The Credit Rating Scam

The great Gretchen Morgenson of the New York Times had a nice overview of the scandalous (and illegal?) scam perpetrated by the credit ratings agencies during the housing boom.

The key section:

Consider a residential mortgage pool put together in summer 2006 by Goldman Sachs. Called GSAMP 2006-S5, it held $338 million of second mortgages to subprime, or riskier, borrowers.

The safest slice of the security held $165 million in loans. When it was issued on Aug. 17, 2006, Moody’s and S.& P. rated it triple-A. Just eight months later, Moody’s alerted investors that it might downgrade the top-rated tranche. Sure enough, it dropped the rating to Baa, the lowest investment-grade level, on Aug. 16, 2007.

Then, on Dec. 4, 2007, Moody’s downgraded the tranche to a “junk” rating. On April 15 of this year, Moody’s downgraded the tranche yet again; today, it no longer trades. The combination of downgrades and defaults hammered the securities.

The article, like others, is a damning critique of the profit first philosophy of the rating agencies entrusted with determining the financial soundness of multi-trillions of dollars of financial instruments.

These men have been before Congress already, and they are heading back. Rating financial instruments, like healthcare, is too important to be entrusted to the profit motivated marketplace. A laser-like focus on a quarterly bottom line is not a recipe for sound ratings.

It’s remarkable that it took this crisis to make that clear.

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