The man who wrecked Wall Street and our economy: Gary Witt

MC.no.spin · 09-27-08, 12:32 PM

I have traced the beginnings of the brewing Wall Street catastrophe to August 2004 and to one man's decision.

Had this ONE decision not been made, we would not be facing a 1930's scenario of a depression, when unemployment soared to nearly 30 % of America. Where getting a loan was nearly impossible. Where thousands of people applied for the same job. Where breadlines were placed throughout cities. Where campgrounds called "Hoovervilles" were full of people living in tents as they could not afford anything else.

Who made the decision? Gary Witt.

Gary Witt was the managing director for Moody's until he retired recently. He was the one who changed the rating system for C.D.O.s which led to AAA ratings on junk bonds backed by sub-prime mortgages. This made a market for these securities that otherwise would not have been possible.

S & P quickly followed suit to avoid losing business.

Here is an article on this. It's long, but good. I'll bold significant parts.

One thing to add is that in the SEC report it mentions from two months ago, it did NOT properly censure Moody's and other credit rating agencies with any real criticism. It was a very soft report. For more details, see my thread on how the SEC Chairman is responsible for failing to get C.D.O. transparency enforced, and failing to regulate Moody's and S & P here:

http://www.debatepolitics.com/econom...post1057738947

There is also more investigation needed on who lobbied Witt to make this decision. Fannie and Freddie lobbyists are the likely suspects.

Quote:

`Race to Bottom' at Moody's, S&P Secured Subprime's Boom, Bust
2008-09-25 04:01:00.40 GMT

By Elliot Blair Smith
Sept. 25 -- In August 2004, Moody's Corp. unveiled a new credit-rating model that Wall Street banks used to sow the seeds of their own demise. The formula allowed securities firms to sell more top-rated, subprime mortgage-backed bonds than ever before.

A week later, Standard & Poor's moved to revise its own methods. An S&P executive urged colleagues to adjust rating requirements for securities backed by commercial properties because of the ``threat of losing deals.''
The world's two largest bond-analysis providers repeatedly eased their standards as they pursued profits from structured investment pools sold by their clients, according to company documents, e-mails and interviews with more than 50 Wall Street professionals. It amounted to a ``market-share war where criteria were relaxed,'' says former S&P Managing Director Richard Gugliada.
``I knew it was wrong at the time,'' says Gugliada, 46, who retired from the McGraw-Hill Cos. subsidiary in 2006 and was interviewed in May near his home in Staten Island, New York. ``It was either that or skip the business. That wasn't my mandate. My mandate was to find a way. Find the way.''
Wall Street underwrote $3.2 trillion of loans to homebuyers with bad credit and undocumented incomes from 2002 to 2007.
Investment banks packaged much of that debt into investment pools that won AAA ratings, the gold standard, from New York-based Moody's and S&P. Flawed grades on securities that later turned to
junk now lie at the root of the worst financial crisis since the Great Depression, says economist Joseph Stiglitz.

`Would Have Stopped Flow'

``Without these AAA ratings, that would have stopped the flow of money,'' says Stiglitz, 65, a professor at Columbia University in New York who won the Nobel Prize in 2001 for his analysis of
markets with asymmetric information. S&P and Moody's ``were trying to please clients,'' he said. ``You not only grade a company but tell it how to get the grade it wants.''
Presidential candidates John McCain and Barack Obama lay responsibility for the carnage with Wall Street itself. The Securities and Exchange Commission in July identified S&P and Moody's as accessories, finding they violated internal procedures and improperly managed the conflicts of interest inherent in providing credit ratings to the banks that paid them.
S&P and Moody's earned as much as three times more for
grading the most complex of these products, such as the unregulated investment pools known as collateralized debt obligations, as they did from corporate bonds. As homeowners defaulted, the raters have downgraded more than three-quarters of the AAA-rated CDOs bonds issued in the last two years.

`Cut Too Many Corners'

Facing the threat of lawsuits and tighter regulation,
Moody's and S&P now say they are adopting tougher requirements to more accurately evaluate and monitor debt. (somebody help me sue these guys ~ MC.no.spin)
``We have made significant progress in achieving these
goals,'' Chris Atkins, S&P's vice president of communications, wrote last week in a statement to Bloomberg. ``Working with policy makers and market participants around the world, we will
continue to take steps to meet and exceed the high standards for quality we have put in place.'' He wouldn't respond to specific questions for this story.
Moody's spokesman Anthony Mirenda declined to comment after Bloomberg submitted questions in writing and by phone.
``The rating agencies' models were too flawed and cut too many corners, and the raters got pressured by the bankers,'' says Tonko Gast, the chief investment officer of the $5.1 billion New York hedge fund Dynamic Credit Partners LLC. He reverse-engineers the raters' models as part of his investing strategy.
``That's how the race to the bottom was kind of invisible for a lot of people,'' he says.

