Sunday, November 11, 2007


A report in the week-end edition of the Wall Street Journal dated Saturday/Sunday, October 27 - 28, 2007--that Moody’s, Standard & Poor and Fitch are being investigated in connection with potential antitrust violations--sheds light on potential abuses that may account for the recent precipitous round of rating downgrades by these same agencies. According to the REPORT, the Connecticut Attorney General’s office has issued subpoenas to the three rating agencies in connection with the alleged practice of “unsolicited ratings, “notching,” and “exclusive contracts.” CLICK HERE FOR FULL ARTICLE.

"There are allegatuions that some raters conduct an unsolicited rating and then demand the issuer pay for it or face a possible poor rating," the attorney general said. Notching is when raters allegedly threaten to downgrade an issuer's debt unless they get a contract to rate the issuer's entire debt pool, even if parts already have been assessed by another agency.
Exclusive contracts give issuers discounts for having all their debt rated by a single agency. "Such agreements may hinder competition by locking out other debt raters," the attorney general said.

These practices, if they did occur, are designed to do anything but ensure accurate classification of residential mortgage backed securities, such as collateralized debt obligations (CDOs). Whether the alleged practices violate antitrust laws or not, they could and would have resulted in inaccurate and misleading ratings upon which investors relied in purchasing CDOs, which have been sold in the billions. Such practices would also explain why many such products have been substantially downgraded only a few months after receiving a favorable rating.

In fact, the same Wall Street Journal edition carries a report with the headline “CDO Ratings Are Whacked By Moody’s: AAA to Junk in a Day Raises More Questions About Credit Arbiters.” The Journal announces $8.3 billion of DOWNGRADES by Moody’s primarily in connection with mortgage back securities. In one instance a $843 million CDO slice, known as a tranche, and having a AAA rating (which means first call on the income stream of a mortgage loan pool) was downgraded “10 notches to a junk rating of Ba1.” Another $229 million AAA tranche was cut “14 notches to a junk rating of B2.”

These kinds of changes can lead to a distress sale by purchasers, such as insurance companies, pension funds, and hospital or educational non-profits, who are required to hold rated investments by regulatory mandate or by the terms of their established investment policy.

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