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FINANCIAL CRISIS INQUIRY COMMISSION REPORT
risk they were taking. It advised them to make sure that they understood the nature
of the rating agencies’ models, especially for CDOs. And it further advised them to
make sure that counterparties from whom they bought credit protection—such as
AIG and the financial guarantors—would be good for that protection if it was
needed.
The regulators also said they had researched in some depth, for the CDO and de-
rivatives market, the question “Are undue concentrations of risk developing?” Their
answer: probably not. The credit risk was “quite modest,” the regulators concluded,
and the monoline financial guarantors appeared to know what they were doing.
The [Joint Forum’s Working Group on Risk Assessment and Capital]
has not found evidence of ‘hidden concentrations’ of credit risk. There
are some non-bank firms whose primary business model focuses on
taking on credit risk. Most important among these firms are the mono-
line financial guarantors. Other market participants seem to be fully
aware of the nature of these firms. In the case of the monolines, credit
risk has always been a primary business activity and they have invested
heavily in obtaining the relevant expertise. While obviously this does
not rule out the potential for one of these firms to experience unantici-
pated problems or to misjudge the risks, their risks are primarily at the
catastrophic or macroeconomic level. It is also clear that such firms are
subjected to regulatory, rating agency, and market scrutiny.
The regulators noted that industry participants appeared to have learned from
earlier flare-ups in the CDO sector: “The Working Group believes that it is important
for investors in CDOs to seek to develop a sound understanding of the credit risks in-
volved and not to rely solely on rating agency assessments. In many respects, the
losses and downgrades experienced on some of the early generation of CDOs have
probably been salutary in highlighting the potential risks involved.”
MOODY’S: “IT WAS ALL ABOUT REVENUE”
Like other market participants, Moody’s Investors Service, one of the three dominant
rating agencies, was swept up in the frenzy of the structured products market. The
tranching structure of mortgage-backed securities and CDOs was standardized ac-
cording to guidelines set by the agencies; without their models and their generous al-
lotment of triple-A ratings, there would have been little investor interest and few
deals. Between and , the volume of Moody’s business devoted to rating res-
idential mortgage–backed securities more than doubled; the dollar value of that busi-
ness increased from million to million; the number of staff rating these
deals doubled. But over the same period, while the volume of CDOs to be rated in-
creased sevenfold, staffing increased only . From to , annual revenue
tied to CDOs grew from million to million.
When Moody’s Corporation went public in , the investor Warren Buffett’s