Favoring Diversity

Starting in 1996, Moody's used a framework known as the binomial expansion technique for rating CDOs, structured funds consisting of aircraft leases, franchise loans, high-yield bonds, hotel mortgages and mutual-fund fees. On the theory that diversification reduced risk, the BET formula rewarded balanced portfolios and punished concentrations of assets, using a proprietary measurement Moody's called the diversity score.
On Aug. 10, 2004, Moody's Managing Director Gary Witt
introduced a new CDO rating method that dispensed with the diversity test and made other adjustments to the evaluation of structured-finance products.
``People were just starting to do deals that were all
residential,'' says Witt, 49. He retired from Moody's this year and is now an assistant professor of statistics at Temple University's Fox School of Business in Philadelphia. The BET model ``is not as well suited for the highly correlated portfolios that were becoming common in 2004,'' he says.
The emphasis on diversity turned into an obstacle after the 2001 recession, when some assets plummeted in value. Home mortgages, auto loans and credit-card receivables offered higher returns for CDO managers. As mortgage rates fell and the market boomed, investment firms argued the risks in housing were small.

`Moody's Obliged'

``I know people lobbied Moody's to accommodate more
concentrated residential mortgage risk in CDOs, and Moody's obliged,'' says Douglas Lucas, 52, the head of CDO research at UBS Securities LLC in New York. The former Moody's analyst says he invented the diversity score in the late 1980s.
A statistical tabulation appearing in the appendix of Witt's paper represented the new formula as more rigorous in calculating risks than the BET. A side-by-side comparison showed that the new model projected losses that were 24 to 165 percent higher than forecast by the old, on a hypothetical investment pool.
Bankers ``could put together a deal with greater
concentrations in one area or another,'' says Jeremy Gluck, 52, a former Moody's managing director, who worked with Witt at the time.

Fewer Defaults Projected

In September 2005, Witt and colleagues published a follow-up analysis. Compared with the BET, the new model now projected that the likelihood of collateral defaults affecting CDO bonds rated at least Aa could be 73 percent lower at the extreme, in a range
of possibilities.
The new comparison was based on a hypothetical investment pool in which 75 percent of the assets were residential mortgage-backed securities, including 30 percent that were subprime.
Moody's could produce a lower default rate by incorporating a decade of ratings stability for structured finance into its assumptions. The average five-year loss rate on U.S. structured finance products between 1993 and 2003 was 1.9 percent, compared with 6.3 percent for corporate bonds, the company had said in September 2004. A drawback was that raters didn't have data going back to the 1920s, as they did on corporate bonds.
In a press release on the report, Moody's said ``structured-finance ratings are broadly comparable in quality to the ratings of corporate bonds.''

`More Aaas'

Philippe Jorion, 53, a finance professor at the University of California, Irvine, criticizes the Moody's decision to factor ratings stability into its evaluations.
``This uses the output of their model as input into their models,'' Jorion says. ``This type of model is totally out of touch with the underlying economic reality.''
Witt declined in an e-mail exchange to discuss the September 2005 findings or his earlier projections from August 2004.
``The effect that had on structures was to create more
Aaas,'' says Thomas Priore, 39, chief executive officer of Institutional Credit Partners LLC in New York, which oversees $13 billion of fixed-income investments.
The Moody's share of the market for rating CDOs was falling before the change, to 76.8 percent in 2004 from 91.5 percent a
year earlier, according to the industry publication Asset-Backed Alert in Hoboken, New Jersey. It climbed afterward, to 85.1 percent in 2005 and 96.8 percent in 2006. S&P had 97.5 percent that year, the publication said. Underwriters made obtaining a top grade from one or both raters a condition for the sale of the
investment pools.

E*Trade's CDO

The value of asset-backed CDOs tripled to $30 billion in the fourth quarter of 2004, according to the London-based monthly journal Creditflux. The yearly total increased 87 percent to $104.3 billion in 2005. Subprime mortgages came to account for about half the collateral on all asset-backed CDOs issued that
year, according to a Moody's estimate.
In December 2005, New York-based E*Trade Financial Corp. raised $300 million to fund E*Trade ABS CDO IV Ltd. It followed the formula Witt and co-authors outlined in the September paper.
Moody's assigned Aaa grades to three-quarters of the CDO's rated bonds, which invested 73.5 percent of the fund's assets in mortgages backed by loans to homeowners with bad credit and limited income documentation. As the subprime market deteriorated, the company in June 2008 lowered $137.3 million of the bonds initially rated Aaa to Baa2 and the rest to speculative.

ARTICLE CONTINUES IN NEXT POST

MC.no.spin · 09-27-08, 12:33 PM

Quote:

Gast's Reverse Engineering

Investors began to recognize that Aaa ratings on asset-backed CDOs weren't equivalent to top grades on corporate debt.
Dynamic Credit Partners' Gast, 35, a Dutch-born quantitative analyst, says he began to discern that Aaa ratings weren't consistent even between CDOs. He says this demonstrates erosion in the rating companies' standards.
``In '05 already what was clear, I think, was that there was a deteriorating underwriting trend,'' Gast says. ``Because we had it all in-house, we were able to figure out: `Wow, you can tweak so many different parameters to come to the same result.'''
Two CDOs issued two years apart illustrate the point. Both invested in subprime and other mortgage securities, and received AAA ratings on their senior bonds from Moody's and S&P.
In December 2004, NIB Capital Bank NV of The Hague, the Netherlands, and UBS AG of Zurich jointly issued the $1 billion Belle Haven ABS CDO Ltd. The fund manager, an arm of NIB Capital, borrowed 45 times investors' equity to buy real estate securities and other assets, according to the prospectus. That magnified potential gains, while also increasing possible losses.

