You can pay the rating agencies the way they are, providing that another type of service just as the one rating agencies provide banks is available to Buyside firms and get paid by the buyside firms.
The answer to all of this is to remove the congressional blessing bestowed upon the NSROs and let anyone get into the ratings game, just like is done in equities. Investors wouldn't like this cause they'd actually have to do, you know, credit analysis, rather than just blindly relying on the credit rating, but it would instill discipline back into the market and punish idiotic structures like CDO-cubed's that couldn't exist without myopic modelers on the ratings side and gullible investors.
It's too bad that everyone is so down on government regulation. It really does work for common goods problems like "information".
Ritholz posted a video from Steven Pinker, who happened to be saying something interesting. People often use language to be obtuse and deceptive and to maintain "plausible deniability". This is the free market outcome of normal human interactions. To prevent this, we need higher level regulation by social institutions.
subscriber-paid ratings wouldn't particularly solve anything because it would likely give bond investors even less incentive to do their own analysis. 'hey, i pay moody's to do that'. is that what we want? i would say one of the better results of this mess is that people will start doing more of the credit analysis work themselves.
U.S. Housing-Slump Bottom Not Yet Near, Fannie Mae's Mudd Says
The housing market won't hit a bottom ``until the end of '08 and then we have some period of time to work our way back up again,'' Mudd said today in an interview.
U.S. home prices will fall 2 percent to 4 percent this year, and ``more next year,'' he said.
Balance the playing field. If the sellside has someone working for them, then the buyside needs someone with a like kind service working for them and their best interest. I dont think this is rocket science and to have the government put there hands in this would only mess things up even more. They mess everything up. Look at there bail out plans. All they want is votes and the illusion of "doing something". Worthless. There are more important things they need to worry about like the BAO's report on the impending fiscal problems for the country because of Social security and healthcare costs from all the retirees that will be coming up. Just an FYI. The system will be insolvent and a huge drag on the economy if they dont fix it sooner rather than later.
you also might want to buy something with a little extra risk to juice your yield, but you don't want it to look like extra risk, so you get mad-eye to notch it up.
to have the government put there hands in this would only mess things up even more. They mess everything up.
So you think we should repeal the Fair Credit Reporting Act, and have Fannie and Freddie back off on policing creditors who manipulate ratings? Just let the ol' free market sort it out?
My take on this is that one reason why the ratings have sucked so badly is, in part, that the RAs don't demand enough gritty loan-level data to run in their models (leaving off what other problems there might be with the models).
Are investors really going to demand more data to look at?
All industry insiders have known all along that there is more information available on an origination and servicing database than the RAs use to measure collateral quality. And if it isn't there, the fields can be added; we do that all the time when new regulations come out.
But the demand was not for granularity, it was for executive summaries.
there's always money to be made off of information asymmetry
Perhaps the ratings themselves are where the problem lies. Dump the ratings and release the raw data. Not practical I'm sure, but it would clear some of the smoke.
After all, the current situation is one where the raw data is being disregarded in favor of a rating which pretends to be some sort of honest Cliff Note.
Those are a couple of outstanding corporations to use as an example
Kevin, it happens to be a true example. What should I do, put on a pair of ideological blinders so that Fannie and Freddie are always the bad guys and the private sector is always the good guys?
It just blows me away that after all we've been through in the past year, people can still have that Pavlovian response to any mention of the GSEs, who differ from other mortgage companies because they got caught by the regulators long before the music stopped. I bet all the NEW and LEND shareholders, for instance, are really happy that they got out of FNM and FRE, aren't you?
Tanta - I dont think free market can regulate everything, but to have the government stick its hands into things everytime someone or people have a problem is not good. There should be some level of regulation, not excessive. Just provide a like kind service to the Buyside without the intervention from any rating agencies that get paid from the buyside. Its almost like a bid/ask price for ratings. What the government is doing is not a free market. A riskless free market is the same as religion without sin. Its not going to work.
bacon dreamz, the link won't work (and I'm a registered user). If you link to the public page the pdf link is on, I think it works.
