2. Our ratings on structured deals are merely opinions, protected by the 1st Amendment; and
3. We downgraded these mortgage securities on a timely basis.
By suggesting that the deals had a reasonable margin for error, Moody's suggested that the ratings were assigned in good faith (Number 1). And by suggesting that a deal could burn through a 10% loss rate before any rated debt tranches would be impaired, it suggested that the need to slash the ratings of subprime bonds in April 2007 was less than obvious, (Number 3). As you'll see, the rating agencies put forth a variety of distortions that can be subsumed into these three categories of deceit, which all require further explication.
1. We rated these residential mortgage securities in good faith.
A Simple Example: Residential mortgage securitizations involve a number of moving parts, so before we get into all the conceptual issues, let's start off with a concrete example of a preposterous rating. GSAA Home Equity Trust 2006-1, a $900 million transaction put together by Goldman Sachs, financed 3,965 Alt-A home mortgages. It's substantially similar to hundreds of other Alt-A deals structured without any reasonable assurance that the borrowers could afford to pay back their loans, or that the loans had not been induced by fraud.
About 82% of the mortgage pool was comprised of "stated income" loans, aka liar loans. The remainder included loans that relied on "alternative" forms of documentation. About 89% of the loans were interest-only, which substantially reduced the borrowers' monthly payments. To establish each borrower's creditworthiness, the deal relied on FICO scores, which averaged 709. However, a FICO score is not based on a borrower's income, and FICO scores are easily manipulated.
The borrowers financed, on average, 88% of the home's appraised value, with: (a) about 78% from first lien mortgages held as collateral by GSAA 2006-1, and (b) another 10% in 2nd lien financing. A majority of the loans were located in four states California, Florida, Arizona and Nevada--where home prices had doubled over the prior five years. Since all of the loans were originated by non-bank lenders, primarily Countrywide Home Loans and PHH Mortgage Corporation, the source of the down payments was not verified. Federal Anti-Money Laundering statutes applied only to depository institutions, like banks or S&Ls.
By adding up all those risk factors, "Moody's expects collateral losses to range from 0.80% to 1.00%." In other words, the expected loss on this deal was lower than the average expected loss observed on jumbo loans in the early 1990s. Which is how GSAA Home Equity Trust 2006-1 could be structured with 94% of the deal rated triple-A. Did Moody's have any reasonable basis to believe that this pool of 30-year loans would incur credit losses in the range of 1%? No, none whatsoever. For anyone with a background in credit, or for anyone familiar with the concept "garbage-in/garbage-out," this is obvious. As Markopolos said, you can figure out that something is really wrong in about five minutes. And Moody's rated hundreds of Alt-A deals just like this one, for which it calculated an expected loss in the range of 1.5% or less.
As with the other rating agencies, Moody's analysts were compelled to rely on a financial model that was rigged to produce the results desired by Wall Street clients. In theory, models are useful tools for analysts and managers. But in practice, the analysts are frequently subservient to the models or templates, and their primary job is to rationalize a consistency with the models' design flaws. Now let's go through the different ways that the rating agencies violated the basic rules of credit in order to award the bogus credit ratings that fueled the real estate bubble.
Rating Through The Bubble
The key to Michael Kanef's testimony before Congress, and to Moody's disinformation campaign, is embedded in the subordinate clause of this sentence:
"As illustrated by Figure 3, the earliest loan delinquency data for the 2006 mortgage loan vintage was largely in line with the performance observed during 2000 and 2001, at the time of the last U.S. real estate recession."
There was no real estate recession in during 2000 and 2001. On July 6, 2000 the Mortgage Bankers Association announced that delinquencies had fallen to a 28-year low. Though overall delinquencies would rise thereafter, they remained low by historical standards, because home prices kept rising everywhere, even in the states affected by a severe manufacturing recession. Subprime delinquencies rose during 2000 and 2001, but they fell dramatically in the later part of 2001, when Greenspan began slashing interest rates and pushed home prices further upward.
A housing bubble conceals a multitude of sins. If a borrower can't afford his monthly installments, he sells his house and recovers his equity. Or he refinances with a bigger loan based on a higher appraised value. Or he flips the house, in which he never intended to live, to secure a quick profit.
By using 2000/2001 as a benchmark, Kanef wanted to mislead Congress and the public into believing that Moody's rated these deals "through the cycle," that the ratings were calibrated according to how the deals would fare during a cyclical downturn. In fact, Moody's, S&P and Fitch did the opposite. They rated through the bubble. In order for their ratings to work, the housing bubble had to continue its upward climb. If home prices experienced the gentlest of soft landings and fell even slightly, hundreds of billions of investment grade mortgage securities got wiped out.
Since time immemorial, real estate lending has been governed by two rules: (1) Location, location, location; and (2) Timing is everything. Simply put, after a loan is booked, the rate of home price appreciation, upward or downward, is the most important factor in determining whether a lender gets his money back. The impact is exponential. That is, when prices are rising at a brisk pace, the risk that a borrower will default is exponentially lower. And if a borrower does default in a rising market, then the rate of loss on any foreclosure sale is exponentially lower.
Next Page 1 | 2 | 3 | 4 | 5 | 6 | 7
(Note: You can view every article as one long page if you sign up as an Advocate Member, or higher).
1
1
1