Tale of Two CDOs

The least-protected bondholders were backed by collateral equal to 102.26 percent of their stake, according to the prospectus, providing a cushion against declines.
Two years later, in December 2006, a U.S. arm of the Zurich investment bank Credit Suisse Group AG issued the $1.5 billion McKinley Funding III Ltd. CDO. The manager, New York-based Vertical Capital LLC, borrowed 84 times investors' equity, and junior investors were backed by a narrower cushion of assets equal to 100.98 percent of their stake, the prospectus shows.
While Belle Haven could put 20 percent of its assets in other CDOs, further magnifying the risks and returns, McKinley could place twice that percentage.
Both CDOs were downgraded as the subprime market
deteriorated, with the earlier CDO holding up better than the later one.
Belle Haven's most senior Aaa tranche today retains a
Moody's investment-grade rating of A1- and an S&P grade of BBB-.
By contrast, Moody's lowered the top tier of the McKinley CDO to junk status, Ca, on September 23. S&P's rating is CCC-.Because the funds are registered in the Cayman Islands and don't disclose holdings, it isn't known how much investors may have lost.

S&P's Model Changes

Meanwhile, S&P tinkered with its methodology for grading CDOs that bought commercial mortgage securities backed by apartments, hotels, offices and stores, according to an Aug. 17, 2004, e-mail obtained by Bloomberg. Managing Director Gale Scott
warned of the ``threat of losing deals'' to Moody's unless the company relaxed its rating requirements.
``OK with me to revise criteria,'' replied Gugliada, then S&P's top CDO-rating executive, the e-mail exchange shows.
In an interview, Gugliada confirmed the e-mail's contents and said it led to one of S&P's adjustments to accommodate clients. He says Scott did research supporting a relaxation of S&P's assumptions about how closely correlated the default probabilities were for commercial real estate securities.

More Flexibility

The changes gave S&P's clients more flexibility. The switch directly preceded ``aggressive underwriting and lower credit support'' in the market for commercial mortgage-backed securities from 2005 to 2007, according to an S&P report that Scott co-wrote in May 2008. This led to growing delinquencies, defaults and losses, the report said.
Scott left in August as S&P cut staff. The company declined to make her available for comment before her departure, and subsequently she couldn't be reached.
Errors sometimes worked their way into the analysis. Kai Gilkes, 40, a former S&P quantitative analyst in London, says he discovered a flaw in the company's main CDO model, the CDO Evaluator, which he updated in late 2005.
In some cases, the S&P system overstated the quality of synthetic CDO Squared securities, Gilkes says. These complex investment pools are based on credit default swaps, a type of insurance against corporate default.
``On collateral rated AA or higher, the S&P model did not properly stress the default behavior of the underlying CDOs, resulting in assets with a lower default probability than their ratings suggested,'' Gilkes says.

`Line in Sand Shifts'

He says he fixed the glitch during ``a major revision'' that December and doesn't know whether any investment was inappropriately rated as a result of the error.
Still, Gilkes says he believed that competitive
considerations, as communicated by management, intruded on S&P's ratings decisions up until he left the London office in 2006.
``The discussion tends to proceed in this sort of way,'' he says. ```Look, I know you're not comfortable with such and such assumption, but apparently Moody's are even lower, and, if that's the only thing that is standing between rating this deal and not rating this deal, are we really hung up on that assumption?' You don't have infinite data. Nothing is perfect. So the line in the sand shifts and shifts, and can shift quite a bit.''

`Golden Goose'

Gugliada says that when the subject came up of tightening S&P's criteria, the co-director of CDO ratings, David Tesher, said: ``Don't kill the golden goose.''
S&P declined to make Tesher available for comment.
In the SEC's July 8 report examining the role of the credit rating companies in the subprime crisis, the agency raised questions about the accuracy of grades on structured-finance products and ``the integrity of the ratings process as a whole.''
``Let's hope we are all wealthy and retired by the time this house of cards falters,'' one unidentified analyst told a colleague in a December 2006 e-mail, according to the SEC report.
The e-mail was signed with a computerized wink and smile:
``;o).''
Moody's stock peaked at $74.84 on Feb. 8, 2007, a day after London-based HSBC Holdings Plc said it would set aside about $10.56 billion for losses on U.S. home loans. That statement was among the first signs of the subprime meltdown.
The reckoning swept Wall Street five months later. On July 10, Moody's cut its grades on $5.2 billion in subprime-backed CDOs. That same day, S&P said it was considering reductions on $12 billion of residential mortgage-backed securities.