And yes, I love hearing people with monopoly power whining about how they can't get information from those crazy servicers.
The whole reason I brought up the GSE credit reporting thing is because two big 800 pound gorillas used the power that they have to force servicers to cough up data.
If Fannie and Freddie can do that, the RAs can do it. You just announce that you will not rate a bond unless you get the data you want.
A riskless free market is the same as religion without sin. Its not going to work.
Yeah, well, I have a major problem with religion masquerading as economics.
Why do I feel that sometimes people just don't read my posts?
Who takes the privacy and theft risks of consumer credit reporting? Are you aware that consumers have no choice in this matter, and no "pricing power"? If you decide that you don't get a big enough "return" from having your personal data at a credit bureau, given the risks of theft or misuse of that data, you are aware I hope that you cannot opt out of it? You cannot stop someone from selling your payment history with Citibank if you don't care for the risk of that.
We have to stop pretending that only the "subscribers" are taking the risk.
Tanta - I read all your posts, with vigor, might I add I dont disagree with you, I was simply discussing the part of the issue I think individuals have more control over.
Someday, some 'consumers' will not be treated as wards of the credit rating system.
Someday, these 'consumers' be on equal footing with the other parties involved in electronic transactions, in the sense that they will have purchased the ability to project meaningful and valuable electronic interfaces into the marketplace.
Less intelligent consumers may waive their right to purchase such services, but I suspect it will become common knowledge that, to get a mortgage without such consumer-side services is foolish.
It still wont' be totally fair. The rich will always have better systems. But their advantage will no longer be based on the digital/transactional nakedness of the 'consumer'.
This is an interesting question, Tanta, but it may soon be moot.
So far, it's been mainly the regulators, politicians and institutions asking questions about ratings agencies.
But if the municipal bond insurers unravel, it will be Mom and Pop Public shaking their fist and asking why their AAA-bonds turned to junk.
At that point, Merrill and others will have to implement a new more objective ratings scheme, just like the dot.bomb research saga. The older raters will get thrown out and new raters will come in.
I think I can rate default risk more accurately just reading a closing statement than a FICO. How would you rate a 95% cash out NINJA refi where the loan fees were $42,000 to net $48,000 cash out. Oh yeah, and the starting rate on the Option ARM was 9.25%.
Perhaps because they don't? Verbosity has its pitfalls you know.
Of course it does. But I didn't ask why people don't like them sometimes. That I know about. I was asking about where the comments are coming from.
That's the problem, you know. In order to try to move the conversation beyond the same old swapping of slogans, we have to get down into some nitty gritty. Sorry if it comes off as tedious, but hell, the net's full of blogs with short, 'tudeless writing. I'm trying to meet a different set of needs.
Brian, that is the source of my frustration. It's not whether people read the posts in their entirety or not; lots of people don't.
But the ones who don't bother to read the posts generally don't bother to comment on them. Sorry if I took your response to be a comment to my post, but I thought that's what it was.
Those of you who are just engaging in a forum that has only tangential relationships to the posts will just have to put up with a bit of impatience from time to time from the post writer, who is mistakenly under the impression that you were responding to what was written above that comment link.
How would you rate a 95% cash out NINJA refi where the loan fees were $42,000 to net $48,000 cash out. Oh yeah, and the starting rate on the Option ARM was 9.25%.
can i have the front-end NIM? if so, i'll rate your loan 'A+' with a smiley face!
They are very very special. How many other Government Sponsored Enterprises do you know of, who have a federally-granted charter to provide liquidity to the mortgage marketplace?
When other companies accept the GSEs' mandates, maybe they can get the GSEs' deal with the delisting issue.
I'm perfectly willing to debate whether we need GSEs or not, but I'm not really interested in debating whether we should treat them just like any other company. That would be insane.
Tanta - I am an reader of all comments on this blog and all articles posted. I work in teh industry. I enjoy all of it. Ill apologize if my comment came out wrong. Now I will go to my room with no dinner and cry. LOL.
