Dangerous Myths about NRSROs

In her article on the RGE Monitor Web site, R&R’s Ann Rutledge discusses two myths that she sees offered as fact in a recent position paper by the Financial Economists Roundtable, “Reforming the Role of the Statistical Ratings Organizations in the Securitization Process.”

Myth 1: The notion that SROs ever evaluated collateral. “Even the SROs have made no secret about accepting data provided by sellers and financial arrangers at face value without investigation.”

Myth 2: The notion that SROs played a central role in creating and marketing tranches of graded claims. “I call this assertion a myth, but perhaps a better word is ‘half-truth.’ It is true that the target rating — without which the market cannot establish a price — determines tranche size. But what is missing is the explicit recognition that rating and structure are non-linearly interdependent. To ignore the nonlinear relationship between structure, rating and price or interest cost, is to build in a loophole in the system for one party, usually the seller, to exploit at the expense of the other, usually the buyer.”

Ann concludes, “Our banks today still hope for forbearance. Thus far, the government seems to be letting them have their way. The accounting system is badly damaged. The financial system still clings to the illusion that ratings mean something. The truth of ratings and the structured finance market is still muddled in emotion, ignorance and confusion. So far, the solutions have all been political. But, any political solution is a zero sum game. If we do not want to go on being manipulated by the same institutions who had profited illicitly from a perversion of securitization and ought now to earn back the trust of the public or face resolution, our only choice is to begin to insist on factual analysis.”

Readers on the RGE Web site commented, “This article is outstanding. I practiced in the area of mortgage securitization for about 7 years, and I have never seen a better technical analysis of the root problems with valuations and the rating system.” “Excellent article. I wish I had the confidence that members of the FER have the same insights as you. In my opinion, they are discussing perceptions not reality.”

Ann’s comments are a continuation of her commentary on the FER statement, following her first article, “Rethinking Our Inheritance.” Ann will explore other myths in the FER statement in future blog articles.

Read Ann’s full article on RGE Monitor, complete with graphic cash flow models and reader comments.