More Aaas

Still, they continued stamping out AAA ratings.
Moody's announced Aaa grades on at least $12.7 billion of new CDOs in the last week of August 2007. Five of the investments were lowered by one or both companies within three months. The rest were cut within six months.
``The greed of Wall Street knows no bounds,'' says Stiglitz, the Nobel laureate. ``They cheated on their models. But even without the cheating, their models were bad.''
By last month, Moody's had downgraded 90 percent of all asset-backed CDO investments issued in 2006 and 2007, including 85 percent of the debt originally rated Aaa, according to Lucas at UBS Securities. S&P has reduced 84 percent of the CDO tranches it rated, including 76 percent of all AAAs.
``Credit in Latin means `to believe,''' says former Moody's analyst Sylvain Raynes, 50, now the head of his own New York bond-analysis firm, R&R Consulting. ``Trust and credit is the same word. If you lose that confidence, you lose everything, because that confidence is the way Wall Street spells God.''

Gary Witt sold his soul and became a terrorist.

Economic terrorism is just as evil as any other kind of terrorism.

Justice will be served.

MC.no.spin · 09-27-08, 01:48 PM

This is Gary Witt. Photo editing courtesy of MC.no.spin

donsutherland1 · 09-27-08, 05:47 PM

MC.no.spin,

During the euphoric periods in which credit booms underwrite what culminates in the rise of asset bubbles, one often sees more rigorous credit/risk standards supplanted by the pursuit of increased market share in the hope/expectation of a rapid realization of large returns on investment. The mentality that one can only lose out on hugely profitable opportunities from engaging in practices that are consistent with sound risk management takes hold, especially as competitors enjoy increasing returns on investment from the bubble's accelerating growth.

Mr. Witt was but one participant out of many who engaged in such behavior. He merely sprinkled the seeds of financial market contagion with his new ratings model.

The psychological process that leads to what literally amounts to a stampede toward quick returns (even as that pursuit brings the proverbial cliff ever closer) is an attribute of human nature. Therefore, while excessive regulation can impede economic activity, a lack of carefully targeted regulation that is focused on sytemic risk can assure that there are few barriers to the kind of economic and investment behavior that leads to asset bubbles. Henry Kaufman, one of the world's leading bond traders since the 1970s explained , "When markets are highly deregulated, firms face stiff competition and therefore have great incentive to take risks at the marginal edge." In other words, risk taking becomes an extreme sport of sorts, especially when other people's money (leverage) is involved.

Kaufman's observation is not a hindsight analysis. As far back as 1987, Kaufman warned:

High price volatility will continue to be a feature of both our equity and debt markets. The securitizaion of assets will breed more intensive efforts at achieving near-term performance objectives. The globalization of markets will subject them even more to the impact of international capital flows. The efforts to further deregulate the financial system will encourage the abuse of fiduciary responsibility by the market participants that can only be cured through extreme price volatility...

The new decision makers in the financial markets are exceedingly well trained in analytical skills; they are ambitious and they are willing to take risks, but unfortunately their entreprenerial drive has not been tempered by the lessons of history. We should not be surprised that this is so. There are few schools of business in the United States that teach financial history. How can we remember the lessons of history if we have not been taught them?

Following the Panic of 1857, The New York Times observed:

[ I ]f every merchant, banker and manufacturer who has been compelled to succumb under the present pressure, would but narrate the causes that led to his own prostration, we should have an amount of evidence that might be turned to most profitable account by their successors in business...

[ I ]n the majority of cases it would be found that failures occurred because there had not been proper caution used to guard against the chances of a reverse; and, in too many instances it would be found that disaster had been produced by departing from the legitimate business in which merchants are engaged.

Lesson forgotten.

History is vitally important. In fact, without the discipline an understanding of the historic experience brings, it is much easier for people, to quote Julius Caesar, "to willingly believe what they wish."

People wanted to believe that the rapidly rising home prices were somehow justified by market fundamentals. They wanted to believe that in the era of the Internet, mortgage securitization, and the global economy, the old rules (that home price appreciation could not be detached from the broader economy and that home valuations could, in fact, decline) had become irrelevant. They wanted to believe that homes can only increase in value.

As home prices rose into the stratosphere in the early 2000s, those gains seduced them to increase their lending, borrowing, and investing in homes. In essence, one witnessed the opposite of a panic. During a panic, people rush to pull funds out of financial instituitions. In this case, there was a panic in reverse so to speak in which an increasing torrent of funds poured into home purchases. During the financial flood, U.S. mortgage debt, which had peaked at 65.9% of GDP rocketed past 100% of GDP, finally peaking at 105.8% of GDP in 2007, even after the housing market had been softening. All said, the wishful thinking that had helped feed the housing bubble was no substitute for market realities. By their very nature, asset bubbles are unsustainable. The U.S. housing bubble was no exception.