Too bad we fired the egghead that used to sit in the corner cube and dissect those offerings. Apparently doing in-house due diligence would have been cheaper in the long run. Anyone have his current contact info?
Why do I feel that sometimes people just don't read my posts?
Because of selection bias? They only perceive what they think you're trying to say. To solve this we should have two rating services vet your posts: one, a GSE, and the other a private corporation. Or maybe just BDreamz could publish a rating and then we could just pretend we read them (like pretending we're doing due diligence) and,...
If it makes anyone else feel better, I usually have to read through twice, because Tanta's worldview and mine are so different.
I've been thinking about this for a while. Is it possible that the main reason that credit ratings agencies have been experiencing these problems is because disclosure requirements for debt issuers are frequently much lower than they are for public equity issuers - that ratings agencies are being paid because issuers (and I have to admit I'm primarily talking about corporate issuers here) prefer the situation to the disclosure arrangements they have for equities. I understand your point about FICO scores and credit reporting bureaus, and the security of their procedures, but I don't think it's fair to compare the privacy of individuals to the privacy of corporations. My personal feeling is that the institutions which depend on ratings will need to perform or pay for that analysis themselves. Banks, for instance, are starting to do this under Basel II, and there would be no reason for other users that depend on them for capital adequacy and solvency reasons not to take this function back in-house. Hedge funds and traders would no longer enjoy a free ride on this analysis, but the small number of bond rating firms outside the big three would be able to pick up some of this slack.
Let's say there was somebody out there who was really good, better than everyone else, at predicting default on fixed income securities. Why on earth would this person work for rating agency? This ability could produce at least a 7 figure income running a hedge fund.
Or maybe just BDreamz could publish a rating and then we could just pretend we read them
BD: Damnit lady, if you want this six page post to get a AAA rating you have to put up credit enhancement in the form of a colorful cartoon somewhere in the middle. It protects the post from lost readership by absorbing waning attention spans. And you better believe CE requirements are going up on 70s rock videos!
T: Look bub, this post is going up as is, and if you keep talking, I'm going to print out the 1000 words I edited out of this and shove them up your [deleted by siteowner] while I make you watch opera on YouTube.
BD (gasps and mutters meekly): Yes, ma'am, I'm sorry, can I get you another cup of coffee please?
I don't think it's fair to compare the privacy of individuals to the privacy of corporations.
Oh, I certainly agree with that. But structured securities are backed by loans made to individuals. You don't really want any old Tom, Dick or Harry getting access to your loan file to do "due diligence." GE may not have much right to the privacy of its accounts payable, but surely you and I do? By getting a mortgage, we didn't sign away our privacy to every jerk in the secondary market who might invest in a CDO tranche.
The security of the due diligence process is probably grist for another long and annoying post, but it's a big issue. If you send someone like me in to represent some institutional investor on a due diligence visit to some lender's file room, you are in fact giving me access to thousands of credit reports, bank statements, account numbers, you name it. Of course, when I did that kind of work I was affiliated with a consulting firm that carried a fair amount of liability insurance, and I cheerfully signed the confidentiality agreements, and I'm a trustworthy scout who would never supplement my earnings by selling some of the data I had access to. But if you think every trader and hedgie and other party out there would pay my rates (i.e., cover my E&O and surety costs), I think you're mistaken.
We already have cheap low-bid subservicers screwing up loans for less; I don't want to see cheap low-bid due diligence.
The rating agencies are very careful not to receive any personally identifying information about loans; they get these files with LTV and DTI and stuff, but they can't put a unique borrower on that file data. That's good news and bad news. The good news, obviously, is that the rating process isn't risking identity theft or misuse of personal data again. The bad news is that, for instance, they can't tell if ten loans in a pool are made to the same borrower. Now, I'd see that kind of thing in old-fashioned pool due diligence, and I'd kick up a problem with concentration (not to mention I'd notice if more than one of them was coded "principal residence").
End of the day: bonds backed by consumer credit are just different. Applying the same processes that we do for corporates is a problem.
Let's say there was somebody out there who was really good, better than everyone else, at predicting default on fixed income securities. Why on earth would this person work for rating agency?
