Bear Stearns, Lehman and company made sure nobody understood the garbage they were peddling.
Each mortgage backed security (MBS) included different tiers, called “tranches”, which permitted investors to select from a series of different risk-return profiles within the MBS.
The top tier of a MBS, called the senior tranche, was the safest investment in a mortgage-backed-security and carried the lowest yield. By giving up yield, investors in senior tranches of mortgage-backed-securities had the first claims on the cash-flows generated by monthly payments on underlying mortgages. Even though the senior tranche of a MBS often held only subprime mortgages, S&P, Moody’s and Fitch almost always rated the senior tranche as “investment grade.”
Investment banks turned low quality mortgages into investment grade securities by over-collateralizing the senior tranches of MBS's. In other words, Wall Street stuffed senior tranches full of enough extra subprime mortgages to allegedly give investors a sufficient cushion of extra cash-flow to protect investors against the possibility that some subprime borrowers might default. That explanation - along with the high fees Bear Stearns, Merrill Lynch, Lehman and others paid to S&P, Moody’s and Fitch for rating the securities – was nearly always sufficient to secure the all-important investment grade credit rating.
Because investors had almost no way to tell what was in a MBS, or a CDO filled with many mortgage-backed-securities, the word of the ratings agencies was gold. This is how Wall Street used a little double-talk, and a lot of cash, to get their subprime junk an investment grade rating.
By Brett D. Sherman, Esq.
In some sense, it seems as though the rating agencies were not even rating the actual issues but rather were rating the methodology used to create the issues. After all, the agencies never even bothered to look at any of the underlying assets, and so they could not possibly have been rating based on them.
If this is the case, then this was a SEVERE departure from what they were claiming to do and what investors had been led to believe they had done. And because they were not telling anyone that this is what they were doing, doesn't their first amendment argument fly right out the window?
In essence, it isn't so much a matter that their ratings were wrong (which would be protected under the first amendment), but rather that they misrepresented what they were doing (which would not be so protected.)
Posted by: Benedict@Large | 13 May 2009 at 01:58 AM