How Well Did Bond Ratings Match Financial Crisis Losses?

Robin Wigglesworth was staggered to find that credit ratings looked pretty good once final losses from the financial crisis were counted out. Prices told a harsher story. Buyers trusted nothing, so even AAA tranches of CDOs tumbled, and lots of the synthetic deals blew up completely. The actual RMBS and CMBS markets tracked the grades much more closely.

AAA bonds in the RMBS and CMBS markets did take losses, and a grade supposed to be as good as gold should not lose money. Broadly, the ratings were not massively out of whack with the losses that showed up. The record comes from a lot of financial-crisis post-mortems gathered for a chapter on how it all played out.

Rating agencies can be wrong, and so can everybody else. George Box put it as all models are wrong, but some are useful. Ratings are a handy shorthand, and if the agencies did not exist, something like them would probably have to be invented. Selling ratings to the highest bidder is a separate failure, and it is what happened in the financial crisis. The agencies gave up a lot of financial authority and credibility. Bond investors no longer give a wit about rating agencies, because an agency willing to sell itself to the highest bidder is not trustworthy. The incentives have not changed and remain unquestionably problematic. Most investors have treated ratings as a starting point, and no self-respecting bond analyst treats a rating as the ending point. The buyers who did not were the proverbial idiots in Dusseldorf buying AAA CDOs.