Moody’s

Fitch Ratings does not want to find itself in S&P’s shoes. Read more »

A primary goal of financial engineering is to confuse the bejeezus out of Them while remaining crystal clear to Us. There’s no point to it if it doesn’t in some way confound the expectations of some Other, whether that Other is the tax authorities, bank capital regulators, rating agencies, customers, or markets generally.1 But the worst possible outcome is for a product to be unpredictable to whoever built it, mostly because, if it was any good, they built a lot of it, and if it blows up on them it’ll hurt.

There is an obvious tension here: complicated products serve well to confuse Them but are more likely to end up acting up on Us as well.2 One fruitful approach is for Us to be just a bit smarter than Them. Another approach, lovely when it works, is to build a product that is so beautifully simple that anyone can understand it, but that has one simple conceptual twist that falls right in the particular blind spot of one particular targeted Them.3

You can bracket the question of whom residential mortgage backed securitizations were designed to confound,4 and just take a moment to realize: they kind of screwed the banks that did them, no? I mean, “compared to what” I guess – imagine if Countrywide had done all the lending it actually did, but kept everything on its balance sheet – but the fact that BofA has eighty zillion dollars in putback liability must be discouraging for whoever’s left there on the securitization desk. Like: the whole idea was to put some loans in a box and sell the box to investors; the investors, not you, now own the credit risk on the loans. You own nothing. The loans have nothing to do with you. Sure you signed a piece of paper saying some stuff about the loans, just before you waved goodbye to them, but why would you have read that? Those are just reps and warranties; those are for the junior law firm associates to haggle over. You sold the loans, it’s done, right? Read more »

Michael Lewis had this to say yesterday about Greg Smith’s criticisms of Goldman Sachs:1

None of this exactly came as news. The news was that a living, breathing Goldman employee had said it. There was also, between the lines, a fresh hope: Goldman had employed an idealist! For a decade!

That was pretty much my reaction to the Department of Justice’s curiously underwhelming complaint against S&P for misrating subprime-mortgage-backed securities in the run-up to the financial crisis. Wait: S&P got paid to rate deals, and wanted to rate more deals and get paid more, so it rated deals favorably? TELL ME MORE. But then it is enlivened by an occasional cameo from a quant truther whom you would not have expected to exist inside S&P. Like Executive H:

Or Senior Analyst C:

Haha what? You can tell that the DoJ is getting its analytical framework for this case from those quant truthers, but that framework is dumb. Read more »

  • 30 Nov 2012 at 6:17 PM

EFSF Conveniently Downgraded

Here are two tiny little puzzles about Moody’s's’s downgrade of the European Financial Stability Facility from Aaa to Aa1 just now. But first, here is some math on EFSF guarantees; basically every €100 of EFSF bonds has €165 of member guarantees, of which €103ish were Aaa-rated and €62ish were not. Until Moody’s downgraded France last week. Now it appears that each €100 EFSF bond has only €67 of Aaa guarantees, €36 of Aa1, and €62 of … various lesser things.

So the puzzles: first, this thing – the EFSF – is basically a structured credit product that is roughly two-thirds guaranteed by a Aaa thing, one-third guaranteed by an Aa1 thing, and roughly another two-thirds guaranteed by an assorted lower-rated miscellany that you can safely ignore. Should that make it (1) Aaa, (2) Aa1, or (4) other? S&P, as it happens, has a mechanism to sort of solve this, which is to say that a bond is rated by its probability of defaulting. Discarding the cats and dogs (and ignoring correlation questions), something that is 1/3 AA+ and 2/3 AAA has about an AA+ chance of defaulting: even if those AAAs are rock-solid, a default by that AA+ counts 100% as a default. Moody’s doesn’t have that – they, in theory, rate structured products1 based on expected loss, not just chances that there will be a default. So something that is two-thirds Aaa and one-third Aa1 is … at least arithmetically closer to Aaa than Aa1, is it not? (Especially if you assume the cats and dogs add a little bit of recovery.) But here you are stuck in a granular world: a thing that is two-thirds Germany and one-third France may be better than France, but I guess it’s also worse than Germany, so you gotta pick one or the other and I suppose pessimism is always a good look.

But a second and possibly related puzzle: if you were the EFSF, would you be bummed about being downgraded? Here is a weird fact2 (via Alea): Read more »

There are many great businesses in the world but surely none is as great as being paid money not to do stuff. I was in that line of work for two glorious months in the summer of 2011 and I’m pretty sure it was the peak of my career. Counterintuitively this business is not always massively scaleable,1 but there are some examples. My favorite is that in the 1980s companies would pay Skadden Arps a retainer fee to prevent Skadden from representing a hostile acquirer; I have idly suggested that David Einhorn look into charging similar fees to direct-marketing companies who want peaceful earnings calls.

If I were Moody’s I’d have a sliding scale of CMBS fees that goes like:

J.P. Morgan seems to have opted for false economy: Read more »

They’re gonna downgrade their outlook from stable to negative though, just in case. [WSJ]

  • 22 Jun 2012 at 10:03 AM
  • Banks

Moody’s Slightly Reduces Overrating Of Banks

Are we supposed to care about these downgrades? I like Glenn Schorr at Nomura, emphasis mine:

We think the net financial impact of these downgrades will be manageable as 1) potential collateral calls are small percentages of these firms’ liquidity pools; 2) counterparties have been preparing for this for some time and ratings downgrades have been an issue for the last 2+ years (there was little impact on Citi and BAC when they were downgraded back in September of 2011); 3) ratings are a relative game: given that Moody’s downgraded all capital markets firms, no single-firm is an outlier, so we don’t expect to see one company uniquely impacted. Yes, we get that counterparties looking to do long-dated derivatives might prefer a single-A rated entity, but as Basel III is implemented and more derivatives move to central clearinghouses, counterparty ratings should become less meaningful and clients will adapt (and not do all their business with JPM and GS).

It would be a serious misinterpretation of credit ratings to think of them as a global rank ordering of risks in the world. “A-rated things are of course safer than BBB-rated things,” you say, and get punched in the face repeatedly by life. A-rated things are not safer than BBB-rated things. A-rated RMBS CDOs were not safer than BBB-rated corporates, A-rated corporates are not safer than BBB-rated municipalities, and A-rated banks are it goes without saying not safer than BBB-rated software companies. Nobody really suggests otherwise – if they did, this graph would be a huge embarrassment to Moody’s: Read more »