Well . . . because consumer-credit-backed securities are Different.
They aren't supposed to have enough default variation to matter. I know that sounds weird, but that's because the context of the last several years is weird. I can't stress how historically unprecendented this "risk based pricing" or "high yield ABS" thing is. To say it's unprecendented isn't to say it's wrong--I'm not an old-fashioned conservative who believes that new = bad. I'm just saying that the fact that inefficiencies in credit default prediction seem "normal" is no reason to think it is, or that it will continue.
"The government" will get involved. Always. That's a fact. No elected member of Congress, the state legislators, or your local HOA is going to sit still if defaults on home mortgage loans get over a certain "tolerable" level. I'm not saying that's good, bad, or indifferent; I'm saying it's reality. Has been at least since FDR's day.
So there's not much of a seven-figure opportunity for those who can predict defaults outside of a relatively narrow band of them, because they will not be allowed to escape that band. That's the process we're in right now. And level of defaults will not always drive pricing of asset-backed bonds. If credit standards normalize, everyone will go back to worrying more about inflation or prepayment speeds than about credit losses, and credit analysts will go back to being their usual underpaid and invisible selves.
Well, I don't know about "nothing." Although I prefer my coffee unadulterated, I can forgive people who put cream in it. I can tolerate people who put sugar in it.
People who put artificial amaretto flavoring in it should be deported. I don't care if you were born here. Some other country needs you.
Well . . . because consumer-credit-backed securities are Different. They aren't supposed to have enough default variation to matter.
Consumer-credit backed securities were different. People with poor credit just couldn't get mortgages. Risk-based pricing almost requires a big jump in default since a good chunk of the premium on the coupon is going to be eaten up by default.
"The government" will get involved. Always.
You are probably right and I consider this outcome unfortunate since the government will do the wrong thing. The only way I see to lower the default rate is to ration credit to the best risks which would include both good credit history and lower LTVs. Our government will probably create some market distortion that raises the overall cost of borrowing and does little or nothing to stem the default rate.
If credit standards normalize, everyone will go back to worrying more about inflation or prepayment speeds than about credit losses, and credit analysts will go back to being their usual underpaid and invisible selves.
For consumer debt, possibly but there will always be segments like distressed corporate or emerging market sovereign debt where default risk is key component of the risk premium. My implicit assumption is default prediction skills are transferable between the consumer and corporate debt but I know of no reason why this would not be so.
"I really want to know why we think subscriber-paid fees in the bond rating world is going to result in something we'll be happy with."
That raises the question for me: what is it the investor community or other 'users' of ratings would be 'happy' with? Ratings are an opinion, not a recommendation (although a 'AAA' might seem like one), not a guarantee. In the end, investors should do their own homework and be 'happy' with whatever that happens to be. But if one relies on others to do your own homework, you may not be 'happy' with the result. If the investment is too complex to understand, that begs the decision to buy.....buyer beware.
You can pay the rating agencies the way they are, providing that another type of service just as the one rating agencies provide banks is available to Buyside firms and get paid by the buyside firms.
I am going to pay them from my campaign money, if nobody else comes to help me. So will my friends Schummer and Osama....oops, Obama.
New homes sales biggest drop in 37 years.
"Don't you dare buy a house now. You will lose money." - Cramer
NAR demands a retraction. What they'll get is a correction. In the market.
Single-family home sales fall 8.3 percent in August
The answer to all of this is to remove the congressional blessing bestowed upon the NSROs and let anyone get into the ratings game, just like is done in equities. Investors wouldn't like this cause they'd actually have to do, you know, credit analysis, rather than just blindly relying on the credit rating, but it would instill discipline back into the market and punish idiotic structures like CDO-cubed's that couldn't exist without myopic modelers on the ratings side and gullible investors.
"Don't you dare buy a house now. You will lose money." - Cramer
Damn maybe were closer to the bottom then I thought.
It's too bad that everyone is so down on government regulation. It really does work for common goods problems like "information".
