And did they review the FICO score distribution, or how many loans were stated income?

There were indicators - its not about what percentage of loans go into default. It's about what percentage of Stated Income Loans at a certain FICO score range go into default (and I'll bet there was NO history to this question).

here's the quote

"Moody’s used statistical models to assess C.D.O.’s; it relied on historical patterns of default."

They compared History of Mortgages of people who got mortgages, with people who NEVER got mortgages in the past. This is a comparison of dis-similar populations. It's invalid. Moody's compared a population of people who historically got mortgages with a population of people who historically did not get mortgages. Provably dis-similar populations.

That's a classic case of negligence.

I am not willing to let them off the hook so easily.
Smart people do stupid things if they think they can take the money and run...especially when there is a lot of it and your client is asking for a 20% return.
The river of denial flowing thru our financial industry is so deep. There has been a 30 years run of free market propaganda, if it feels good do it, casino lottery make my day money for nothing and the chicks are free.
As long as they believed the invisible hand was just wanking them, it was all ok and gogo on to the next big thing.
But karma can be a bitch and it looks like she wants her due.
When the snake oil salesman tries to sell to another snake oil salesman, the market usually freezes up. Everyone is lying to everyone else and fiduciary responsibility is such a headache. Just repackage it and keep the ball moving.
I've never seen a black swan so they don't exist. Right?
Isn't that what we've been doing for at least the last 30 years?

Hi, thanks for pointing out this great article.

This is not a black swan, however. This is simply an example of lack of rigour in both modeling the underlying assets, and a lack of rigour in due diligence.

The banks, mortage firms, and credit agencies were both greedy and lazy. They cut corners.

If you fail to do your due diligence on any asset, blaming a default (or even a perceived windfall) on an obscure probabalistic phenomena is a lame excuse, in my book.

I'm not a finance guy, but the article mentions that Moody's breakthrough was condensing all of the information into a single value. As much as the people who produce these ratings appear to be ...ethically unfettered... people who are relying on blatantly oversimplified analysis should hardly be described as sophisticated investors.

Regardless, markets crunching is basically inevitable - any system wich is basically a bunch of agents trying to predict the behavior of the system is going to go through phase changes. Tying a bunch of things together just means a smaller number of nastier crashes.

With 700 Trillion worth the Ds out there, the day some one calls in their marks it's by, by. China after the Games?
jo6pac

Lots of people, including Warren Buffet were warning about this for some time. The rating agencies could not have been unaware of this.

The problem, as the article suggests, was the cozy relationship between the agencies and the investment banks and broker dealers who were paying them for the triple A ratings.

This relationship doesn't pass the smell test.

Conflict. Of. Interest.

were too simplistic. In that respect, they were incompetent.

Obviously all of reality is cycles within cycles, but it seems there is a larger con permeating the system that is glaringly obvious, but minimally commented on. The efforts to privatize Social Security would be a clear example. Beyond all the arguments whether we can trust government or free markets is the obvious fact that there are limits on effective investment potential in the economy and they are already flooded with too much capital. The savings glut, as Bernanke put it. The cause of this whole mortgage backed securities mess in the first place is because of this need to find ways to invest the surplus of wealth.
Now obviously no one with a tenured position in the corporate media is going to examine this because it goes to the heart of Capitalism. When you have a religion of money for money's sake, is it any wonder we should have far more money floating around than anyone knows what to do with.
So I think it is extremely obvious that the next stage of stability isn't going to arrive until we begin to understand the functions and limits of a currency system as a tool of a healthy society and economy, not the pagan god ruling over it. As a medium of exchange issued, regulated and insured by the government, it is a form of public utility, not private property and the totem of extreme wealth needs to be dismantled, not just because it is a waste of resources we can no longer afford to waste and amounts to fatty deposits on an economic body on the verge of a heart attack, but because it provides a corrosive and corrupt ideal for the rest of society to aspire.
Originally politics was primarily privatized, it was called monarchy. We learned that political power can be a public function. It's time to make economic power a public function as well. Call it Economic Republicanism.

The Moody's model in its essence takes past data and assumes the future will unfold in about the same way. The seductiveness of the model is the very long history of data points on the U.S. economy that Moody's and S&P have in their files. For corporate bond defaults it goes back to the 1930s, and for mortgages to the 1970s. Tens of thousands of observations in a data set give the statistician comfort that they have satisfied all of the basic rules of statistical analysis that call for deep, accurate, consistent and frequent data observations.

Still, with all this data, you fall back as an analyst on the fundamental assumption that it tells you how the world works. In this case, real estate prices always go up, not just over time (like stock prices), but regularly year after year.

To break free of these assumptions, the analyst would have to say "I don't trust these data." That's not so easy to do when so much fee revenue is at stake for the firm. But the statistical argument was available, and it was made by a few investment managers, some of them well known with decades of experience. One such analysis around 2004-2005 looked at the standard deviation of housing prices from their long term growth rate, and when they went beyond 2 s.d.'s this firm declared a housing bubble in existence. They also observed that no financial market with such bubbly price characteristics had ever escaped a collapse where prices corrected severely and usually overshot the growth rate. This meant in some markets housing values could fall by at least 50%. We are on track for that prediction.

If Moody's thought like these contrarian investors, they could have avoided a huge mess. As it is, they are now forced to defend themselves by pointing to all the fraud in the housing market, but this is specious. The fraud was occasioned by the very bubble that Moody's helped create.