"Who d'ya trust?": The Mortage Bond Raters
Triple-A Failure, an interesting look into the bond-rating agencies.
Imagine a college-educated analyst in a little office, working an excel sheet that describes a bunch of homeowners borrowers. This "quant" lacks crucial expertise and visibility into the mortage market, but he sure can work a pivot table!
This ignorant, but well-meaning analyst has been a crucial cog in the mortgage mess. They, and their employers, have been key influencers in the international market for mortgage-backed securities. The ratings given to mortgage backed bonds are critical to their acceptance to investors, and thus the growth of this market.
The growth of this market for mortgage-backed bonds, in turn incentivized banks and lenders to prime the lending pump, encouraging shaky borrowers, cajoling loan officers and generally cutting corners to approve more home loans. Thus, we have the growth of the mortage industry, fueled not by demand from the housing market, but by demand from the bond market.
One of my interests is in quantitative finance, partucularly in finding ways to model and price "real" assets. One of the things I have learned, and is illustrated in this article, is the fact that many folks who have to model markets and assets, have little connection to what they are modeling. The analysts had no good method of checking the validity of their models or assumptions. And the people who depended on these models to make decisions misvalued investments and misread risk. The same thing happens all the time in banks, product companies, and marketing firms.
(hat tip to Agonist)
Shizi
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