Colossal Failure of Rating Agencies

The ratings agencies (Moody’s, Standard & Poor’s and Fitch) had a terrible track record even before the Great Real Estate Bubble and the Great Recession.

• Enron was rated AAA days before its collapse in 2001.
• They didn’t foresee the spectacular collapse of Long-Term Capital Management in 1998.

Despite these and other warnings, Wall Street and regulators did nothing to stop the problems.

Everyone screwed up. They trusted the rating agencies.

Race to the bottom. Remember, there were 3 ratings agencies. If Fannie or Freddie didn’t like the rating they got on one of their mortgage-backed securities, they could always try another rating agency.

Over-ratings - particularly of subprime mortgages, particularly in the later years of the boom - were key to the explosive growth of 1) mortgage-backed securities, 2) the amount of money chasing homes, and 3) home prices.

Without their colossal over-ratings, the real estate boom would have been far smaller and we may have avoided the bust entirely.