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Friday, June 29, 2007 9:33 PM

The Rating Game Scam

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Bloomberg is reporting S&P, Moody's Mask $200 Billion of Subprime Bond Risk

Standard & Poor's, Moody's Investors Service and Fitch Ratings are masking burgeoning losses in the market for subprime mortgage bonds by failing to cut the credit ratings on about $200 billion of securities backed by home loans.

The highest default rates on home loans in a decade have reduced prices of some bonds backed by mortgages to people with poor or limited credit by more than 50 cents on the dollar and forced New York-based Bear Stearns Cos. to offer $3.2 billion to bail out a money-losing hedge fund. Almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the ratings criteria in place when they were sold, according to data compiled by Bloomberg.

[Mish comment: 65% of the subprime bonds no longer meet the original (and flimsy) initial ratings criteria. One might think that would be reason to re-rate the bonds. Think again.]

That may just be the beginning. Downgrades by S&P, Moody's and Fitch would force hundreds of investors to sell holdings, roiling the $800 billion market for securities backed by subprime mortgages and $1 trillion of collateralized debt obligations, the fastest growing part of the financial markets.

[Mish comment: What's with this "may" stuff. We are obviously just getting started, and the wildfire is going to spread far beyond subprime]

"You'll see massive losses from banks, insurance companies and pension managers," said Joshua Rosner, a managing director at investment research firm Graham Fisher & Co. in New York and co-author of a study last month that said S&P, Moody's and Fitch understate the risks of subprime mortgage bonds. "The longer they wait, the worse it's going to be."

[Mish comment: Corporate America always puts off until the bitter end anything and everything that looks smells or tastes like medicine, no matter how sick the patient is and how badly the medicine is needed. The reason is simple: short term profits are at stake and the greed and fees to be made by protecting improper relationships is simply too overwhelming]

Institutional Risk Analytics, a Hawthorne, California-based company that writes computer programs for accounting firms, says 25 percent of the face value of CDOs is in jeopardy, or $250 billion.

Losses may rival the savings and loan crisis of the 1980s and 1990s. The Resolution Trust Corp., formed by the U.S. government to resolve the thrift crisis, sold $452 billion of assets at a cost to taxpayers of about $140 billion.

[Mish comment: Rival the S&L crisis?! These losses are not going to "rival" the S&L crisis. The S&L crisis vs. the current mess is more like comparing an ant to a moose.]

Executives at New York-based S&P, Moody's and Fitch say they are waiting until foreclosure sales show that the collateral backing the bonds has declined enough to create losses before lowering ratings on some of the $6.65 trillion in outstanding mortgage-backed debt.

[Mish comment: S&P, Moody's and Fitch say they are waiting for Godot. The fact that Merrill Lynch could not find buyers for the toxic waste at Bear Stearns was not good enough for them. Nor was the fact that the Bear had to put up over $3 billion to prevent a fire sale of assets. I guess if you can stop the fire sales, then you don't have to mark anything to market? Is that the idea? Of course it is. And it is an extremely risky game, that is guaranteed to blow up. I suspect all of the players no it now too. But as long as the game goes on, lucrative fees and more deals can be put in the pipeline. No one cares about the consequences down the line.]

"We're taking action as we see it," said Brian Clarkson, Moody's global head of the structured products in New York. "We're not doing knee-jerk responses."

[Mish comment: Of course you're taking action as you see it. You see that if you tip the boat you jeopardize relationships that you really ought not be in, in the first place. In other words you are not acting as an independent rating company at all. Not only are you not making "knee-jerk" responses you are doing anything at all other than cover up for those in trouble.]

Downgrades of CDOs "could finally force the hand of ratings-sensitive holders," Morgan Stanley analysts led by Vishwanath Tirupattur in New York wrote in a reported dated June 28. "Our worry is that this selling would be very unbalanced, with no established taker of risk on the other side, even at current market levels."

"The Petri dish turns from a benign experiment in financial engineering to a destructive virus," Gross, who oversees the world's biggest bond fund, said this week in a commentary on the firm's Web site. The companies gave the mortgage bonds investment-grade ratings, duped by the "six-inch hooker heels" of collateral that can't be trusted, he said.

[Mish comment: Petri dish is an apt description. But the mold is not only toxic but spreading. Is that stopping Moody's, Fitch, or the S&P? Of course not. All three have made it clear they are not going to react until the patient is dead.]

Fitch is "deliberate" in its actions, John Bonfiglio, the firm's head of U.S. structured finance ratings, said in an interview in his New York office. Fitch is a unit of Paris-based Fimalac AS. "I would not say we were slow."

[Mish comment: "Deliberate", yes that is a good word for what is happening. Fitch is taking "deliberate" measures to try and contain the mess rather than downgrade debt that the market has stated to downgrade and that Fitch should damn well better know deserves a downgrade. By the time any of the ratings companies actually does make a mammoth debt downgrade, the debt is likely to have hit bottom and ready to rally.]

S&P abandoned seven-year-old criteria for determining a bond's protection against default in February.

Under the old guidelines, S&P said a bond's "credit support'' must be twice the rolling 90-day average of the sum of value of mortgages delinquent by three months or in foreclosure plus real estate that has been seized by the lender.

[Mish comment: Guidelines? What guidelines? Who needs guidelines? Certainly the S&P has no use for anything that would make them downgrade this toxic waste before they are damn good and ready.]

Fitch, Moody's, and the S&P ought not be allowed to have outside relationships with companies whose debt they rate. By the way, the same idea holds true for the Merrill Lynch, Bear Stearns, and Goldman. I have talked about this many times before. But if there was ever any doubt about the ability of ratings companies to police themselves that doubt should now be erased. The current process is nothing but out and out fraud.

Hello from Homer Alaska. I have been in Alaska since June 23, fishing, kayaking, hiking etc. If you wanted an explanation for no economic posts from me for nearly a week, there it is. I simply had no computer access most of the time I was here. I arranged for some posts to be made for me in my absence (thanks trotsky) as well as a book review and a post on energy. I will be back in full swing next week.


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