Rating Junk Mortgage Credit as Quality High Grade Loans

This WSJ article highlights how lenders shoped their loan portfolios to a wide array of rating firms like Standard & Poor’s and Moody’s, looking for the best rating, and taking their business elsewhere if the ratings were not as high as they would have liked:

When Wall Street first began securitizing subprime loans, rating firms leaned heavily on lenders and underwriters themselves for historical data about how such loans perform. The underwriters, in turn, assiduously tailored securities to meet the concerns of the ratings agencies, say people familiar with the process. Underwriters, these people say, would sometimes take their business to another rating company if they couldn’t get the rating they needed.

“It was always about shopping around” for higher ratings, says Mark Adelson, a former Moody’s managing director, although he says Wall Street and mortgage firms called the process by other names, like “best execution” or “maximizing value.”

Every rating system gets worked, from the lanuage used to classify investments (junk vs subprime) to how investments are mixed and rated. The problem with this sort of cozy relationship is that end investors typically remain ignorant to the process until it stops working. And then nobody could have seen it coming, but once the rating firms give a bit here or there the relationship heads down a long slippery slope that virtually guarantees it will fail. Even Alen Greenspan endorsed subprime loans, but now Angelo R. Mozilo, the CEO of Countrywide, said home prices were falling “almost like never before, with the exception of the Great Depression.”