Rating Agencies and Junk Science: Credit Crunch Cocktail (Video)

CNBC's Squawk Box – September 11, 2007

»VIDEO: Rating Agencies and Junk Science - CNBC (subscription required)

The cartel-like benefits of the NRSRO designation have made the rating agencies complacent. If I can see the problems in advance, if hedge fund managers can see the problems (the shorts), the rating agencies could have seen them:

In 2003, I devoted a large part of my book Collateralized Debt Obligations and Structured Finance to the fact that rating agencies are not properly rating CDOs. Since 2003, I’ve pointed out several failings in ratings of several types of CDOs and followed up with several articles. Since early 2006, I have said subprime CDOs are misrated.

SEC: On February 14, 2007, my comment letter on proposed rules for the credit rating agencies was the first one received and posted on the SEC’s web site. I warned that “AAA-rated” CPDOs were misrated, and the credit rating agencies were not following even basic statistical principles.

AAA Failures

• “AAA” tranches of ABS CDOs are not fully AAA
• “AAA” tranches of CDO-squared have principal risk
• “AAA” rated debt of Unmatched Structured Investment Vehicles (SIVs) were recently downgraded to CCC
• “AAA” rating on principal-at-risk Constant Proportion Debt Obligations (CPDOs)

The rating agencies have completely failed where it counts most:

• Not distinguishing between BBB and BB- corporate backed tranches 2005/2006
• Downgrades of BBB tranches of new vintage (2006 and 2007) subprime backed CDOs
• Not demanding documented evidence of appropriate due diligence of the collateral risk on mortgage loans
• Not demanding thorough background checks on CDO managers
• Giving out “AAA” ratings to principal-at-risk structures tied to leveraged market bets


Clients of Tavakoli Structured Finance also have access to proprietary TSF research, which is not published in any other paid or public forum.

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