Legally, Moody’s did nothing wrong. But Moody’s, through it rating system, enabled other agencies to provide loads to individuals that were not qualified all in the name of financial gain.
Was Moody’s at fault, no, was the financial system that Moody’s was part of, flawed – absolutely, yes. The issue that that Moody’s needed to address was how ethical were their decisions as a company as their revenue grew from $564 million in 1999 to nearly $2. 3 billion in 2007 – an increase of nearly 75% in 8 years. Does a company’s ethical duty exceed legal obligation? Which stakeholders were helped and which were hurt, by Moody’s actions?The companies that provided the securities in exchange for favorable ratings were the stakeholders that benefitted the most.
The case study also mentions that Moody’s charged 11 basis points ($11 for every $10,000 in value) for RMBS (residential mortgage backed securities) due to the complexity of the security, which is higher than the typical 4. 25 basis points for traditional corporate bonds which makes Moody an obvious stakeholder as well. The more RMBS’s that were issued and sold by lending institutions to investment houses, the more Moody would make as it rated each transaction.The investors, such as Merrill Lynch and Lehman Brothers were the ones that were hurt the most as the investments they purchase, quickly were devalued as homeowners defaulted on loans they could not afford. You could probably include the homeowners receiving these loans as well since they, technically, did nothing wrong other than applying for and receiving money for a home they could not afford. Did Moody’s have a conflict of interest? If so, what was the conflict, and who or what were the principal and the agent? What steps could be taken to eliminate or reduce this conflict? The bond rating system did not work in this instance.
Moody’s built its company on rating bonds, beginning with rail road bonds, in the early 1900’s. Moody’s conflict of interest was being paid to rate bonds that were held by investment banks that it partnered with. All institutions from the lender to the investor to Moody’s had a vested interest in issuing as many loans as possible as the continued issuance would lead to a stronger rating from Moody’s. These loans provided cash flow for the lending institutions to continue to issue subprime loans to unqualified home owners, in essence, this was a vicious cycle.Stronger government oversight and regulations would probably help this situation, but the government would need to act more quickly to even realize there is a problem.
Is this case, the writing was on the wall in early 2000’s but wasn’t recognized until late 2006, early 2007. What share of the responsibility did Moody’s and its executives bear for the financial crisis, compared with that of the home buyers, mortgage lenders, investment bankers, government regulators, policymakers, and investors? According to Raymond McDaniel, Jr testimony before the House of Representatives congressional committee, Moody’s did nothing wrong, basically blaming the system.My opinion is that Moody’s has to bear some of the blame for the crisis as it was the one that provided the positive credit ratings to the investment bankers, as well as compensating them for issuing the loans. They did not rate the home owners or the mortgage lenders themselves; I view this as the trickle-down theory. Moody’s was the top of the pyramid and facilitated the ratings which drove the lenders to create the loans, which were sold the investment banks for cash to generate more loans to unsuspecting home buyers.
What steps can be taken to prevent a recurrence of something like the subprime mortgage meltdown?In your answer, please address the role of management policies and practices, government regulation, public policy and the structure of the credit ratings history. There were little to no regulations in place, which led to the crisis. Lending money to borrowers that were not qualified as evidenced by a man who received a $540,000 loan even though he didn’t have a full-time job and a weak credit history. This is just one example where the system failed as it provided loans to people with poor credit history and high debt to income ratios.
As mentioned previously, the subprime issue arose as a combination of events that nearly crippled the economy and sent it into a recession that we only now, in 2014, beginning to come out of. It began with the lenders, which were fueled by the investment banks which were funded by the credit ratings agencies which relaxed their standards in the name of the ol’ mighty dollar and lastly the investors who purchased the securities which were generated by the lenders and investment banks and rated by Moody’s.