The U.S. Financial Crisis Inquiry Commission have released a preliminary report on its findings after investigating the rating agencies role in the financial crisis. Inflated initial ratings, and later rapid downgrades, on mortgage‐related securities by the agencies have contributed to the financial crisis through a number of channels, the commission concludes.
“In total, $2.5 trillion worth of RMBS and $564 billion worth of CDOs have been downgraded since January 2007.”
Financial Crisis Inquiry Commission
In other words; the rating agencies have erased more than 3 trillion dollars from investors accounts by correcting their own initial mistakes, triggering the biggest financial crisis since the 1930’s. The preliminary report explains what happened and how, but leaves the questions on why open to more speculations.
April 20, 2007:
Moody’s issue a report stating:
“Barring cumulative losses well in excess of current expectations, we do not expect a material number of downgrades to bonds rated A or higher.”
July 10, 2007:
S&P announce that they are placing 612 subprime RMBS tranches issued in late 2005 through 2006 on watch for possible downgrade.
Moody’s followed by downgrading 399 tranches of 2006 vintage subprime RMBS and placing an additional 32 tranches on watch for possible downgrade.
The downgraded securities totaled $5.3 billion in value and constituted 1.3% of 2006 vintage first lien RMBS.
July 11, 2007:
Moody’s placed 184 tranches of CDOs backed primarily by RMBS, with original face value of approximately $5 billion, on watch for possible downgrade.
July 12, 2007:
S&P downgraded 498 of the 612 tranches it had placed on watch two days earlier. The majority of the tranches were rated BBB or lower, but 8 AAA rated tranches were included.
By the middle of 2008 over 90% of Baa tranches had been downgraded.
Downgrades of Aaa tranches of RMBS did not begin in earnest until the middle of 2008 and continued steadily until the middle of 2009, when they leveled off with about 80% of tranches downgraded.
“In total, $2.5 trillion worth of RMBS and $564 billion worth of CDOs have been downgraded since January 2007,” the Financial Crisis Inquiry Commission writes in their preliminary report.
Stupidity Or Manipulation?
There are only two possible explanations for the rating agencies handling of the credit derivatives:
1. They had no clue what so ever about what they were doing.
2. They purposely tried to manipulate the market.
The commission don’t make any conclusive statements at this point, but the last word have definitely not been said in this matter.
But its beyond doubt that the rating mess was one of the main triggers behind today’s the financial crisis.
This is the report’s introduction:
The purpose of this preliminary staff report is to present background on the role that credit rating agencies (RAs) may have played in the financial crisis. Most subprime and Alt‐A mortgages were held in residential mortgage‐backed securities (RMBS), most of which were rated investment grade by one or more RA. Furthermore, collateralized debt obligations (CDOs), many of which held RMBS, were also rated by the RAs. Between 2000 and 2007, Moody’s rated $4.7 trillion in RMBS and $736 billion in CDOs. The sharp rise in mortgage defaults that began in 2006 ultimately led to the mass downgrading of RMBS and CDOs, many of which suffered principal impairments. Losses to investors and writedowns on these securities played a key role in the resulting financial crisis.
Inflated initial ratings on mortgage‐related securities by the RAs may have contributed to the financial crisis through a number of channels. First, inflated ratings may have enabled the issuance of more subprime mortgages and mortgage‐related securities by increasing investor demand for RMBS and CDOs. If fewer of these securities had been rated AAA, there may have been less demand for risky mortgages in the financial sector and consequently a smaller amount originated. Second, because regulatory capital requirements are based in part on the ratings of financial institutions’ assets, these inflated ratings may have led to greater risk‐adjusted leverage in the financial system. Had the ratings of mortgage‐related securities not been inflated, financial institutions would have had to hold more capital against them. On a related point, the ratings of mortgage‐related securities influenced which institutions held them. For example, had less subprime RMB been rated AAA, pension funds and depository institutions may have held less of them. Finally, the rapid downgrading of RMBS and CDOs beginning in July 2007 may have resulted in a shock to financial institutions that led to solvency and liquidity problems.
In addition, downgrades of monoline bond insurers such as Ambac and MBIA and other providers of credit protection such as AIG triggered collateral calls built into insurance and derivative contracts, exacerbating liquidity pressures at these already troubled firms. This led to ratings downgrades of the securities these firms insured, prompting increased capital requirements at the firms which held these securities and – in the case of money market mutual funds only permitted to hold highly rated assets – sales of assets into an already unstable market.
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