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 DISSENTING STATEMENT

• The increasing complexity of housing-related assets and the many steps be-
tween the borrower and final investor increased the importance of credit rating
agencies and made independent risk assessment by investors more difficult. In
this respect, complexity did contribute to the problem, but the other problems
listed here are more important.
• Credit rating agencies assigned overly optimistic ratings to the CDOs built

from mortgage-backed securities. By erroneously rating these bundles of
mortgage-backed security payments too highly, the credit rating agencies sub-
stantially contributed to the creation of toxic financial assets.
• Borrowers, originators, securitizers, rating agencies, and the ultimate buyers of
the securities into which the risky mortgages were packaged all failed to exer-
cise prudence and perform due diligence in their respective transactions. In
particular, CDO buyers who were, in theory, sophisticated investors relied too
heavily on credit ratings.
• Many financial institutions chose to make highly concentrated bets on housing
prices. While in some cases they did that with whole loans, they were able to
more easily and efficiently do so with CDOs and derivative securities.
• Regulatory capital standards, both domestically and internationally, gave pref-
erential treatment to highly rated debt, further empowering the rating agencies
and increasing the desirability of mortgage-backed structured products.
• There is a way that housing bets can be magnified using a form of derivative. A
synthetic CDO is a security whose payments mimic that of a CDO that contains
real mortgages. This is a “side bet” that allows you to assume the same risk as if
you held pieces of actual mortgages. To the extent that investors and financial
institutions wanted to increase their bets on housing, they were able to use syn-
thetic CDOs. The risks in these synthetic CDOs, however, are zero-sum, since
for every investor making a bet that housing performance will fall there must
be other investors with equal-sized bets in the opposite direction.

These are related but different problems. While many involve the word “deriva-
tive,” it is a mistake to bundle them together and say, “Derivatives or CDOs caused
the crisis.” In each case, we assign responsibility for the failures to the people and in-
stitutions rather than to the financial instruments they used.

Conclusions:

Rather than “derivatives and CDOs caused the financial crisis,” it is more accurate
to say:

• Securitizers lowered credit quality standards;
• Mortgage originators took advantage of this to create junk mortgages;
• Credit rating agencies assigned overly optimistic ratings;
• Securities investors and others failed to perform sufficient due diligence;