At the start of this year, Moodys published a research piece entitled Archaeology of the crisis. One might have expected the rating agency to steer clear of digging up the bones of the sub-prime debacle, as it, along with its fellow raters, wrongly classed billions of dollars of sub-prime RMBS and ABS CDOs as top-quality securities. It seemed that the rating agency was starting 2008 with a New Year confessional.
But this was no mea culpa. Rather, Moodys argument boiled down to this: "It is wrong to blame us or other actors for what has just taken place, because things are so complicated it is virtually impossible for anyone to really know what is going on. But hey, its OK because without financial markets being allowed full freedom to operate and innovate, economic growth would slow."
This is facile. It ignores the fact that most so-called innovations have been thought of before just under another guise. Excessive leverage is a commonplace feature of bubbles. Its the task of regulators and rating agencies to analyse the structural complexity that disguises it, not to avoid responsibility by hiding behind that complexity.
Six months on, news emerges of Moodys failure accurately to rate constant proportion debt obligations because of a glitch in its computer software. As a result, it rated this new innovation some four notches higher than it should have, meaning that the securities received triple-A ratings, much to the consternation of DBRS and Fitch whose methodology could not get the instruments beyond single A.
Was this cock-up or conspiracy? Cynics might suggest that the prospect of earning fat fees from the issuers the arranging banks overcame any doubts Moodys might have had about awarding the top credit rank to the innovation. Similar opinions have been expressed previously in relation to the agencies ratings for sub-prime RMBS, ABS CDOs and the monoline insurers. Detractors even suspect that there was a fee-earning agenda behind the agencys wholesale upgrading of financial institutions in 2006, a move that it was forced to back down from in the face of severe market hostility.
The CPDO revelations seemingly remove a vital part of Moodys wider defence on its structured finance ratings methodology. It did not immediately come clean on its mistake and immediately downgrade the securities the four notches lower to single A. Had it come clean as soon as the mistake was uncovered (apparently early in 2007) it would at least have been able to maintain that it acted in good faith. Instead, by not seriously downgrading CPDOs for nearly a year, it has left itself open to accusations of a cover-up. Surely disgruntled CPDO investors will open up this line of reasoning in law courts at a later date should the occasion arise.
But at least Moodys has the defence that it got it so wrong because it made an honest mistake even if it did surreptitiously lower the ratings on these bonds, masked by using the wider credit markets deterioration, early in 2008.
What shield against the cynics does S&P have? S&P was the only other agency to grant CPDOs a triple-A rating at the time. It cannot have had the same software problem as its co-duopolist. S&P is not explaining its position... for now. But surely, given the ever hardening regulatory stance on the agencies, it will have to come clean at some point.