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Moody’s Credit Ratings and the Subprime Mortgage Meltdown Essay

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Moody’s Credit Ratings and the Subprime Mortgage Meltdown

Table of Contents

Introduction……………………………………………….3

Background………………………………………………..4-10

Analysis……………………………………………………10-12

Conclusion…………………………………………………12-13

References………………………………………………….14

In the early-2000s, Moody’s, one of the leading credit rating agencies in the world, evaluated thousands of bonds backed by so-called “subprime” residential mortgages—home loans made to those with both low incomes and poor credit scores. When housing prices began to fall in 2006, the value of these bonds disintegrated, and Moody’s was compelled to downgrade them significantly. In late 2008, several commercial banks, investment banks, and mortgage lenders that had been
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Rating agencies also had a strong motivation to compete for market share by catering to their clients. In 2000, Moody’s became an independent, publicly owned firm after being released by its parent company, Dun & Bradstreet. This placed even more pressure on Moody’s managers to increase revenues and improve their shareholder’s returns. (Lawrence, p. 456) From this point on, we begin to see the credit rating agencies drastically underestimate the risks of mortgage-backed securities in a selfish attempt to further their own bottom lines. The birth of structured finance came from new techniques of quantitative analysis used by Wall Street investment banks, and suddenly, Moody’s was not just evaluating corporate, municipal, state and federal government bonds. Structured finance consisted of combining income-producing assets—everything from conventional corporate bonds to credit card debt, home mortgages, franchise payments, and auto loans—into pools and selling shares in the pool to investors. (Lawrence, p. 456)
A structured finance product that became popular in the early 2000s was the residential mortgage-backed security (RMBS). An RMBS started with a lender—a bank like Washington Mutual or a mortgage company like Countrywide Financial—that made home loans to individual borrowers. The lender would then bundle several thousand of these loans and sell them to a Wall Street investment bank such as Lehman Brothers or Merril Lynch. The Wall
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