What follows are excerpts from Absence of Fear, an excellent...

What follows are excerpts from Absence of Fear, an excellent article written by Robert L. Rodriguez at First Pacific Advisors. BEA 4th Quarter GDP 1st Estimate 0.7% Q&A: Why Did GDPNow Rise After Durable Goods? When are Construction Revisions Coming? We were on the March 22 call with Fitch regarding the sub-prime securitization market’s difficulties. In their talk, they were highly confident regarding their models and their ratings. My associate asked several questions. Fitch: They responded, FICO scores and home price appreciation (HPA) of low single digit (LSD) or mid single digit (MSD), as HPA has been for the past 50 years. Essentially Fitch extrapolated a model of constantly rising home prices forever into the future, in spite of obvious signs of rampant speculation and home price appreciation far above the long term average for four consecutive years. In addition, Fitch made no allowances for reversion to the mean on home prices, in fact did not even make provisions for a flattening market let alone a reversion to the mean at a time of massively declining lending standards, and with home price appreciation orders of magnitude above affordability indices and rental prices. That is some set of assumptions that Fitch made in their model isn't it? One might think that those flaws are so obvious that anyone with any reasonable degree of competence would catch. The asset quality problems in sub-prime and Alt-A have the potential to affect other areas, such as the collateralized debt obligation (CDO) market, in ways that many of the holders of those securities have little idea of how exposed they might be to unexpected changes in the security’s credit rating. It is estimated that U. S. banks have invested as much as 10% of their assets in CDOs, and the Office of the Comptroller of the Currency (OCC) requires that all of those CDOs be investment grade, says Kathryn Dick, deputy comptroller for credit and market risk. She says, “We rely on the rating agencies to provide a rating.” As Kevin Fry, chairman of the Invested Asset Working Group of the U. S. National Association of Insurance Commissioners says, “As regulators, we just have to trust that rating agencies are going to monitor CDOs and find the subprime.” While so many investors and regulators are relying on these ratings, the rating agencies take the position, as exemplified by S&P, “Any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision.” S&P: “Any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision.” Starting with 'does not perform, due diligence' I doubt that truer words were ever spoken. A lawsuit will likely decide whether or not Moody's has an obligation. If someone has Fitch's disclaimer and I would be glad to post it, but I am told it is similar. So in spite of Fitch being proud of its model (back in March anyway) the ratings companies warned people not to use their ratings. I wrote about Moody's stunning display of twisted logic, whereby they actually made it a blessing to have rising default risk. June 29 (Bloomberg) -- Standard & Poor's, Moody's Investors Service and Fitch Ratings are masking burgeoning losses in the market for subprime mortgage bonds by failing to cut the credit ratings on about $200 billion of securities backed by home loans. The highest default rates on home loans in a decade have reduced prices of some bonds backed by mortgages to people with poor or limited credit by more than 50 cents on the dollar and forced New York-based Bear Stearns Cos. to offer $3.2 billion to bail out a money-losing hedge fund. Almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the ratings criteria in place when they were sold, according to data compiled by Bloomberg. That may just be the beginning. Downgrades by S&P, Moody's and Fitch would force hundreds of investors to sell holdings, roiling the $800 billion market for securities backed by subprime mortgages and $1 trillion of collateralized debt obligations, the fastest growing part of the financial markets. 'You'll see massive losses from banks, insurance companies and pension managers,' said Joshua Rosner, a managing director at investment research firm Graham Fisher & Co. in New York and co-author of a study last month that said S&P, Moody's and Fitch understate the risks of subprime mortgage bonds. 'The longer they wait, the worse it's going to be.' Rosner estimates that collateralized debt obligations, which have packaged thousands of bonds and derivatives into new securities, will lose $125 billion. Institutional Risk Analytics, a Hawthorne, California-based company that writes computer programs for accounting firms, says 25 percent of the face value of CDOs is in jeopardy, or $250 billion. Losses may rival the savings and loan crisis of the 1980s and 1990s. The Resolution Trust Corp., formed by the U. S. government to resolve the thrift crisis, sold $452 billion of assets at a cost to taxpayers of about $140 billion. article on Bloomberg points to obscure references of things but the article is missing. For whatever reason, Bloomberg seems to have removed the article and switched links to it to a second, far more tame article written at a much later date. How can it be that an entire system of investment decisions are based on ratings that the ratings companies tell everyone not to use for investment purposes? Why has only a minuscule portion of subprime debt (2.1% or $12 billion of a massive $565.3 billion of subprime bonds) downgraded. See Why is it that ratings companies are allowed to have outside business relationships with the companies whose debt they rate? Did banks realize how absurd those ratings were but look away because of greed and the ease in offloading he debt to pension plans, insurance companies, and hedge funds out of pure greed? Heck, did the upper echelons at the ratings companies themselves know their ratings model was flawed and look the other way out of greed? The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. 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