Tuesday, November 4, 2008

Rating agency surprised by the markets

Deven Sharma, President of Standard & Poors stated in front of the US House of Representatives' Oversight Committee that the agency had been surprised by the developments in the housing and mortgage markets:

"S&P is not alone in having been taken by surprise by the extreme decline in the housing and mortgage markets. Virtually no one -- be they homeowners, financial institutions, rating agencies, regulators, or investors -- anticipated what is occurring. Although we highlighted to investors looming issues we saw in the housing market as far back as early 2006, the reality remains that in publishing our initial ratings on many of these securities we never expected such severe, negative performance in thehousing and mortgage markets. There is no doubt that had we anticipated theextraordinary events that have occurred -- and we did not -- we would haveutilized different economic forecasts and would not have assigned many ofthe original ratings that we did."

I think this is a fairly embarrassing statement for a company that has a business model to evaluate the likelyhood of an asset's default based on careful research and analysis.

Investigations by the Oversight Committee have shown that S&P's own analysts were not always convinced that their ratings were accurate. Have a look at these excertps of an S&P internal IM conversation:
Rahul Dilip Shah: btw: that deal is ridiculous
Shannon Mooney: I know right ... model def does not capture half of the risk
Rahul Dilip Shah: we should not be rating it
Shannon Mooney: we rate every deal
Shannon Mooney: it could be structured by cows and we would rate it

When the head of the company says that S&P is not wiser than the other participants as far as market developments are concerned, it begs the question what the company's purpose actually is.

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