Clive Crook is the former deputy editor of The Economist and is currently a senior editor at The Atlantic. He blogs at:

clivecrook.theatlantic.com

Oh, so it was the free market that caused this problem and not Fed policies? The solution is to let the thieves fail not socialize their losses and not create more regulations which "the smartest guys in the room" will always be three steps ahead of. The free market didn't create the problem but it could definitely solve it.

lesserliz -

The "smartest guys in the room" showed they weren't smart enough to understand the consequences of their own actions - and that is why we need enhanced regulation. They claimed the financial structures they created would spread the risk but instead these structures obscured the risk. They can ascribe any risk profile they like to a package of loans but when they are six layers removed from the borrower the likelihood of that risk profile being accurate is diminished. And we are all paying the the price for their hubris.

The idea is laughable that the "free market didn't create the problem but it could definitely solve it." This is precisely the mentality that caused the problem.

Where to begin?

First of all, Clive Crook is a left-wing nut who has dropped all semblance of impartiality in his blog and his articles.  He suffers Bush Derangement Syndrome in the extreme; I would not read or take his word on anything, including vacation recommendations.

Secondly, having been an analyst at one of the rating agencies in the exact field of quantitative analysis of CDO's, CMO's, and other structured financial assets, I can assure you that there was no malice or willful misconduct on the part of the agencies.  Perhaps their default tables (historical data) were not conservative enough.  Perhaps the modeling analysis was wrong in that it assumed higher than realized recovery rates.  But the last year's subprime mortgage defaults exceeded any historical expectations.  At the rating agencies, we were constantly assuming conservative estimates of future possible defaults.  The bankers, as their jobs entailed, always complained that we were assuming the worst case scenarios.  Apparently, the worst cases were not bad enough.

You can't blame the bankers either because if your competition at the other firms are closing 10 deals a month, what are you going to do? Hold off and watch your career prospects go down the tubes? There was peer pressure to do deals even if your instincts told you that these deals were not risky.

The mortgage brokers were largely at fault; because they couldn't care less about the future performance of the loans, they lent as much as they could.  These brokers immediately turned their mortgage over to one of the large investment banking firms for collateralization so what do they give a damn whether the guy loses his home or not?

Then there's the homeowner themselves.  They should have done proper due diligence on their abilities.  Buying a house is not like buying vegetables.  You have to know what you're getting into and have enough capital stowed away in case you lose your job and need cash flow to pay the mortgage.

If one were to assign blame, it'd probably be about 35-40-20-5 (Mortgage Brokers - Home owners - bankers - rating agency).

There are several problems with jwl2672 's comment:

-- First of all, Clive Crook is a left-wing nut who has dropped all semblance of impartiality in his blog and his articles.  He suffers Bush Derangement Syndrome in the extreme; I would not read or take his word on anything, including vacation recommendations.

This is obviously false. The odds of a left-wing nut becoming deputy editor of The Economist are precisely nil. Furthermore, Crook's blog focusses on economics not politics and in a quick browse just now I didn't see the name Bush mentioned at all. jwl2672 is confusing Crook with someone else and that someone else is probably Paul Krugman since jwl2672 is mouthing of a typical wingnut diatribe against Krugman.

-- Secondly, having been an analyst at one of the rating agencies in the exact field of quantitative analysis of CDO's, CMO's, and other structured financial assets, I can assure you that there was no malice or willful misconduct on the part of the agencies.

Of course the part of the financial world employing jwl2672 is totally innocent. The rating agencies voluntarily gave AAA ratings to piles of horse manure masquerading as sound financial instruments. And, of course, the ratings agencies were not handsomely compensated for going along with the financial models underpinning CDOs.

-- But the last year's subprime mortgage defaults exceeded any historical expectations.

The problem is not that mortgage defaults exceeded historical expectations the problem is that they matched historical expectations. It was pretty widely reported over the last several years that the financial world was proud of its newfound computer-driven ability to identify customers to whom products like credit cards and mortgages could be sold even though these customers would previously never have been offered these products - because they were too risky. The financial markets allowed short-term greed to swamp any desire to understand, let alone manage, the risks they were willfully exposing themselves to.

While homeowners do deserve some of the blame for this crisis the majority of the blame must be reserved for those foolish enough to lend them the money all the way up the chain.

ndmack-the "mentality that created the problem" was that the Fed is all-knowing and and can create money forever without the inevitable consequences of money printing(bubbles, inflation, dollar decline). I 'm not giving credit to the "smartest guys" I am saying that there will always be predators like them who can work around any new regulations to their benefit. The free market solution is to let the malfactors suffer their losses. What is laughable is the notion that more Fed bullsh*t is going to correct the problem. And to put out a fire add more gasoline.

