Case Study One

Case Study One

Moody’s Credit Ratings and the Subprime Mortgage Meltdown

  1) What did Moody’s do wrong, if anything?

What Moody’s did wrong was that it gave mortgage-backed securities a high rating making them appear safe for investors and bonds issuers. The problem with this high rating is that Moody’s used the wrong data to estimate the risk. Looking back historically, what they saw was a very low rate of defaulting, a very low foreclosure rate. However, the current situation was different - with new qualification requirements, new mortgages given to people who would never have gotten them before and of course, and a big speculative housing bubble that eventually popped.
2) Which stakeholders were helped, and which were hurt, by Moody’s actions?

It was a double edged sword for Moody’s stakeholders.   They enjoyed the massive gains on the way up and then suffered the massive losses after Moody’s began to readjust the risk ratings. The people who took out as many loans as possible to purchase homes that they clearly could not afford were also hurt by Moody’s actions.   After Moody’s rating adjustment many loan rates when up and subprime customers could no longer make the mortgage payments. Also, the investors who bought mortgage –backed securities were negatively affected. Many banks and loan agencies went under after the “bubble popped”. One of the main banks that were hurt by this was Washington Mutual.

3) 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?

I believe that there was a conflict of interest between Moody’s and the companies they rate for. The conflict is that the companies being rated pay Moody’s, the rater. The higher they rated the RMBS the higher the fees they received from the investors or banks.   In fact, so lucrative was for Moody’s to rate these securities that the profit...