Bogus ratings of mortgage-related securities show conflicts of interest by credit rating agencies

August 16, 2011 By Lloyd B. Thomas Jr

Obvious conflicts of interest and poor performance are among the reasons why a Kansas State University economist says the way the leading credit rating agencies are funded should be changed.

Standard and Poor's incompetent -- and arguably corrupt -- behavior in the years leading up to the 2007-2009 financial crisis makes its recent downgrade of U.S. debt hard for many to swallow, said Lloyd B. Thomas Jr., a K-State professor of economics and the author of a recent book about the financial crisis.

"Standard and Poor's, Fitch and Moody's -- the three leading credit rating agencies -- behaved very poorly during the housing and credit bubbles of 2000-2006," Thomas said. "Many buyers of mortgage-backed bonds can only purchase those rated AAA. The rating agencies routinely stamped mortgage-backed bonds and related derivatives AAA without carefully examining the quality of the individual mortgages that backed them."

Many of these bonds were essentially junk bonds because of the inferior quality of mortgages backing them. Thomas said this failure of the rating process helped feed an enormous expansion in the pipeline of credit to the housing sector, and its inevitable collapse after 2006 is the primary cause of the nation's today.

"These credit rating agencies have been funded by the very investment banks that built the toxic mortgage-backed bonds and related securities," he said, adding that many think that this led to corruption of the ratings process as Standard and Poor's, Moody's and Fitch engaged in a "race to the bottom."

"Standard and Poor's knew that if it failed to rate a mortgage-backed bond AAA, the would take it's business to Fitch or Moody's, which would likely rate the bond AAA in order to collect its million-dollar fee for its rating service from the investment bank," Thomas said. "Clearly this obvious needs to be corrected by implementing a new way of funding the rating agencies."

Thomas is the author of "The and Federal Reserve Policy," which was recently published by Palgrave Macmillan.

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5 / 5 (2) Aug 16, 2011
This was widely reported during and after the GFC...OUTSIDE the USA. The corruption, the conflicts of interest, issuing loans to people who can't possibly pay them but making them look good by lending those same people the deposit and first year's payment (afterwhich the mortgage must default) and then packaging and selling them overseas was widely reported in Europe and Oceania but I didn't see much about this in the US press...America brought the GFC down on itself due to governmental incompetence and is now paying the price, a fair price if you ask people outside the USA.
1 / 5 (2) Aug 16, 2011
One reason for AAA ratings was the mandate for GOVERNMENT SPONSORED 'enterprises' like Fannie and Freddie to buy mortgages so the finance companies could sell more.

"This report concludes that, in an attempt to increase home ownership, particularly by minorities and the less affluent, virtually every branch of the government undertook an attack on underwriting standards starting in the early 1990s. Regulators, academic specialists, GSEs, and housing activists universally praised the decline in mortgage-underwriting standards as an innovation in mortgage lending. This weakening of underwriting standards succeeded in increasing home ownership and also the price of housing, helping to lead to a housing price bubble. The price bubble, along with relaxed lending standards, allowed speculators to purchase homes without putting their own money at risk. ";id=30
3 / 5 (4) Aug 16, 2011
"No Housing Bubble Trouble,"Washington Times (January 8, 2005): "In short, we are asked to worry about something that has never happened for reasons still to be coherently explained. 'Housing bubble' worrywarts have long been hopelessly confused. It would have been financially foolhardy to listen to them in 2002. It still is." - Alan Reynolds, Senior Fellow, Libertarian Cato Institute

"Recession Fairy Tales," Townhall (October 5, 2006): "When it comes to homes . . . many people have spent the last four years fretting that the 'housing bubble' might end. That is, they worried that overpriced homes might become more affordable. This is not quite as nonsensical as worrying the price of oil might fall too much, but it's close." - Alan Reynolds, Senior Fellow, Libertarian Cato Institute
2.3 / 5 (3) Aug 16, 2011
"Mr. Hassett of the conservative American Enterprise Institute thinks housing prices will be pretty much O.K. He acknowledges there might be some bubble dynamics at play in some regions. But he argues that for the most part people are paying more for homes because their incomes are higher and interest rates are lower, reducing the cost to own a home.

"Mr. Hassett expects that rising interest rates would raise this cost and home prices would then decline proportionately. But he sees no reason to expect a catastrophic decline. 'I don't think a catastrophe is very likely,' he says. - Kevin Hassett, Director of Economic Policy Studies, American Enterprise Institute (Libertarian)

"While such signs of speculation are troubling, there is little solid evidence that a real estate bubble is puffing up." - James K. Glassman, Senior Fellow, American Enterprise Institute (Libertarian)

"There is No Housing Bubble!!" - National Review - Free Market/Libertarian
2.3 / 5 (3) Aug 16, 2011
" There is NO real estate bubble. The slowdown appears to be psychology oriented and has been egged on by constant articles and comments in the press. The reports are greatly exaggerated and inflammatory and designed to cause trepidation amongst consumers. It is a known fact, that negative news sells many more papers and garners more attention than positive news." - Marlene Goldberg - 2006 - Libertarian

"Homebuilders led the stock parade this week with a fantastic 11 percent gain. This is a group that hedge funds and bubbleheads love to hate. All the bond bears have been dead wrong in predicting sky-high mortgage rates. So have all the bubbleheads who expect housing-price crashes in Las Vegas or Naples, Florida, to bring down the consumer, the rest of the economy, and the entire stock market." - Larry Kudlow 2005 - Libertarian
2.3 / 5 (3) Aug 16, 2011
At the national level, what could possibly kick national home prices downstairs? There is nothing to suggest massive job loss ahead or a huge oversupply of new homes. That leaves only the dubious assumption of a big increase in mortgage interest rates as the trigger for any nationwide decline in home prices." -No Housing Bubble Trouble 2005 - Alan Reynolds - Libertarian CATO Institute.

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