Finally, one other lesson of history that is relevant is that the sophisticated models employed in the financial services industry often perform well during tranquil, if not ideal, market conditions. That good performance can seduce risk managers to become overconfident in the models. Rather than recognizing that the models are representations--and often highly simplistic ones when compared to the actual marketplace and its multitude of complex interactions--and have real limitations on account of that, they are lulled into a sense that the models are essentially clairvoyant. Models offer a piece of guidance. They are no substitute for human judgment that must examine far more than the models' output in reaching informed decisions.

In any case, the historic experience has shown time and again that once turbulence descends on the markets, the models' performance disintegrates. That happened with the advanced quantitative hedging model that Long-Term Capital Management employed. It happened with Mr. Witt's risk rating model. Barring a dramatic change in human nature and/or greater appreciation of the historic experience, it almost certainly will happen again.

metreon · 09-28-08, 12:44 AM

I heard on the radio today a round-table disscussion of the misleading mortgage backed security ratings. Although I have yet to source this in an article, a security analyst on the panel blamed the ratings problem on newness of the risky subprime loan types which proliferated from 2003 onward. There was no historical data to accurately predicte their default rates. Basically old data sets for more traditional loans were modified with "educated guesses" about how they might perform and the computer models ended up spitting out overly optimistic default rates for the underlying mortgages.

It therefore also seems likely that whatever default rate data they did accumulate for the subprimes prior to the bust was also obfuscated by the boom they helped create. The true risk would not be known until the market had a downturn sufficient to shake out the actual risk. According the the analyst some of the mortgage bonds out there have up to a 50% default rate in the underlying mortgages, far exceeding the estimated 5% rates in the computer models.

Was this an intentional miscalculation to advance short-term gain? No one will know for sure, and some will always suspect it was purely a fraud based upon greed rather than an under parametized but rational analysis.

Also, another panel member, a mortgage broker and banker explained their businesses effectively played the competitive ethos of one investment firm against one another in their auctions. When a bank had a risky set of mortgages they wanted to sell off to a Bear Stearns or similar investment house, and there was reluctance by the investment house to bid, all the broker had to do was keep calling different investment banks until they found one to bid on it at any level. Then they could call back all the other investment firms which had previously turned down the loan package and tell them so-and-so is bidding on these loans, - then, suddenly, because of the competitive nature of the business and desire not to lose share to a competitor, all the investment firms would pile on and the loans would quickly be sold off to the highest bidder to be securitized. It sounded like investment banks also decreased risk oversight when loans were being bid on by more than one bank.

Ultimately though, it sounds as though whatever risk assessment models were being used, they were flawed, and not necessarily by intent, but rather from a misguided belief in false data and false assumptions.

donsutherland1 · 09-28-08, 07:17 AM

Quote:

Originally Posted by metreon

There was no historical data to accurately predicte their default rates. Basically old data sets for more traditional loans were modified with "educated guesses" about how they might perform and the computer models ended up spitting out overly optimistic default rates for the underlying mortgages.

The lack of historical insight is part of the reason the models typically fare badly during times of market stress. The sample size is simply too small. However, a historic understanding of what had happened before, including some significant downturns in the housing market, would have strongly suggested that scenarios for large home price declines be considered in evaluating possible risk. In large part, that's why judgment should always take precedence over model guidance.

Quote:

Was this an intentional miscalculation to advance short-term gain? No one will know for sure, and some will always suspect it was purely a fraud based upon greed rather than an under parametized but rational analysis.

I'm sure that some firms/individuals engaged in a degree of fraud. Such behavior is commonplace during the euphoric periods that give rise to bubbles. Many others, and probably most, simply made bad judgments.

In today's edition of The New York Times, there's a good piece about the financial crisis that touches on some of the points raised in this thread. Some excerpts:

Although America’s housing collapse is often cited as having caused the crisis, the system was vulnerable because of intricate financial contracts known as credit derivatives, which insure debt holders against default. They are fashioned privately and beyond the ken of regulators — sometimes even beyond the understanding of executives peddling them.

Originally intended to diminish risk and spread prosperity, these inventions instead magnified the impact of bad mortgages like the ones that felled Bear Stearns and Lehman and now threaten the entire economy.

In the case of A.I.G., the virus exploded from a freewheeling little 377-person unit in London, and flourished in a climate of opulent pay, lax oversight and blind faith in financial risk models...

chriskaplan · 09-28-08, 09:59 PM

I have an issue with the journalist, Elliot Blair Smith, who wrote the article on which MC spin based his allegation.
First of all, Mr. E. Blair Smith has a reputation for being a sensational journalist who pastes his subjects' comments incoherently in order to suit his theme. I used to work for a rating agency and so I know for a fact that this journalist is on the list of "exercise caution before talking to this one".
So, MC spin, I have some comments for you. You wrote about a few names but you mainly scapegoated Gary Witt.
Mr. Witt was not THE managing director at Moodys, he was just a team managing director who reported to a group managing director, who consequently reported to a senior MD, then to several more, before reporting to the President, then to the CEO.
Also, he was not in that group after the autumn of Sept. 2005, two other MDs had replaced him afterwards. Of course, Mr. Elliot Blair Smith omitted this fact, because that would have been an inconvenient truth for him. So, MC spin, please do not believe everything you read. You know that journalists can't be sued because they are protected by the fifth amendment. So they don't bother to do their research like the rest of us folks do. Remember this, we are all accountable.

