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THE BUST 

tranches initially rated investment grade—that is, rated Baa or higher— of
those issued in  were downgraded to junk, as were  of those from . 

CDOS: “CLIMBING THE WALL OF SUBPRIME WORRY”
In March , Moody’s reported that CDOs with high concentrations of subprime

mortgage–backed securities could incur “severe” downgrades. In an internal email
sent five days after the report, Group Managing Director of U.S. Derivatives Yuri
Yoshizawa explained to Moody’s Chairman McDaniel and to Executive Vice Presi-
dent Noel Kirnon that one managing director at Credit Suisse First Boston “sees
banks like Merrill, Citi, and UBS still furiously doing transactions to clear out their
warehouses. . . . He believes that they are creating and pricing the CDOs in order to
remove the assets from the warehouses, but that they are holding on to the CDOs . . .
in hopes that they will be able to sell them later.” Several months later, in a review of

the CDO market titled “Climbing the Wall of Subprime Worry,” Moody’s noted,
“Some of the first quarter’s activity [in ] was the result of some arrangers fever-
ishly working to clear inventory and reduce their balance sheet exposure to the sub-

prime class.” Even though Moody’s was aware that the investment banks were
dumping collateral out of the warehouses and into CDOs—possibly regardless of
quality—the firm continued to rate new CDOs using existing assumptions.
Former Moody’s executive Richard Michalek testified to the FCIC, “It was a case
of, with respect to why didn’t we stop and change our methodology, there is a very
conservative culture at Moody’s, at least while I was there, that suggested that the
only thing worse than quickly getting a new methodology in place is quickly getting
the wrong methodology in place and having to unwind that and to fail to consider
the unintended consequences.” 
In July, McDaniel gave a presentation to the board on the company’s  strate-
gic plan. His slides had such bleak titles as “Spotlight on Mortgages: Quality Contin-
ues to Erode,” “House Prices Are Falling . . . ,” “Mortgage Payment Resets Are

Mounting,” and “. MM Mortgage Defaults Forecast –.” Despite all the evi-
dence that the quality of the underlying mortgages was declining, Moody’s did not
make any significant adjustments to its CDO ratings assumptions until late Septem-

ber. Out of  billion in CDOs that Moody’s rated after its mass downgrade of sub-
prime mortgage–backed securities on July , ,  were rated Aaa. 
Moody’s had hoped that rating downgrades could be staved off by mortgage mod-
ifications—if their monthly payments became more affordable, borrowers might stay
current. However, in mid-September, Eric Kolchinsky, a team managing director for
CDOs, learned that a survey of servicers indicated that very few troubled mortgages

were being modified. Worried that continuing to rate CDOs without adjusting for
known deterioration in the underlying securities could expose Moody’s to liability,
Kolchinsky advised Yoshizawa that the company should stop rating CDOs until the
securities downgrades were completed. Kolchinsky told the FCIC that Yoshizawa
“admonished” him for making the suggestion. 