The only way to get out of the current mess is to go to its roots, and return to the personal responsibility that is inherent in the private-property order. Further regulating will only open new doors for doing shaky business. Verbal sh*t shovelilng from politicians can't change the nature of reality. Or we can await Zimbabwe's fate.

NDmackenzie:

I'm pretty sure it's Crook.  He's the dude who writes in the Atlantic? I remember reading several of his articles and shutting off the web page in disgust.  His Economist articles may be a little more on point and on facts but his Atlantic articles are off the deep end.

And another thing, rating agency fees are not "handsome" in the least.  They're approx. 6-10 basis points on 300MM deals which works out to about $180K-300K.  Analysts at the agencies always got paid less than their banker counterparts and usually by a wide margin.

Also, the tranches atop one of these deals are not horse manure.  As I've used in an analogy before, imagine each one of these tranches as a 5 layer wedding cake.  The mice (defaulting loans) eat the bottom layers/tranches first.  There'd have to be a shitload of mice to eat all the way up to the top.  And the statistical probability of that was nil.  Hence the AAA ratings.  

The problem was exacerbated by rating agency conditions (put in place to protect investors) that required the deal to start selling assets into a down market after tests were failed.  If they held the assets until maturity, maybe enough mortgage borrowers might have paid up to prevent the collapse of these deals.

And I have to agree with lesserliz about the smartest guys in the room being always 3 steps ahead.  Face it, no one who is really smart would work for the Fed at gov't salaries.  They'd be at the banks trying to circumvent and profit from any rules that were passed.

In fact, the huge explosion in structured deals (and hence the enormity of their  failures) had a lot to do with new Fed rules introduced after Enron.  Companies were looking to offload assets from their balance sheets to avoid capital charges.  They'd create shell companies to offset these assets and liabilities.  And they'd sell them to "sophisticated investors," like pension plans and such.  But of course, none of the plan managers really knew what they were buying.  It's pretty difficult to fully understand the risks of these deals unless you're completely entangled in this very specific sector of the finance industry.

JWL2672

Why did your  ratings agency  give a AAA ratings to a CDO chalk full of loans  where neither the income, assets or debt of the party was verified? Do you think this represents due diligence. .

Aren't ratings agencies responsible for detecting fraud?  Really, verifying income, assets & debt of borrowers is not a terribly complicated endeavor

As it turns, out, this whole subprime debacle is chalk full of fraud. I challenge  you to identify when any of the ratings agencies rejected a CDO because of borrower misrepresentations, and reported their findings to the proper authorities.

Myself, I think that borrowers how engaged in fraud should not be bailed out. Ditto those who purchased properties as investments, and now are being forced to eat their investment

Finally   all parties who failed to perform due diligence on these investments should be out of business. And JWL, that means your company

tembrach

You don't understand the difficulty of analyzing these loans.  In most cases, these deals were worth billions.  Divide 1 billion by the average mortgage size ($250k?) and you get 4000 mortgages.  4000 credit analyses? And as an analyst when you have 8 deals in your pipeline (8 x 4000 = 32000)?There is positively no way for any rating agency (at the price they were paid and with their limited number of employees) to drill down to the level of individual mortgage borrowers.  The best we could do was to use averages and standard deviations.  Loan to value metrics, weighted average credit score, weighted average risk ratings, etc. etc.

And even if one were to drill down to the level of individuals and their personality/job stability, who's to say that that analysis would be adequate? Do remember that these were deals that have existed only for the past decade.  The analysis as well as the techonology of the structure were created piecemeal and was always a work in process.  The rating agencies regularly changed their methodology to adapt to new data or new capabilities in computer modeling.  I'm not trying to defend them (quite frankly, I don't care cause I don't work for them anymore), but the truth is the truth.  I find it very annoying when people compare 20/20 hindsight with 20/200 foresight.

Do read today's (4/11/08)  article on exactly this subject, regarding Moody's relaxing its ratings analysis when issuers complained.

online.wsj.com/.../SB120787287341306591.html

It's eye opening.  Even though I was an analyst there until 2000, I wasn't privy to the senior level discussions on how to improve market share.  The Managing Director, Brian Clarkson, from my experience was a hard driving head who did put pressure on analysts to relax ratings and also would swap analysts if an issuer complained.  The analysts themselves were bookish types however who wanted to be conservative and to "get it right. "

So in light of these revelations, my assignment of blame to the rating agencies would have to double to 10%.  They're still not entirely at fault (who's more liable the thief or the incompetent cop?) though.

Apparently since my departure from the company they've undergone quite a few changes and not for the better.  A spin-off from a parent company and personal stock options will do that to ya.

I've posted about the rating agencies -- Moody's, S%P, Fitch -- myself, and about their culpability

I've been posting about the rating agencies (Moody's, Fitch, S&P) for months. They and the

Henry Waxman, the chairman of the House of Representatives oversight committee, said on Wednesday that