Ratings Farce Hurts Credit Markets

A: I want to quickly discuss one more aspect of why the carnage in the CDO markets and other structured credit markets are getting killed. It lies in the rating agencies! What once was thought to be AAA rated securities, actually are NOT! As rating agencies adjust their criteria for rating these assets, and downgrade the ratings, the investment opportunities shrinks as many hedge funds and other institutions have restrictions on purchases of junk rated holdings. Let me explain.

A very big portion of the problem lies in the ratings of these CDO's, CMO's. Although many were and still are rated AA and AAA, they really are more like junk! We just don't know and neither do the investment banks that hold the assets!

The rating agencies are in the process of fixing their mistake; by adjusting their ratings criteria. Moodys already cut the ratings of about $35B worth of CDO's, but they are in the process of reviewing a hell of a lot more of these instruments. Once they get downgraded to basically junk status, investments in them become restricted by hedge funds and the like! That exponentially will hurt this problem of illiquidity as there already is no market for valuing these instruments. So how do you mark these assets to market value if there is no market? You can't? You have to try to value them and that is what is being adjusted by many of these large banks as the original valuations are way off!

According to Bloomberg:

Moody's Investors Service cut the ratings of collateralized debt obligations tied to $33 billion of subprime mortgage securities it downgraded this month, a decision that may force owners to mark down the value of their holdings.

Securities with ratings as high as AAA from at least 45 CDOs were either cut or put on review for a downgrade, according to individual statements distributed today by the New York-based ratings company.

"They're going down now and they're likely to go down further in the future," said Dan Ivascyn, a managing director at Pacific Investment Management Co. in Newport Beach, California, manager of the world's largest bond fund. "This is just one step in aligning ratings with where the market is trading bonds."

Almost 480 tranches of CDOs had been downgraded, according to an Oct. 5 report by Morgan Stanley structured credit analysts. That included 69 AAA securities and 106 with AA ratings.

This is another reason why the ABX indices are plunging as the insiders buy credit protection and bet that more carnage is coming in foreclosure world. I hope this helps those desperately trying to understand what is going on in this very complicated, and un-transparent world! Expect many more ratings downgrades to come as the review process continues! Also expect the pool of buyers for these distressed assets to shrink as the rating downgrades limits investments in these instruments as they don't pass what is 'allowable' by funds previously looking to buy them at cheap prices!