Ritholz posted a video from Steven Pinker, who happened to be saying something interesting. People often use language to be obtuse and deceptive and to maintain "plausible deniability". This is the free market outcome of normal human interactions. To prevent this, we need higher level regulation by social institutions.
subscriber-paid ratings wouldn't particularly solve anything because it would likely give bond investors even less incentive to do their own analysis. 'hey, i pay moody's to do that'. is that what we want? i would say one of the better results of this mess is that people will start doing more of the credit analysis work themselves.
U.S. Housing-Slump Bottom Not Yet Near, Fannie Mae's Mudd Says
The housing market won't hit a bottom ``until the end of '08 and then we have some period of time to work our way back up again,'' Mudd said today in an interview.
U.S. home prices will fall 2 percent to 4 percent this year, and ``more next year,'' he said.
Balance the playing field. If the sellside has someone working for them, then the buyside needs someone with a like kind service working for them and their best interest. I dont think this is rocket science and to have the government put there hands in this would only mess things up even more. They mess everything up. Look at there bail out plans. All they want is votes and the illusion of "doing something". Worthless. There are more important things they need to worry about like the BAO's report on the impending fiscal problems for the country because of Social security and healthcare costs from all the retirees that will be coming up. Just an FYI. The system will be insolvent and a huge drag on the economy if they dont fix it sooner rather than later.
subscriber-paid ratings wouldn't particularly solve anything because it would likely give bond investors even less incentive to do their own analysis.
Yep, paying for FICOs has really made us better mortgage underwriters, hasn't it? "Hey! I pay Fair, Issacs to read the details . . ."
you also might want to buy something with a little extra risk to juice your yield, but you don't want it to look like extra risk, so you get mad-eye to notch it up.
to have the government put there hands in this would only mess things up even more. They mess everything up.
So you think we should repeal the Fair Credit Reporting Act, and have Fannie and Freddie back off on policing creditors who manipulate ratings? Just let the ol' free market sort it out?
My take on this is that one reason why the ratings have sucked so badly is, in part, that the RAs don't demand enough gritty loan-level data to run in their models (leaving off what other problems there might be with the models).
Are investors really going to demand more data to look at?
All industry insiders have known all along that there is more information available on an origination and servicing database than the RAs use to measure collateral quality. And if it isn't there, the fields can be added; we do that all the time when new regulations come out.
But the demand was not for granularity, it was for executive summaries.
there's always money to be made off of information asymmetry
Perhaps the ratings themselves are where the problem lies. Dump the ratings and release the raw data. Not practical I'm sure, but it would clear some of the smoke.
After all, the current situation is one where the raw data is being disregarded in favor of a rating which pretends to be some sort of honest Cliff Note.
"have Fannie and Freddie back off on policing creditors who manipulate ratings?"
Those are a couple of outstanding corporations to use as an example Tanta. OK.
Tanta, didn't you read Moody's senate testimony yesterday? 'we need more loan level details from originators and servicers...'
i don't know if this link will work, maybe.
Moodys.com
Those are a couple of outstanding corporations to use as an example
Kevin, it happens to be a true example. What should I do, put on a pair of ideological blinders so that Fannie and Freddie are always the bad guys and the private sector is always the good guys?
It just blows me away that after all we've been through in the past year, people can still have that Pavlovian response to any mention of the GSEs, who differ from other mortgage companies because they got caught by the regulators long before the music stopped. I bet all the NEW and LEND shareholders, for instance, are really happy that they got out of FNM and FRE, aren't you?
Tanta - I dont think free market can regulate everything, but to have the government stick its hands into things everytime someone or people have a problem is not good. There should be some level of regulation, not excessive. Just provide a like kind service to the Buyside without the intervention from any rating agencies that get paid from the buyside. Its almost like a bid/ask price for ratings. What the government is doing is not a free market. A riskless free market is the same as religion without sin. Its not going to work.
bacon dreamz, the link won't work (and I'm a registered user). If you link to the public page the pdf link is on, I think it works.
And yes, I love hearing people with monopoly power whining about how they can't get information from those crazy servicers.
