Not one Wall Street Law Blog contributor majored in economics or has an MBA. Still, some of us did take freshman economics in college (and some of us dropped it). We seem to remember a few lessons from our college years that cast this AAA credit gaming - err, rating - thing in a dubious light.
If two investments offer the same return, but one investment is riskier than the other, then (according to our old notes) all rational investors should choose the safer investment. Similarly, if two fixed-income investments have the same risk profile and were issued at or around the same time, the investments should offer close to identical returns.
If two fixed income investments issued at or around the same time have the same credit rating, but one has a higher yield than the other, rational investors will buy the investment with the higher yield. This can happen for short time periods. However, market forces should quickly act on, and correct, the discrepancy in investment returns.
It violates fundamental principles of economics for two AAA investments to produce different returns for an extended period (we think).
And yet, during the housing bubble era, AAA (as safe as an investment gets) rated mortgage-backed securities and AAA-rated CDOs consistently promised and produced higher returns than AAA rated U.S. Treasuries. How was this possible?
It seems to us at WSLB that these returns could not differ substantially unless...unless... unless these AAA credit ratings for mortgage-backed securities were rigged.
By rigged, we mean the issuers of mbs and CDOs filled with mortgage-backed securities (mainly our once mighty investment banks) understood that the AAA rating to mortgage bonds meant something different that the AAA rating given to, say, impregnable U.S. Treasuries.
The point - it appears - was that most investors wouldn't think twice once they saw the AAA rating. Investors simply looked at a AAA rated mortgage security and assumed a mortgage bond was in fact as safe as a bond issued by the United States Treasury (which has never defaulted on its debts).
To our litigation trained eyes, something is rotten in Denmark... Could be some old gouda cheese or possibly securities fraud.
By The Staff
Wall Street Law Blog
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