The Bond Rating Fiasco Is Back

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The Wall Street Journal reports that bond rating firms are once again in brutal competition, which allows bond issuers to promote only the highest rating their funky new products receive:

Fierce competition among ratings firms in a fast-growing corner of the bond market is allowing issuers to cherry pick the most favorable ratings. The result is that securities deemed safe by the ratings firms have increasingly smaller cushions against losses.

The security in question is a cross between two of Wall Street’s hottest markets—commercial mortgage bonds, which are backed by mortgage payments on apartment buildings, malls and the like—and collateralized loan obligations, which are pools of bonds backed by payments on corporate borrowings.

I won’t pretend that the ratings fiasco of the aughts was a huge driver of the 2008 financial collapse. Still, it played a role. By routinely slapping AAA ratings on opaque and complicated securities, rating agencies helped make them more popular than they otherwise would have been. When the collapse came, this meant the world was flooded with trillions of dollars worth of CDOs that had iffy counterparties and lots of hidden risk, essentially causing the entire market to freeze up because no one knew for sure which issues were solid and which ones weren’t. This made an already bad situation even worse.

And now it’s happening again. Of course it is. Because Wall Street is incapable of keeping lessons in its tiny collective head for more than about five or six good years. Then the Minsky cycle seizes them yet again.

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