A big culprit in the housing crisis is punished

After living through the housing crisis and reading and watching news, books and movies, I read with interest that one of the biggest culprits has been punished – the rating agency Moody’s. In my view and the view of others, Moody’s failed in its job to forewarn investors of the true risks of packaged together mortgage loans. They fell into a “pay to play” modus operandi.

What is pay to play? Per an article in Reuters, “Moody’s ratings were ‘directly influenced by the demands of the powerful investment banking clients who issued the securities and paid Moody’s to rate them,’ Connecticut Attorney General George Jepsen said in a statement on Friday.” This would be akin to you paying off the inspector of the house you just built and want to sell. The buyer would not know the inspector was gaming the system against him or her.

So, individual investors, pension funds, 401(k) funds, states, and countries all fell prey to this pay to play ratings approach. Iceland had to declare bankruptcy, e.g. As a result of their actions, Moody’s was fined $864 million which will be distributed to twenty-one states and the federal government, who were part of the lawsuit.

We should not lose sight of an industry who became enamored with riskier investments and did not ask enough questions. Executives did not fully understand the risk they were taking on and it brought them down, along with the housing market, stock market and economy. An excellent movie to watch is called “The Big Short,” based on Michael Lewis’ book, which takes a complex topic and explains it with the dialogue, but also with clever sidebars which use laymen’s terms to define what things mean.

In essence, mortgage loans were given out to anyone who could fog a mirror, then these lesser risks were packaged together to spread risk and sold to investors. The problem is packaging bad risks does not make the risk less, it makes it concentrated bad risk. The law of large numbers to mitigate risk is only effective if good risks are mixed with some bad risks. Moody’s stamped these packaged loan investments with much higher ratings than they deserved. And, investors who trusted Moody’s and the seller bought them in good faith.

We rely on Moody’s and other rating agencies to take their job with seriousness of purpose and ethics. If they cannot shoot straight with us, they will let us down. And, that is precisely what they did. In my view, that fine may not be enough for the damage they helped perpetuate.

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8 thoughts on “A big culprit in the housing crisis is punished

    • Hugh, thanks. This is a complex issue, which is why it needs to be broken down as done in “The Big Short.” The movie makes you less trustworthy of investment bankers and mortgage lenders looking passed risk to make a profit. Keith

  1. Let me guess… no one went to jail. Although $864 million sounds like a lot, given the enormity of the fraud, it hardly sounds like enough. The Big Short did a great job explaining each step that led to the collapse. My logic and skepticism tell me that we haven’t seen the end of the corporate corruption that will eventually put us in a similar position again.

    • Janis, with the idea that some hold that everything about the Dodd-Frank is bad and it should be repealed is evidence that memories are poor. Dodd-Frank need improvements, but should remain. And, the Consumer Financial Protection Bureau that the GOP wants to do away with would be a horrible mistake as it is hugely successful. Keith

    • Holly, you bet. If you get a chance, the movie is very good with Christian Bale, Steve Carell, Ryan Gosling with a key cameo from Brad Pitt. Christian Bale’s character predicted the housing crisis about 2 years before and tried to forewarn people, then bet against them and was laughed at. He made huge fortune for his clients. His big concern right now – water. Keith

  2. Dear Keith,

    Thanks for a great blog.There was a commission established to look into all of this and the participants did a great job..Here is the source:[PDF]:
    Financial Crisis Inquiry Report (PDF) – U.S. Government …www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf FINANCIAL CRISIS INQUIRY REPORT .
    The commission listed some bad actors that should be further investigated. This would definitely meet the test of “intense public interest. Have you seen any action on this by the FBI.

    Ciao, Gronda

    • Gronda, many thanks. Here is summary dated in 2014 of various fines following the housing meltdown. Not all were directly traceable, but are related. Bank of America, Citibank, JPMC and Wells received their fair share. Bear Stearns, WaMu and Wachovia all were bought for peanuts and Lehman, of course, went under. Bank of America had bought Merrill Lynch for a bargain and Countrywide has been the gift that keeps on giving in penalties and fines after BAC bought them quiute cheaply.

      The one group who is the poster child for the meltdown, yet was a small player, is Beazer Homes. Their C-suite actually were punished for crimes. They gamed the system by dressing up applications and not revealing to the client that they owned the inspector and mortgage company.

      At the bottom of all this is greed, as these players took advantage of people who wanted the American dream and sold them loans and houses they could not afford. Keith

      http://finance.yahoo.com/news/u-s–bank-penalties-now-exceed-the-gdp-of-most-countries-160353393.html

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