The whole reason I brought up the GSE credit reporting thing is because two big 800 pound gorillas used the power that they have to force servicers to cough up data.
If Fannie and Freddie can do that, the RAs can do it. You just announce that you will not rate a bond unless you get the data you want.
A riskless free market is the same as religion without sin. Its not going to work.
Yeah, well, I have a major problem with religion masquerading as economics.
Why do I feel that sometimes people just don't read my posts?
Who takes the privacy and theft risks of consumer credit reporting? Are you aware that consumers have no choice in this matter, and no "pricing power"? If you decide that you don't get a big enough "return" from having your personal data at a credit bureau, given the risks of theft or misuse of that data, you are aware I hope that you cannot opt out of it? You cannot stop someone from selling your payment history with Citibank if you don't care for the risk of that.
We have to stop pretending that only the "subscribers" are taking the risk.
okay, let me try again (hopefully this works):
Moodys.com
S&P analyst: 'oh man, now that all this blew up we're going to have to start digging through all that shit?...nutz.
Why do I feel that sometimes people just don't read my posts?
too text-heavy.
Tanta:
Why do I feel that sometimes people just don't read my posts?
Perhaps because they don't? Verbosity has its pitfalls you know.
(For the record, I do read them, usually in their entirety, though the holier-than-thou tenor sometimes grates.)
Tanta - I read all your posts, with vigor, might I add
I dont disagree with you, I was simply discussing the part of the issue I think individuals have more control over.
Someday, some 'consumers' will not be treated as wards of the credit rating system.
Someday, these 'consumers' be on equal footing with the other parties involved in electronic transactions, in the sense that they will have purchased the ability to project meaningful and valuable electronic interfaces into the marketplace.
Less intelligent consumers may waive their right to purchase such services, but I suspect it will become common knowledge that, to get a mortgage without such consumer-side services is foolish.
It still wont' be totally fair. The rich will always have better systems. But their advantage will no longer be based on the digital/transactional nakedness of the 'consumer'.
20 years out, I'd say.
This is an interesting question, Tanta, but it may soon be moot.
So far, it's been mainly the regulators, politicians and institutions asking questions about ratings agencies.
But if the municipal bond insurers unravel, it will be Mom and Pop Public shaking their fist and asking why their AAA-bonds turned to junk.
At that point, Merrill and others will have to implement a new more objective ratings scheme, just like the dot.bomb research saga. The older raters will get thrown out and new raters will come in.
I think I can rate default risk more accurately just reading a closing statement than a FICO. How would you rate a 95% cash out NINJA refi where the loan fees were $42,000 to net $48,000 cash out. Oh yeah, and the starting rate on the Option ARM was 9.25%.
I bet all the NEW and LEND shareholders, for instance, are really happy that they got out of FNM and FRE, aren't you?
Any other company would have been delisted by now for not filling thier Q's and their stock price would show it but I guess their special. Right?
Perhaps because they don't? Verbosity has its pitfalls you know.
Of course it does. But I didn't ask why people don't like them sometimes. That I know about. I was asking about where the comments are coming from.
That's the problem, you know. In order to try to move the conversation beyond the same old swapping of slogans, we have to get down into some nitty gritty. Sorry if it comes off as tedious, but hell, the net's full of blogs with short, 'tudeless writing. I'm trying to meet a different set of needs.
Brian, that is the source of my frustration. It's not whether people read the posts in their entirety or not; lots of people don't.
But the ones who don't bother to read the posts generally don't bother to comment on them. Sorry if I took your response to be a comment to my post, but I thought that's what it was.
Those of you who are just engaging in a forum that has only tangential relationships to the posts will just have to put up with a bit of impatience from time to time from the post writer, who is mistakenly under the impression that you were responding to what was written above that comment link.
Commenting has its pitfalls, you know?
How would you rate a 95% cash out NINJA refi where the loan fees were $42,000 to net $48,000 cash out. Oh yeah, and the starting rate on the Option ARM was 9.25%.
can i have the front-end NIM? if so, i'll rate your loan 'A+' with a smiley face!
I guess their special. Right?
