Credit rating agencies like Moody's, Standard & Poor's, and Fitch understate the risks underlying securities backed by subprime mortgages and could thus be held liable for investor losses, according to a study to be presented Friday at the Hudson Institute in Washington. The agencies, the study claims, cannot accurately assess the probability of losses because the underwriting standards of the home loans that back the debt are always changing. The study also holds that because the agencies are not impartial – they work with investment bankers to structure deals, and underwriters pay for the ratings they provide -- the agencies themselves could be considered underwriters according to U.S. securities regulation. The agencies maintain that their role is simply to provide opinions that are constitutionally protected by the First Amendment. The criteria they use to reach those opinions are available to anyone, including investment bankers. Bond investors could lose up to an estimated $75 billion on securities backed by subprime mortgages, and S&P noted last month that subprime mortgage-backed securities from 2006 may be the "worst-performing in recent history.'' Moody's rated 96.7% of subprime mortgage bonds created last year, S&P 97.6% and Fitch 51.3.
Sources: Where Did the Risk Go? -- Draft of study by Joseph R. Mason and Joshua Rosner, MoneyCentral, Bloomberg
Commentary: Moody's Concerned About Lending Standards Slide • Credit Rating Companies: The Subprime Debacle's Latest Casualties • It's Not Surprising They're Moody
Stocks/ETFs to watch: Moody's Corp. (NYSE:MCO), Thomson Corp. (TOC), The McGraw-Hill Companies, Inc. [owner of Standard & Poor's] (MHP). ETFs: iShares Lehman 1-3 YR Treasury Bond (NYSEARCA:SHY), iShares Lehman 7-10 YR Treasury Bond (NYSEARCA:IEF), iShares Lehman 20+ YR Treasury Bond (NYSEARCA:TLT)
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