There is little doubt about serious shortcomings for rating agencies and residential mortgage-backed securities and collateralized debt obligations.
By M.Soliman
PRESS RELEASE Sunday, November 15, 2009; Los Angeles, Calif // The rating agencies are viewed as instrumental in allowing the mortgage mess of 2007 and beyond to mushroom out of control. The Securities and Exchange Commission was on top of this issue earlier this year. The big three includes Fitch Ratings, Moody’s Investors Service and Standard & Poor’s whereby these market leaders dominated the rating component necessary for registrants to conduct business unchecked.
The objective is for structured finance ratings to help and not hinder investors who rely on rating agency assessments of collateral. RMBS deals were arranged by 12 investment banking firms and 90% of CDO deals were arranged by 11 investment banks.
We and analysts question how the rating agencies actually went about rating subprime collateral, CDOs and their role in the residential Mortgage backed securities sector consisting of collateralized securities offerings. The SEC investigation sought as much detail and any information from rating agencies leading to a more rationale understanding from such an irrational effort. What’s key here to consider is how critical the rating process is to securitization and why such a massive negligent effort was allowed to succeed.
In other words what are the underlying causes for the problems? Barring any information released from an SEC investigation conducted in June of this year the consensus leans more towards negligence and a general underscore for inappropriate reliance on historical status quo stemming from years gone by. Those years and historical accounts were more than less from portfolio cannibalism by the major securitizers and registrants.
“No doubt” say’s M.Soliman and industry sector analyst based in Los Angeles. “An obvious degree of ineptness was employed in modeling the risk weighted assumptions. Over collateralization was overly relied upon using assumptions void of the reality of artificially stimulated demand from trash content comprising program offerings. The effort by the end of 2004 demonstrated no regard for true meaningful consumption estimates seeking to scale a variety of credit tranches to a single category of cash strapped domestic homeowners.”
Conflicts of interest with regards to issuers are alleged at all three firms. Here is an example of the rating efforts inability to gauge risk and rate quality of assets and deal structure. These deals are structured by deficient modeling based upon some fairly complex assumptions built around some very easy to understand corollaries. For example how does the fact your anticipated cash flow is derived from cash strapped borrowers affect prepayment speed? And, what risk effect is obvious for underlying securities when the cash flows are solely dependent on phantom reserves and over-exaggerated borrower income determined from stated income verification acceptance methods.
The agencies will argue some adjustments using out-of-model rationale were employed. There is nothing available to evidence this assertion considering the rating models. According to Lori Richards, director for the office of Compliance Examinations and Inspections “It was impossible for us, as examiners, to understand the rationale, to determine what happened.”
I question the marketing practices and methods for generating customer brand and loyalty. So ask yourself this “was there likelihood to excite increased production by the agencies marketing divisions whereby concessions were offered to a ratings model solely to increase market share.
The SEC commission, who is absent from the broader subprime enforcement picture will eventually step in here, that is should it ever decide to take enforcement action. The SEC can certainly influence the solutions to the problem of rating agencies and integrity for RMBS and CDOs. It is assumed the three top agencies have initiated taking some action for correcting the problems. What else can serve as the elixir for ensuring investor confidence?
M.Soliman is an expert witness who provides attorneys with testimony in mortgage fraud related cases. He can be reached at 213-627-2324

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