Yes! Absolutely! Got it in one!
They are very very special. How many other Government Sponsored Enterprises do you know of, who have a federally-granted charter to provide liquidity to the mortgage marketplace?
When other companies accept the GSEs' mandates, maybe they can get the GSEs' deal with the delisting issue.
I'm perfectly willing to debate whether we need GSEs or not, but I'm not really interested in debating whether we should treat them just like any other company. That would be insane.
Tanta - I am an reader of all comments on this blog and all articles posted. I work in teh industry. I enjoy all of it. Ill apologize if my comment came out wrong. Now I will go to my room with no dinner and cry. LOL.
Now I will go to my room with no dinner and cry. LOL.
Hey! That's better than being in the doghouse, which is where I usually end up. Sure, I get dinner, but it's Alpo. Wanna swap?
Too bad we fired the egghead that used to sit in the corner cube and dissect those offerings. Apparently doing in-house due diligence would have been cheaper in the long run. Anyone have his current contact info?
Why do I feel that sometimes people just don't read my posts?
Because of selection bias? They only perceive what they think you're trying to say. To solve this we should have two rating services vet your posts: one, a GSE, and the other a private corporation. Or maybe just BDreamz could publish a rating and then we could just pretend we read them (like pretending we're doing due diligence) and,...
If it makes anyone else feel better, I usually have to read through twice, because Tanta's worldview and mine are so different.
I've been thinking about this for a while. Is it possible that the main reason that credit ratings agencies have been experiencing these problems is because disclosure requirements for debt issuers are frequently much lower than they are for public equity issuers - that ratings agencies are being paid because issuers (and I have to admit I'm primarily talking about corporate issuers here) prefer the situation to the disclosure arrangements they have for equities. I understand your point about FICO scores and credit reporting bureaus, and the security of their procedures, but I don't think it's fair to compare the privacy of individuals to the privacy of corporations. My personal feeling is that the institutions which depend on ratings will need to perform or pay for that analysis themselves. Banks, for instance, are starting to do this under Basel II, and there would be no reason for other users that depend on them for capital adequacy and solvency reasons not to take this function back in-house. Hedge funds and traders would no longer enjoy a free ride on this analysis, but the small number of bond rating firms outside the big three would be able to pick up some of this slack.
Let's say there was somebody out there who was really good, better than everyone else, at predicting default on fixed income securities. Why on earth would this person work for rating agency? This ability could produce at least a 7 figure income running a hedge fund.
Or maybe just BDreamz could publish a rating and then we could just pretend we read them
BD: Damnit lady, if you want this six page post to get a AAA rating you have to put up credit enhancement in the form of a colorful cartoon somewhere in the middle. It protects the post from lost readership by absorbing waning attention spans. And you better believe CE requirements are going up on 70s rock videos!
T: Look bub, this post is going up as is, and if you keep talking, I'm going to print out the 1000 words I edited out of this and shove them up your [deleted by siteowner] while I make you watch opera on YouTube.
BD (gasps and mutters meekly): Yes, ma'am, I'm sorry, can I get you another cup of coffee please?
I don't think it's fair to compare the privacy of individuals to the privacy of corporations.
Oh, I certainly agree with that. But structured securities are backed by loans made to individuals. You don't really want any old Tom, Dick or Harry getting access to your loan file to do "due diligence." GE may not have much right to the privacy of its accounts payable, but surely you and I do? By getting a mortgage, we didn't sign away our privacy to every jerk in the secondary market who might invest in a CDO tranche.
The security of the due diligence process is probably grist for another long and annoying post, but it's a big issue. If you send someone like me in to represent some institutional investor on a due diligence visit to some lender's file room, you are in fact giving me access to thousands of credit reports, bank statements, account numbers, you name it. Of course, when I did that kind of work I was affiliated with a consulting firm that carried a fair amount of liability insurance, and I cheerfully signed the confidentiality agreements, and I'm a trustworthy scout who would never supplement my earnings by selling some of the data I had access to. But if you think every trader and hedgie and other party out there would pay my rates (i.e., cover my E&O and surety costs), I think you're mistaken.
