A Rating Agency Example
By Arnold Kling
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.
One question that I would like to see asked at next Tuesday’s hearing on Freddie Mac and Fannie Mae is what those two firms were thinking while the rating-agency nonsense was going on. I imagine that they ran some of these securities through their stress tests, the way any manufacturing company would test a competitor’s products. Surely, they saw that these securities would blow up if house prices started falling. Why did they not call baloney sandwich?