm EDT Mooney, Shannon: i know right…model def does not capture half of the risk

Thursday, April 05, 2007 3:59:09 pm EDT Shah, Rahul Dilip (Structured Finance - New York): we should not be rating it

Thursday, April 05, 2007 3:59:17 pm EDT Mooney, Shannon: we rate every deal

Thursday, April 05, 2007 3:59:30 pm EDT Mooney, Shannon: it could be structured by cows and we would rate it

Thursday, April 05, 2007 3:59:54 pm EDT Shah, Rahul Dilip (Structured Finance - New York): but there’s a lot of risk associated with it - I personally don’t feel comfy signing off as a committee member

A presentation to the BOD of Moody's:

Ideally, competition would be primarily on the basis of ratings quality, with a second component of price and a third component of service. Unfortunately, of the three competitive factors, rating quality is proving the least powerful given the long tail in measuring performance. Were that the extent of the problem - that it is hard to measure quality and hence price and service are disproportionately weighted - it would pinch profitability, forcing rating agencies to spend more on service and take less in fees. But that is no different than for most other businesses and we can cope. The real problem is not that the market does underweights [sic] ratings quality but rather that, in some sectors, it actually penalises quality by awarding rating mandates based on the lowest credit enhancement needed for the highest rating. Unchecked, competition on this basis can place the entire financial system at risk....

Moody’s has struggled for years with this dilemma… For the most part, we hand the dilemma off to the team MDs to solve.

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