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FINANCIAL CRISIS INQUIRY COMMISSION REPORT
Subprime),” “recruit and leverage seasoned Option ARM sales force,” and “maintain a
compensation structure that supports the high margin product strategy.”
After structuring a security, an underwriter, often an investment bank, marketed
and sold it to investors. The bank collected a percentage of the sale (generally be-
tween . and .) as discounts, concessions, or commissions. For a billion
deal like CMLTI -NC, a fee would earn Citigroup million. In this case,
though, Citigroup instead kept parts of the residual tranches. Doing so could yield
large profits as long as the deal performed as expected.
Options Group, which compiles compensation figures for investment banks, exam-
ined the mortgage-backed securities sales and trading desks at commercial and in-
vestment banks from to . It found that associates had average annual base
salaries of , to , from through , but received bonuses that could
well exceed their salaries. On the next rung, vice presidents averaged base salaries and
bonuses from , to ,,. Directors averaged , to ,,. At
the top was the head of the unit. For example, in , Dow Kim, the head of Merrill’s
Global Markets and Investment Banking segment, received a base salary of ,
plus a million bonus, a package second only to Merrill Lynch’s CEO.
MOODY’S: “GIVEN A BLANK CHECK”
The rating agencies were essential to the smooth functioning of the mortgage-backed
securities market. Issuers needed them to approve the structure of their deals; banks
needed their ratings to determine the amount of capital to hold; repo markets needed
their ratings to determine loan terms; some investors could buy only securities with a
triple-A rating; and the rating agencies’ judgment was baked into collateral agreements
and other financial contracts. To examine the rating process, the Commission focused
on Moody’s Investors Service, the largest and oldest of the three rating agencies.
The rating of structured finance products such as mortgage-backed securities
made up close to half of Moody’s rating revenues in , , and . From
to , revenues from rating such financial instruments increased more than
fourfold. But the rating process involved many conflicts, which would come into fo-
cus during the crisis.
To do its work, Moody’s rated mortgage-backed securities using models based, in
part, on periods of relatively strong credit performance. Moody’s did not sufficiently
account for the deterioration in underwriting standards or a dramatic decline in
home prices. And Moody’s did not even develop a model specifically to take into ac-
count the layered risks of subprime securities until late , after it had already
rated nearly , subprime securities.
“In the business forevermore”
Credit ratings have been linked to government regulations for three-quarters of a
century. In , the Office of the Comptroller of the Currency let banks report
publicly traded bonds with a rating of BBB or better at book value (that is, the price
