A primer:
In the world of financials, not only you have a credit score. So do companies and their collateral assets.
The Credit Ratings Agencies are the foundation of risk management for the financial markets. Their job is to give ratings to the credit worthiness of both companies, and for instance, those CDO's (you know the ones loaded up with those toxic subprime assets.)
The Credit Ratings Agencies are the trusted guardians of financial stability, or at least they used to be. When people say there is a crisis of confidence in Credit Markets, they mean no one trusts Credit Ratings from these companies any more.
While I do not propose that problematic credit ratings are solely responsible for all of the loses, I am saying if the system worked, then we'd have had no crisis.
(Speaking truth to power, before his time, Michael Moore in his show The Awful Truth, proposed "Corporate Cops". This would be a show like the popular, syndicated show "Cops", where instead of the typically poor suspect being jumped and handcuffed by police, the targets are instead the Corporate Raiders. Think Bernie Madoff with no shirt, his face on the sidewalk, and a boot on his head.)
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The technical term for Credit Ratings Agency is "Nationally Recognized Statistical Rating Organizations" (NRSROs.) Investor's by law, must rely on the the ratings of these organization in buying stock, particularly insurance and money markets (remember the story about one of the primary money market funds falling below par or < $1.00 per dollar invested? Badly rated investments in the fund caused that failure.)
All institutional investors pay attention to these ratings. They have come to trust them as due diligence in assessing risk in investment.
Why the ratings agencies could have prevented the crisis
If the credit rating agencies marked CDO's as risky, then then institutional investors would likely stay away. In short order, you see, the companies that were buying these would also have their credit ratings downgraded. This would directly effect the market for bad credit products, since it would effect investors attraction to the companies that buy the bad assets. Less demand, less supply. Less supply, fewer and fewer subprime loans.
Underlying the credit crisis gripping the U.S. and world economies is a crisis of confidence. Blame has been laid at the feet of the U.S. Federal Reserve, and an investment bankers’ brew of toxic financial products. Ultimately, however, it was the supposedly trustworthy rating agencies that got everyone to drink the poisoned Kool-Aid.
-Monday Morning
How much was lost?
U.S. Market capitalization at its peak was $16 trillion dollars. That's the collective value of all of the traded stock in the U.S. Markets. Half or $8 TRILLION HAS VANISHED SINCE THE MIDDLE OF LAST YEAR. Is this 100% at the door of ratings agencies? No, but they are THE trusted watcher, and investments live or die by these ratings.
Fraud? Whats all this have to do with fraud, versus incompetence?
The problem with the business of rating the issuers of securities, and rating the securities they issue – such as mortgage-backed securities and collateralized mortgage-backed obligations – is that the rating agencies are paid by the issuers to rate them. Objectivity aside, ratings firms are in business not to rate but to make money for themselves by rating issuers and their securities. It’s like all the contestants in the Miss World pageant paying the judges with country funds ... who’s not going to be judged beautiful?
What was even more problematic in the scheme of the ratings business model was that analysts didn’t understand how to analyze and rate the very complex cash flow structures of these new collateralized mortgage-backed securities. Not wanting to lose business to their competitors, who were all in the same boat, they used the same rating model structures that they used to rate corporate bonds, though the two different securities had nothing in common.
It was like asking your local car mechanic to certify your Citation V jet – just before you take off for a transatlantic flight to London. God help you if there’s a problem.
And there were problems.
-Monday Morning
Where fraud comes in, of course, is in the conflict of interest here. Companies pay to have their own company, and its investments,rated. No one outside the financial cabal could possibly test the stability of CDO's, so no one could disprove these artificial ratings. A company might have pressured a ratings agency through veiled threats to the ratings agency, but typically they did not have to. It was understood.
Greed in ratings agencies existed, no doubt. Their sole source of income was in serving companies and providing ratings to them. If they wished to make more money for themselves, they had to rate more products. There is a limited market for ratings, and thus to increase market share they would consequently have to provide a better service than the next guy. A top rating for that junk.
This is effectively comparable to "Grade inflation" which is the practice of universal increases in grades from colleges and universities: students ultimately pay for a grade. There is statistical proof that this conflict of interest has caused average grades to increase over time.
According to a July SEC report, which included as exhibits several e-mail exchanges between analysts at unnamed ratings firms, there was an obvious degree of knowledge and complicity in playing the ratings game
. In one exchange, an analyst said that their ratings model didn’t capture "half" of the deal’s risk but that "it could be structured by cows and we would rate it.
a manager wrote that the firms continued to create an "even bigger monster – the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters."
Where there is inaccuracy in rating for a financial motive, there is a fraud. These people knew precisely what they were doing.
The SEC didn't watch the watchers and was prevented from fixing the problem
Where WAS the SEC in all of this? Well... the SEC under Bush II was basically handicapped. Bush assigned people that wanted to "blow up the SEC" to the SEC.
The best way of ensuring existing regulations aren't enforced isn't to change the legislation: politically obvious and untenable. It's to appoint bad actors to the very bodies that do the work of regulation.
When the SEC did finally look at the sub-prime rating issue and suggest solutions, then they were neutered by the very people that they were supposed to be regulating, aided by lobbyists.
* The rating agencies can’t rate debt they help structure.
* Analysts can’t participate in fee negotiations.
* Analysts can’t be given gifts worth more than $25.
* Analysts must disclose a random 10% sampling of their ratings within six months.
* The ratings agencies must maintain a history of complaints against analysts.
* And that the agencies must record when an analyst’s rating for structured debt differs from a quantitative model.
Calling these proposed rules changes baby steps is like calling the Grand Canyon a ditch.
Because Wall Street didn’t like the idea, what got dropped from the proposed changes were rules to create different structures for rating different products. And the most egregious of the dropped rules was a proposal that ratings firms make public all underlying information they use in making their ratings. Which is exactly the transparency needed.
-Monday Morning
The people are demanding retribution not regulation
Yes, we the people want the rules fixed so this does not happen again, but we want more than that.
There is great public desire to see Madoff and Stanford lose everything and go to jail for their get-rich-quick-scheme involving billions of dollars.
Where is the justice for the ultimate loss of trillions of dollars? If these people got rich through knowingly fraudulent rating of investments, they should go to jail also.
Obama's mistake in approaching the public on the bailout is not the size, scope or approach of the bailout, the public, indeed see it as a necessary evil
They just want someone to pay, and pay as in "Go direcly to jail, do not collect $200"