We already have cheap low-bid subservicers screwing up loans for less; I don't want to see cheap low-bid due diligence.
The rating agencies are very careful not to receive any personally identifying information about loans; they get these files with LTV and DTI and stuff, but they can't put a unique borrower on that file data. That's good news and bad news. The good news, obviously, is that the rating process isn't risking identity theft or misuse of personal data again. The bad news is that, for instance, they can't tell if ten loans in a pool are made to the same borrower. Now, I'd see that kind of thing in old-fashioned pool due diligence, and I'd kick up a problem with concentration (not to mention I'd notice if more than one of them was coded "principal residence").
End of the day: bonds backed by consumer credit are just different. Applying the same processes that we do for corporates is a problem.
Let's say there was somebody out there who was really good, better than everyone else, at predicting default on fixed income securities. Why on earth would this person work for rating agency?
Well . . . because consumer-credit-backed securities are Different.
They aren't supposed to have enough default variation to matter. I know that sounds weird, but that's because the context of the last several years is weird. I can't stress how historically unprecendented this "risk based pricing" or "high yield ABS" thing is. To say it's unprecendented isn't to say it's wrong--I'm not an old-fashioned conservative who believes that new = bad. I'm just saying that the fact that inefficiencies in credit default prediction seem "normal" is no reason to think it is, or that it will continue.
"The government" will get involved. Always. That's a fact. No elected member of Congress, the state legislators, or your local HOA is going to sit still if defaults on home mortgage loans get over a certain "tolerable" level. I'm not saying that's good, bad, or indifferent; I'm saying it's reality. Has been at least since FDR's day.
So there's not much of a seven-figure opportunity for those who can predict defaults outside of a relatively narrow band of them, because they will not be allowed to escape that band. That's the process we're in right now. And level of defaults will not always drive pricing of asset-backed bonds. If credit standards normalize, everyone will go back to worrying more about inflation or prepayment speeds than about credit losses, and credit analysts will go back to being their usual underpaid and invisible selves.
bacon dreamz: I really cherish your contributions to this blog.
Also, it's black, no sugar.
bacon dreamz: I really cherish your contributions to this blog.
Also, it's black, no sugar.
hey, backatcha. nothing ruins a good cup of coffee like milk or sugar, does it?
Well, I don't know about "nothing." Although I prefer my coffee unadulterated, I can forgive people who put cream in it. I can tolerate people who put sugar in it.
People who put artificial amaretto flavoring in it should be deported. I don't care if you were born here. Some other country needs you.
Well . . . because consumer-credit-backed securities are Different. They aren't supposed to have enough default variation to matter.
Consumer-credit backed securities were different. People with poor credit just couldn't get mortgages. Risk-based pricing almost requires a big jump in default since a good chunk of the premium on the coupon is going to be eaten up by default.
"The government" will get involved. Always.
You are probably right and I consider this outcome unfortunate since the government will do the wrong thing. The only way I see to lower the default rate is to ration credit to the best risks which would include both good credit history and lower LTVs. Our government will probably create some market distortion that raises the overall cost of borrowing and does little or nothing to stem the default rate.
If credit standards normalize, everyone will go back to worrying more about inflation or prepayment speeds than about credit losses, and credit analysts will go back to being their usual underpaid and invisible selves.
For consumer debt, possibly but there will always be segments like distressed corporate or emerging market sovereign debt where default risk is key component of the risk premium. My implicit assumption is default prediction skills are transferable between the consumer and corporate debt but I know of no reason why this would not be so.
"I really want to know why we think subscriber-paid fees in the bond rating world is going to result in something we'll be happy with."
That raises the question for me: what is it the investor community or other 'users' of ratings would be 'happy' with? Ratings are an opinion, not a recommendation (although a 'AAA' might seem like one), not a guarantee. In the end, investors should do their own homework and be 'happy' with whatever that happens to be. But if one relies on others to do your own homework, you may not be 'happy' with the result. If the investment is too complex to understand, that begs the decision to buy.....buyer beware.