The role of credit rating agencies like Moody’s, Standard & Poor’s and Fitch in the subprime mortgage mess is going to be investigated by the European Commission.
The agencies have been criticised for moving too slowly on examining the ratings of the securities called Collaterised Debt Obligations which were based on subprime mortgages and on high yield bonds and other securities (Junk Bonds!).
These CDOs were constructed by companies, often with the advice of the rating agencies about how to structure them to get the highest yield possible, Triple A, Double A or A.
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These securities were then marketed as being triple A rated and that enabled them to be bought by a wider range of investors (such as super funds), and it generated good fees for the agencies.
But the catch was that the underlying securities were often low grade, or non-investment grade assets, but were secured on housing and property in the case of subprime mortgages.
So it was a case of that old biblical cliché, turning a sow’s ear into a silk purse; but all the while it was really a sow’s ear.
But when foreclosures on the underlying properties started rising and more of the mortgages started going sour, the ratings of the CDOs didn’t move.
Critics in the US and Europe say the agencies had a conflict of interest they never owned up to: they helped create the securities, rated them but were then reluctant to downgrade them.
The first warnings about the subprime mortgage problems appeared late last year in the US and by the end of March the likes of GMAC, GE Money and other financiers had suffered billions of dollars in losses from the souring securities and mortgages.
S&P and Moody’s only started downgrading the ratings of mortgage-backed securities on a significant scale in May but the big move came last month when around 5,000 or more issues of CDOs were downgraded in two days by the two agencies.