Inside a Subprime Pool

Roger Lowenstein was able to watch Moody's value a subprime pool and gives an eye-shattering view of the process. Rather, I should say a mind boggling view as all rationality and analysis seems to have gone out the window.

The pool consisted of 2,393 mortgages with a face value of $430,000,000. Some issues that should have concerned Moody's:

• 75% of the mortgages carried an adjustable rate
• 43% of the borrowers did not provide written proof of their income
• Almost half had a second mortgage.

The analyst had one day to rate this offering. Given the above three points, that should have been more than enough time to say no. But, hey, Moody's would not have gotten the fee from the investment bank that requested the rating. So, Moody's gave twelve different ratings to the package, from AAA to BA1. Less than two years later - after Moody's had downgraded 5,000 of these pools - this particular pool could boast that 27% of the mortgages were delinquent.

Lowenstein does not think that only the rating agencies are at fault. Securities regulators, such as the SEC, outsourced their regulatory functions to "officially designated rating agencies". But, still it was the ratings agencies that decided to negotiate with their customers, investment banks, as to what the rating should be. It was the rating agencies that rated securities using mathematics rather than common sense. It was the rating agencies who did not understand the dramatic changes in the financial world.

Clearly, the ratings agencies are responsible for a large part of our current situation.