Credit rating agencies and the subprime crisis

Credit rating agencies (CRAs)—firms which rate debt instruments/securities according to the debtor's ability to pay lenders back—played a significant role at various stages in the American subprime mortgage crisis of 2007–2008 that led to the great recession of 2008–2009. The new, complex securities of "structured finance" used to finance subprime mortgages could not have been sold without ratings by the "Big Three" rating agencies—Moody's Investors Service, Standard & Poor's, and Fitch Ratings. A large section of the debt securities market—many money markets and pension funds—were restricted in their bylaws to holding only the safest securities—i.e. securities the rating agencies designated "triple-A".^[1] The pools of debt the agencies gave their highest ratings to included over three trillion dollars of loans to homebuyers with bad credit and undocumented incomes through 2007.^[2]^[3] Hundreds of billions of dollars' worth of these triple-A securities were downgraded to "junk" status by 2010,^[1]^[4]^[5] and the writedowns and losses came to over half a trillion dollars.^[6]^[7] This led "to the collapse or disappearance" in 2008–09 of three major investment banks (Bear Stearns, Lehman Brothers, and Merrill Lynch), and the federal government's buying of $700 billion of bad debt from distressed financial institutions.^[7]

^ ^a ^b McLean, Bethany and Joe Nocera. All the Devils Are Here, the Hidden History of the Financial Crisis, Portfolio, Penguin, 2010 (p.111)
^ (the raw material of the debt securities)
^ Smith, Elliot Blair (September 24, 2008). "Bringing Down Wall Street as Ratings Let Loose Subprime Scourge". Bloomberg. Driven by competition for fees and market share, the New York-based companies stamped out top ratings on debt pools that included $3.2 trillion of loans to homebuyers with bad credit and undocumented incomes between 2002 and 2007.
^ $300 billion collateralized debt obligations (CDOs) issued in 2005–2007 (over half of the CDOs by value during that time period) that rating agencies gave their highest "triple-A" rating to, were written down to "junk" by the end of 2009. (source:The Financial Crisis Inquiry Report (PDF). National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. pp. 228–9.)
^ Barnett-Hart, Anna Katherine. "The Story of the CDO Market Meltdown: An Empirical Analysis" (PDF). March 19, 2009. Harvard Kennedy School. Retrieved 28 May 2013. Overall, my findings suggest that the problems in the CDO market were caused by a combination of poorly constructed CDOs, irresponsible underwriting practices, and flawed credit rating procedures.
^ Cite error: The named reference loose was invoked but never defined (see the help page).
^ ^a ^b Smith, Elliot Blair (September 24, 2008). "Bringing Down Wall Street as Ratings Let Loose Subprime Scourge". Bloomberg. Without those AAA ratings, the gold standard for debt, banks, insurance companies and pension funds wouldn't have bought the products. Bank writedowns and losses on the investments totaling $523.3 billion led to the collapse or disappearance of Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. and compelled the Bush administration to propose buying $700 billion of bad debt from distressed financial institutions.

[McLean_p.111-1] McLean, Bethany and Joe Nocera. All the Devils Are Here, the Hidden History of the Financial Crisis, Portfolio, Penguin, 2010 (p.111)

[2] (the raw material of the debt securities)

[scourge-top-3] Smith, Elliot Blair (September 24, 2008). "Bringing Down Wall Street as Ratings Let Loose Subprime Scourge". Bloomberg. Driven by competition for fees and market share, the New York-based companies stamped out top ratings on debt pools that included $3.2 trillion of loans to homebuyers with bad credit and undocumented incomes between 2002 and 2007.

[4] $300 billion collateralized debt obligations (CDOs) issued in 2005–2007 (over half of the CDOs by value during that time period) that rating agencies gave their highest "triple-A" rating to, were written down to "junk" by the end of 2009. (source:The Financial Crisis Inquiry Report (PDF). National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. pp. 228–9.)

[meltdown-5] Barnett-Hart, Anna Katherine. "The Story of the CDO Market Meltdown: An Empirical Analysis" (PDF). March 19, 2009. Harvard Kennedy School. Retrieved 28 May 2013. Overall, my findings suggest that the problems in the CDO market were caused by a combination of poorly constructed CDOs, irresponsible underwriting practices, and flawed credit rating procedures.

[loose-6] Cite error: The named reference loose was invoked but never defined (see the help page).

[scourge-gold-7] Smith, Elliot Blair (September 24, 2008). "Bringing Down Wall Street as Ratings Let Loose Subprime Scourge". Bloomberg. Without those AAA ratings, the gold standard for debt, banks, insurance companies and pension funds wouldn't have bought the products. Bank writedowns and losses on the investments totaling $523.3 billion led to the collapse or disappearance of Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. and compelled the Bush administration to propose buying $700 billion of bad debt from distressed financial institutions.

[1]

[2]

[3]

[4]

[5]

[6]

[7]