In regard to whether or not the rating agencies played a conspiratorial role? Ofcourse they did, at the request of Spitzer and the Federal Reserve. They were holding their downgrades on the big banks and monolines until the last minute. How would you like to be the head of a quasi-public agencies that threaded the needle for massive economic recession?

In fact I ran into this http://www.soa.org/files/pdf/2008-ny-kalotay-r2.pdf by a Citi analyst. See page 3 for an estimate of 75% losses for ABS CDOs. If the super senior tranche is 70% of the CDO, this implies over 60% losses on the super senior tranche.

That there was significant credit risk for securitizations of securitizations must have been obvious in the fall to the credit rating agencies — which afterall understood the structure of these creatures.

Twofish 16:00:27: Touché.

No more nonsensical then having people base their investment decisions on credit ratings given by an agencies that explicitly tell people not to use rely on those ratings to make investment decisions…….

The trouble was that the AAA rating referred to credit risk not liquidity risk, and even though the values of the securities dropped because they became illiquid the default risk of those assets didn’t markedly increase, thereby giving the credit rating agencies little reason to reevaluate the rating of the security.

I think the basic problem is that a AAA rating didn’t mean what a lot of people thought it meant. (And to be far, there were some huge financial incentives not to think too hard about this.)

While some very short-sighted people might see this protection of the money markets as a good thing because the public would have been frightened, it seems to me that it just allows a fundamentally unstable and contradictory market to continue to operate. (You can’t have investors believing that money market accounts will never break the buck while also requiring them to sign on to the fact that they could lose money. The product is nonsensical on its face.) In short, it seems that the money markets have been protected at the expense of the banking system, when the reverse would have put us on the road to a more stable and sensible investment environment.

I see your point in part, but the fundamental issue has always been the answer to the question, “Has the credit risk effectively been transferred from the bank to the vehicle?” If the answer is yes, the bank frees up its capital while collecting a fee. Credit enhancement is separate and is charged capital. The liquidity backstop lines were structured in such a way as to create the impression that credit risk had been transferred. The problem is that the liquidity scenario had never been thought through to the point of the total breakdown of the securitization system itself, and the collapse of normal funding availability. When funding reverts to the bank permanently, it effectively assumes the credit risk permanently. This is yet another permutation of the classic bank run. These were ‘normal’ liquidity backstops. This did not require circumvention of rules. It was just a rule that didn’t contemplate the worst case. This points to another very fundamental problem with Basle and risk management in general. In general, there is no capital charge for liquidity risk. The macro categories for capital charges are credit risk, market risk, and operational risk. Liquidity risk is managed under separate guidelines, which are somewhat fluffy in substance. These events hopefully will cause Basle to rethink the approach to liquidity risk.