MC.no.spin · 09-28-08, 10:56 PM

Quote:

Originally Posted by chriskaplan

I have an issue with the journalist, Elliot Blair Smith, who wrote the article on which MC spin based his allegation.
First of all, Mr. E. Blair Smith has a reputation for being a sensational journalist who pastes his subjects' comments incoherently in order to suit his theme. I used to work for a rating agency and so I know for a fact that this journalist is on the list of "exercise caution before talking to this one".
So, MC spin, I have some comments for you. You wrote about a few names but you mainly scapegoated Gary Witt.
Mr. Witt was not THE managing director at Moodys, he was just a team managing director who reported to a group managing director, who consequently reported to a senior MD, then to several more, before reporting to the President, then to the CEO.
Also, he was not in that group after the autumn of Sept. 2005, two other MDs had replaced him afterwards. Of course, Mr. Elliot Blair Smith omitted this fact, because that would have been an inconvenient truth for him. So, MC spin, please do not believe everything you read. You know that journalists can't be sued because they are protected by the fifth amendment. So they don't bother to do their research like the rest of us folks do. Remember this, we are all accountable.

It's good to have input from someone who worked at S & P, so thanks for your post.

Attacking the messenger (Smith) and his credentials does not explain the quotes from people cited in the article, which pinpoint the excessive AAA ratings to Mr. Witt's new CDO analysis model. 60 Minutes tonight also exposed the irresponsibility of credit rating agencies. Perhaps you are concerned about your stock value?

Further, the fifth amendment does not protect journalists from being sued for libel. I believe you are referring to the first amendment, and journalists are still on the hook for libel even under those protections.

New York Times Co. v. Sullivan, 376 U.S. 254 (1964), was a United States Supreme Court case which established the actual malice standard which has to be met before press reports about public officials or public figures can be considered to be defamation and libel; and hence allowed free reporting of the civil rights campaigns in the southern United States. It is one of the key decisions supporting the freedom of the press. The actual malice standard requires that the plaintiff in a defamation or libel case prove that the publisher of the statement in question knew that the statement was false or acted in reckless disregard of its truth or falsity. Because of the extremely high burden of proof on the plaintiff, and the difficulty in proving essentially what is inside a person's head, such cases — when they involve public figures — rarely prevail.

Before this decision there were nearly US$300 million in libel actions outstanding against news organizations from the Southern states and these had caused many publications to exercise great caution when reporting on civil rights, for fear that they might be held accountable for libel. After the New York Times prevailed in this case, news organizations were free to report the widespread disorder and civil rights infringements. The Times maintained that the case against it was brought to intimidate news organizations and prevent them from reporting illegal actions of public employees in the South as they attempted to continue to support segregation.

New York Times Co. v. Sullivan - Wikipedia, the free encyclopedia

So where is the libel lawsuit from Moody's? Perhaps it's because they are under FBI investigation for fraud?

Further, the fact that Witt was replaced as MD does not excuse the fact it was his model revision that further fueled the MBS breakdown. By the time he got out the damage had already been done through his reckless revisions of how to rate these securities, making an easy path to receive AAA and other high ratings. I completely understand that Witt was not CEO of Moody's and that he didn't make the final call. Perhaps you can shed light on who lobbied Moody's to revise their ratings model.

Personally, I look forward to Moody's and S & P collapsing over the outrage that will be directed at them within a matter of weeks. It's gaining speed by the minute. They deliver a service based on trust, and they are bankrupt in that department. Buffet's power will not sustain the will of the American tax payer and burned investor to keep this company he owns 20% of afloat. And S & P can burn to the ground right along with it. While they may be "too big to fail" they will be a shell of their former selves when this is done. The are getting stripped of their federal registry and the government wants to be rid of this oligarchy. They have made it easier for new credit ratings agencies to enter this market.

The party is over.

donsutherland1 · 09-29-08, 08:30 AM

Mc.no.spin,

In part, the article you posted states:

Philippe Jorion, 53, a finance professor at the University of California, Irvine, criticizes the Moody's decision to factor ratings stability into its evaluations.

"This uses the output of their model as input into their models," Jorion says. "This type of model is totally out of touch with the underlying economic reality."

Here's an illustration of what Professor Jorion is describing. Let's say there are two models (#1 and #2). Each has a 75% probability of being correct if its input is correct.

The situation that Professor Jorion describes would work as follows: Model #1 would generate output that has a 75% chance of being correct. That output would then become the input for Model #2, even as it has a 75% chance of being correct. Therefore, the output from Model #2 would have only a 56.25% chance of being correct (75% * 75%). That's barely better than flipping a coin.

Overall, that kind of approach is very bad practice. Either the modelers had no big picture understanding of what they were doing or they were swept up in the euphoria of the time. I suspect the latter situation, as it has happened time and again in the historic experience.

Mach · 09-29-08, 03:38 PM

Ah, the newest scapegoat! You're consistent if nothing else.

