Rethinking The Ratings Agency Scandal, Part IV: Homogenous Ratings Labels For Heterogeneous Credits

Posted by John Carney, Feb 12, 2008, 12:46pm

The Big Idea Ratings Agencies.JPGAt the most basic level, the critique of the ratings agencies seem to be that by assigning triple A ratings to riskier credit products, they concealed risk. This dismays the ratings agencies who believe that they never claimed every kind of credit product that bore the same label carried the same risk.

“Credit ratings are relative to the type of credit,” a credit rating official tells DealBreaker. “Different types of products have different inherent risks, and the labels reflect payment expectations within those categories.”

The ratings agencies have all but admitted, however, that by using the same labels for products carrying different levels of risk they may have left themselves open to the critique they now face. This is why they have proposed reforms such as explicit warnings and using different systems of rankings for different types of products.

By and large, Wall Street does not appear to have been fooled by the fact that CDOs and corporate bonds may have both been called AAA. The CDO market typically offered higher yields for triple A paper than the corporate debt market, implying that investors understood the risk profile was different. It wasn’t only the nature of the credit product that was heterogeneous. The pricing was as well.

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Posted by , Feb 12, 2008 1:00PM

i have long harbored suspicion that somehow this is all one big government screwup, and the evidence is mounting ...

Posted by , Feb 12, 2008 2:39PM

I was just thinking about back when I was getting out of college, I had occasion to interview with and ABS group at bear stearns, one of the questions they asked was what has higher credit quality, a AAA t-bill or a AAA CLO with a monoline wrap, the answer she wanted of course was they are the same, risk free is risk free and AAA is AAA no matter what the underlying, this was back in year 2000.

Anyway, this is the kind of mentality, and it is kinda funny that people who think they are so smart judging by the huge paycheck they get every year just mindlessly accept the dogmatic ratings delivered by Moody's MDs who make the same in a year as a first year banking associate

Posted by , Feb 12, 2008 2:43PM

Are you sure that was the answer they were looking for? Its not like a multiple choice test. Typically an interviewer wants you to demonstrate the ability to articulate, reason. It would be preferable to answer that they have the same rating but, based on blah blah.... they're not truly equal risks. And the quality of the blah blahs is what differentiates you.

Posted by , Feb 12, 2008 2:56PM

No, because I definitely said I would rather own the t-bill at the same price, she definitely said "AAA is AAA" that's as direct a direct quote as I can give you 8 years down the line. It was like she took it out of a "questions to test the technical knowledge of job applicants" handbook. In fact, she may have even responded it is a trick question.
I wish I could remember her name, I am almost but not quite mature enough not to send her a bloomberg asking if AAA is still AAA.

Posted by Bulging Bracket, Feb 12, 2008 3:17PM

Was this an actual banker? Or the usual HR know nothings doing some screening? Since it was Bear, I'm guessing it was an actual banker and it shouldn't have been all that surprising.

But yeah, both the people yelling about how CDOs were total fraud and those saying AAA is AAA are idiots who shouldn't be allowed nay influence over policy or any connection to business.

Apparently mixing CDOs with a housing bubble is bad, mmmk. Or rather, tail ends of bubbles have insanely horrible credit standards and lead to ridiculously easy lending like ninja loans.

Posted by , Feb 12, 2008 3:25PM

Hahaha yeah, no it was the second round interviews, so she was only one of like 6 or 8 but I definitely got the sense they were all getting high on their own supply, really enamored with their business, and I guess to be fair if you felt that way you got rich from 2000 to 2007. I happened to be interviewing for a group trading prop but they had some VP level bankers in to the interview process as well.

Posted by daveNYC, Feb 12, 2008 3:54PM

Why use identical rating identifiers and then say that the quality of the identifiers depends on instrument being rated? Why not just adjust the instruments' ratings so that they can all fit on the same scale. Maybe it's because the sales forces would have a much harder time selling these things if they didn't have the sexy AAA rating, and all the safety that it implies.

Posted by Anonymous, Feb 12, 2008 4:49PM

Exactly the point Dave. Does not matter whether Wall St traders recognize the risk difference between AAA products. Without the AAA the CDOs can not be sold to as wide a universe of customer.

Posted by big tobacco, Feb 12, 2008 6:00PM

I was at a recent talk about potential litigations that might materialise as a result of credit related losses and someone asked whether there might be a significant service provider blow up akin to Arthur Anderson in the Enron aftermath.

The answer was vague and non-specific but the question has resonance. I wondered about the rating agencies and whether like the tobacco companies containing the knowledge of their product's inherent harmfulness whether the rating agencies might be culpable for their slowness to act in the face of their accumulated internal knowledge.

For example, if the rating agencies know that the ratings on certain monolines are unsustainable and senseless in the face of their ongoing monitoring (based on their pre-credit crisis parameters) and day to day analysis but don't act fearing the extent of the fall out, might they subsequently be liable for their omission in withholding this discoverable knowledge from the marketplace in dereliction of their duty?

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