I received a thoughtful email recently from someone making a strong case in favor of the beleaguered bond ratings agencies. While many have beat up on the ratings firms for attaching investment-grade ratings to synthetics RMBS that contain a significant amount of subprime debt, thus pointing the finger at agencies as partial culprits in the inability to price these things to market, my corespondent disagrees.
The essence of his argument:
- 1-year to 10-year default probabilities are on-model for 90% of the issued ratings
- CDOs are illiquid, and troubled hedge funds are caught in a mark-to-market cascade, unwinding hastily and marking-to-market, not to model, and thus forcing others to do the same thing, even if it is at a low price
- The lower value of the credit portfolio forces funds to cut equity holdings, etc.
I’ll save my response for later, but happy to hear what others think.