It looks to me like this is all just a product of free-market capitalism.
If the rules of our market were so loose that they allowed it, then they did their duty. And if we're so dumb that we can't make good rules, and enforce them, then we literally are letting individuals destroy our economy.

I know some libertarians who are so caught up in small government, free-market rhetoric that they simply ignore the reality, and keep claiming less is more. It's mind-boggling. Capitalists will do what it takes to profit, even break the law, but sure as hell ethics are irrelevant. If they profited for years off this, and the economy collapses, you may forget:

FOR THEM IT WAS STILL MORE PROFITABLE BECAUSE THEY ALREADY BANKED THAT MONEY.

They love your free-market policies. They also hold you hostage with your own market. It's brilliant.

-Mach

09-27-08, 01:48 PM	#3
MC.no.spin Language,Borders,Culture Join Date: Dec 2007 Last Seen: Today 02:49 PM Location: Sacramento, CA Posts: 3,359 Thanks: 978 Thanked 977 Times in 582 Posts Lean: Slightly Conservative Gender:	Re: The man who wrecked Wall Street and our economy: Gary Witt This is Gary Witt. Photo editing courtesy of MC.no.spin
	__________________ "The guy’s a phony. He has no experience, he has no record; he’s not nearly ready to be commander in chief." Bill Clinton on Obama (from the book Game Change)

09-27-08, 05:47 PM	#4
donsutherland1 Moderator Mod team member Join Date: Oct 2007 Last Seen: Today 07:42 AM Location: New York Posts: 4,034 Thanks: 1,561 Thanked 3,046 Times in 1,620 Posts Lean: Centrist Gender: Total Awards: 1	Re: The man who wrecked Wall Street and our economy: Gary Witt MC.no.spin, During the euphoric periods in which credit booms underwrite what culminates in the rise of asset bubbles, one often sees more rigorous credit/risk standards supplanted by the pursuit of increased market share in the hope/expectation of a rapid realization of large returns on investment. The mentality that one can only lose out on hugely profitable opportunities from engaging in practices that are consistent with sound risk management takes hold, especially as competitors enjoy increasing returns on investment from the bubble's accelerating growth. Mr. Witt was but one participant out of many who engaged in such behavior. He merely sprinkled the seeds of financial market contagion with his new ratings model. The psychological process that leads to what literally amounts to a stampede toward quick returns (even as that pursuit brings the proverbial cliff ever closer) is an attribute of human nature. Therefore, while excessive regulation can impede economic activity, a lack of carefully targeted regulation that is focused on sytemic risk can assure that there are few barriers to the kind of economic and investment behavior that leads to asset bubbles. Henry Kaufman, one of the world's leading bond traders since the 1970s explained , "When markets are highly deregulated, firms face stiff competition and therefore have great incentive to take risks at the marginal edge." In other words, risk taking becomes an extreme sport of sorts, especially when other people's money (leverage) is involved. Kaufman's observation is not a hindsight analysis. As far back as 1987, Kaufman warned: High price volatility will continue to be a feature of both our equity and debt markets. The securitizaion of assets will breed more intensive efforts at achieving near-term performance objectives. The globalization of markets will subject them even more to the impact of international capital flows. The efforts to further deregulate the financial system will encourage the abuse of fiduciary responsibility by the market participants that can only be cured through extreme price volatility... The new decision makers in the financial markets are exceedingly well trained in analytical skills; they are ambitious and they are willing to take risks, but unfortunately their entreprenerial drive has not been tempered by the lessons of history. We should not be surprised that this is so. There are few schools of business in the United States that teach financial history. How can we remember the lessons of history if we have not been taught them? Following the Panic of 1857, The New York Times observed: [ I ]f every merchant, banker and manufacturer who has been compelled to succumb under the present pressure, would but narrate the causes that led to his own prostration, we should have an amount of evidence that might be turned to most profitable account by their successors in business... [ I ]n the majority of cases it would be found that failures occurred because there had not been proper caution used to guard against the chances of a reverse; and, in too many instances it would be found that disaster had been produced by departing from the legitimate business in which merchants are engaged. Lesson forgotten. History is vitally important. In fact, without the discipline an understanding of the historic experience brings, it is much easier for people, to quote Julius Caesar, "to willingly believe what they wish." People wanted to believe that the rapidly rising home prices were somehow justified by market fundamentals. They wanted to believe that in the era of the Internet, mortgage securitization, and the global economy, the old rules (that home price appreciation could not be detached from the broader economy and that home valuations could, in fact, decline) had become irrelevant. They wanted to believe that homes can only increase in value. As home prices rose into the stratosphere in the early 2000s, those gains seduced them to increase their lending, borrowing, and investing in homes. In essence, one witnessed the opposite of a panic. During a panic, people rush to pull funds out of financial instituitions. In this case, there was a panic in reverse so to speak in which an increasing torrent of funds poured into home purchases. During the financial flood, U.S. mortgage debt, which had peaked at 65.9% of GDP rocketed past 100% of GDP, finally peaking at 105.8% of GDP in 2007, even after the housing market had been softening. All said, the wishful thinking that had helped feed the housing bubble was no substitute for market realities. By their very nature, asset bubbles are unsustainable. The U.S. housing bubble was no exception. Finally, one other lesson of history that is relevant is that the sophisticated models employed in the financial services industry often perform well during tranquil, if not ideal, market conditions. That good performance can seduce risk managers to become overconfident in the models. Rather than recognizing that the models are representations--and often highly simplistic ones when compared to the actual marketplace and its multitude of complex interactions--and have real limitations on account of that, they are lulled into a sense that the models are essentially clairvoyant. Models offer a piece of guidance. They are no substitute for human judgment that must examine far more than the models' output in reaching informed decisions. In any case, the historic experience has shown time and again that once turbulence descends on the markets, the models' performance disintegrates. That happened with the advanced quantitative hedging model that Long-Term Capital Management employed. It happened with Mr. Witt's risk rating model. Barring a dramatic change in human nature and/or greater appreciation of the historic experience, it almost certainly will happen again.

