NBER charges ratings agencies with playing favorites
The larger the issuer of mortgage-backed securities, the better the ratings assigned to the deals, according to a white paper from the National Bureau of Economic Research. Due to the favorable ratings, the large issuers, which pay ratings agencies for this service, experienced higher yields on MBS products, at lower prices. The practice was particularly widespread from 2004 to 2006, the NBER paper claims. Consequently, smaller issuers, the NBER report suggests, were placed at a competitive disadvantage. During those three years, commercial banks were the most prevalent MBS issuers, accounting for about 39% of the deals, followed by investment banks at 22%, thrifts with 20%, finance companies 9%, and other firms 10%. All three major ratings agencies, Moody's Investor Service, Standard & Poor's and Fitch Ratings told HousingWire they needed more time to review the white paper before commenting. According to the paper, yield spread on MBS was about 10% higher on tranches sold by large issuers than similarly rated tranches issued by small issuers during market boom years. "For rating agencies, the new fixed-income products emerging out of the growth of structured finance provide substantial revenue potential beyond their traditional market of corporate bonds," the NBER paper claims. "The total volume of originations of subprime mortgages, for example, rose from $65 billion in the late 1990s to over $600 billion in 2006," the text states. "In the case of Moody’s (Investors Service), profits tripled between 2002 and 2006." "There is also direct evidence that rating agencies offer price discounts for large and frequent issuers of corporate bonds," the NBER alleges. But the report does not place all of the responsibility for overly optimistic ratings on the shoulders of credit ratings agencies. Many sophisticated investors and policymakers systematically underestimated default risk in housing, particularly the risk that the whole U.S. housing market would decline simultaneously, the report said. Larger issuers are responsible as well, as they likely sought to bargain with the ratings agencies as more funds received triple-A ratings. Write to Jacob Gaffney. Follow him on Twitter @jacobgaffney.