C.M.O. 3.12.2009

Credit Market Overview
March 12, 2009

In the first part of this millennium the two major rating agencies, Moody’s and S&P, competed fiercely to place “AAA” stamps on a host of collateralized debt products being produced by those that were paying their fees.

In a bit of a turn-around in late April of 2008 (post Bear Stearns) S&P published a report lowering its assumptions for the amount of money investors might receive after defaults of subprime mortgage bonds, leading to downgrades of the CDO’s they had given their blessings to.

The report said that S&P’s new recovery assumptions put the percentage of loss at 100% for any class of debt rated A or lower and moved just slightly above that (95%) to any class rated AA. Saving the best for last the company stated that junior AAA tranches should expect loses of 65% and super-senior AAA tranches, 40%.

S&P and its major competitor, Moody’s, did not stop there and have since downgraded CDO tranches numbering in the tens of thousands. Again, a case of closing the gate after the horse is gone. Additionally, these two companies have now focused on sovereign debt and appear to be falling over each other to add names from Western and Eastern Europe to the list of possible downgrades.

Speaking yesterday at the U.S. Chamber of Commerce Jamie Dimon asked the audience if at any point during the current crisis anyone had moved their money from more risky to less risky investments. Although the camera did not pan the room it appeared from Mr. Dimon’s expression that there was a healthy positive response.

Mr. Dimon then pointed to those same people and said that they helped contribute to the credit crisis. There was a bit of nervous laughter but stepping back for a moment it is easy to see that Jamie was right. By when you think about it by moving to more conservative investments (a.k.a. cash) the investing public had migrated away from the risk side of the spectrum creating more selling pressure on “undesirable” assets. JD immediately comforted those who had replied affirmatively saying it was the logical thing to do; intimating that it was completely in line with the constructs of basic human nature.

Taking this revelation from the individual to the institutional level it is easy to see that the rating agencies, while placing their seal of approval on instruments that were purchased by investors around the globe, helped to inflate the bubble, they have also added to the carnage via downgrades as the World’s economy has contracted.

While it is not a stretch to think that S&P and Moody’s are now taking a hard line on ratings to prevent the possible end of their current, albeit until recently, extremely lucrative business model by demonstrating that they’ve changed their fast and lose ways. Their actions also make clear that regardless of direction, the rating agencies have acted with only their own interests in mind and to repeat myself from above: “completely in line with the constructs of basic human nature”. As a result they have proven once again that in all things market related “caveat emptor” is the order of the day.

Jim Delaney