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Ratings agencies and the Subprimes

Senior staff knew early in 2007 that products rated the previous year had received top-notch triple A ratings and that, after a computer coding error was corrected,
their ratings should have been up to four notches lower.
FT May 20 2008

In a statement to the FT, Moody’s said:
“Moody’s regularly changes its analytical models and enhances its methodologies for a variety of reasons, including to reflect changing credit conditions and outlooks. In addition, Moody’s has adjusted its analytical models on the infrequent occasions that errors have been detected.
“However, ...

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Credit rating agencies need radical reform if they are to do their job properly
Helmut Reisen 3/3 1998

/The rating agency/ Fitch disclosed as recently as March 2007 that
their model for rating CDOs assumed low to single digit home price appreciation forever into the future.

Michael Shedlock, December 31, 2007

This mass belief in a faulty housing premise in spite of evidence to the contrary in Japan is what helped form the US housing top. Greater fools everywhere who came to believe that faulty theory eventually rushed in to speculate in housing. That made the top. Even the rating agencies got into the act.

Please consider Fitch Discloses Its Fatally Flawed Rating Model. As amazing as it might seem now, /The rating agency/ Fitch disclosed as recently as March 2007 that their model for rating CDOs assumed low to single digit home price appreciation forever into the future.

They even admitted their model would break down if home prices were flat for an extended period of time.

es, there are a handful of us that see deflation coming, but as Nimesh writes "For almost thirty years people like you have predicted that our economy will collapse and it hasn't happened."

Mocking of the early visionaries is part of the topping process. Group think sets in and is reinforced over the years. Risk premiums drop as the long term trend reaches the peak. That takes time. Memories fade. Does anyone fear another great depression? Heck, does anyone even remember it, let alone fear it?

Why The Credit Bubble Lasted For Decades

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Ambac, the world’s second-biggest bond insurer, on Friday lost its crucial triple-A credit rating,
undermining its ability to add new business and dealing a blow to the billions of dollars of securities it has guaranteed.
Rating agency Fitch cut the bond insurer’s credit rating to double-A, citing a $1bn capital shortfall caused by losses on mortgage-related bonds Ambac has guaranteed. Fitch did not rule out further downgrades, citing “significant uncertainty with respect to the company’s franchise, business model and strategic direction”.
FT January 18 2008

The real problem is the "monoline insurers" like ACA, Ambac, and MBIA.
Here's a quick primer on how they work.
John Mauldin

Credit rating agencies must rapidly demonstrate that they are reforming their activities or face a clampdown, Michel Prada, the senior French regulator warned.
Gillian Tett, FT January 18 2008

In their fifth evidence session inquiring into financial stability following the Northern Rock crisis, the Treasury committee grilled representatives of the three largest credit rating agencies: Fitch, Moody's and Standard & Poor's. Corporate credit rating agencies are companies that assess the creditworthiness of bonds and bond issuers, in return for a fee. And they gave many securitised assets containing subprime mortgages triple-A ratings.
Agencies have now begun to downgrade these mortgage-backed securities, but questions are being asked as to whether they should have ever been assigned the top rating - and whether agencies should have warned investors of the risks earlier.
Elaine Moore, Financial Times Nov 17, 2007

Regulators to probe ratings agencies
Financial Times Nov 09, 2007

A task force, set up by an umbrella group for global securities regulators, is to examine the role of the credit rating agencies in the subprime crisis and accompanying market turmoil.