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
(Lawrence, p. 456) In an attempt to make RMBS more desirable to investors, the investment banks typically divided them into separated “tranches”, with varying degrees of risk. If any homeowners defaulted on their loans, the lowest tranches would absorb the losses first, and so on, up to the highest tranches. It was here that credit rating agencies such as Moody’s were asked to rate the creditworthiness of various tranches of the mortgage-backed securities. Moody’s charged more for rating structured financial products, considering their higher complexity. Credit ratings were extremely important to investors in mortgage-backed securities because these products were so difficult to understand. Investors had nearly no way to judge the safety of these structured financial products, so they trusted the credit agencies’ judgment. (Lawrence, p. 457)
Moody’s began to increase their revenue significantly since they began rating structured financial products. Revenue from structured finance grew as a proportion of Moody’s overall revenue throughout 1999 to 2007, peaking at 43% in 2006, contributing to the company’s impressive profitability. Operating margins during this period ranged from 48% to 62%, an extremely high level. Moody’s had the highest profit margin of any company in the S&P 500 for five years in a row, beating out companies like Microsoft and Exxon. (Lawrence, p. 458)