09-28-08, 12:44 AM	#5
metreon Advisor Join Date: Nov 2007 Last Seen: 03-14-10 01:09 PM Posts: 322 Thanks: 9 Thanked 111 Times in 79 Posts Lean: Independent Gender:	Re: The man who wrecked Wall Street and our economy: Gary Witt I heard on the radio today a round-table disscussion of the misleading mortgage backed security ratings. Although I have yet to source this in an article, a security analyst on the panel blamed the ratings problem on newness of the risky subprime loan types which proliferated from 2003 onward. There was no historical data to accurately predicte their default rates. Basically old data sets for more traditional loans were modified with "educated guesses" about how they might perform and the computer models ended up spitting out overly optimistic default rates for the underlying mortgages. It therefore also seems likely that whatever default rate data they did accumulate for the subprimes prior to the bust was also obfuscated by the boom they helped create. The true risk would not be known until the market had a downturn sufficient to shake out the actual risk. According the the analyst some of the mortgage bonds out there have up to a 50% default rate in the underlying mortgages, far exceeding the estimated 5% rates in the computer models. Was this an intentional miscalculation to advance short-term gain? No one will know for sure, and some will always suspect it was purely a fraud based upon greed rather than an under parametized but rational analysis. Also, another panel member, a mortgage broker and banker explained their businesses effectively played the competitive ethos of one investment firm against one another in their auctions. When a bank had a risky set of mortgages they wanted to sell off to a Bear Stearns or similar investment house, and there was reluctance by the investment house to bid, all the broker had to do was keep calling different investment banks until they found one to bid on it at any level. Then they could call back all the other investment firms which had previously turned down the loan package and tell them so-and-so is bidding on these loans, - then, suddenly, because of the competitive nature of the business and desire not to lose share to a competitor, all the investment firms would pile on and the loans would quickly be sold off to the highest bidder to be securitized. It sounded like investment banks also decreased risk oversight when loans were being bid on by more than one bank. Ultimately though, it sounds as though whatever risk assessment models were being used, they were flawed, and not necessarily by intent, but rather from a misguided belief in false data and false assumptions.

09-28-08, 09:59 PM	#7
chriskaplan User Join Date: Sep 2008 Last Seen: 09-28-08 10:15 PM Posts: 2 Thanks: 0 Thanked 1 Time in 1 Post Lean: Independent	Re: The man who wrecked Wall Street and our economy: Gary Witt I have an issue with the journalist, Elliot Blair Smith, who wrote the article on which MC spin based his allegation. First of all, Mr. E. Blair Smith has a reputation for being a sensational journalist who pastes his subjects' comments incoherently in order to suit his theme. I used to work for a rating agency and so I know for a fact that this journalist is on the list of "exercise caution before talking to this one". So, MC spin, I have some comments for you. You wrote about a few names but you mainly scapegoated Gary Witt. Mr. Witt was not THE managing director at Moodys, he was just a team managing director who reported to a group managing director, who consequently reported to a senior MD, then to several more, before reporting to the President, then to the CEO. Also, he was not in that group after the autumn of Sept. 2005, two other MDs had replaced him afterwards. Of course, Mr. Elliot Blair Smith omitted this fact, because that would have been an inconvenient truth for him. So, MC spin, please do not believe everything you read. You know that journalists can't be sued because they are protected by the fifth amendment. So they don't bother to do their research like the rest of us folks do. Remember this, we are all accountable.

09-29-08, 08:30 AM	#9
donsutherland1 Moderator Mod team member Join Date: Oct 2007 Last Seen: Today 07:42 AM Location: New York Posts: 4,034 Thanks: 1,561 Thanked 3,046 Times in 1,620 Posts Lean: Centrist Gender: Total Awards: 1	Re: The man who wrecked Wall Street and our economy: Gary Witt Mc.no.spin, In part, the article you posted states: Philippe Jorion, 53, a finance professor at the University of California, Irvine, criticizes the Moody's decision to factor ratings stability into its evaluations. "This uses the output of their model as input into their models," Jorion says. "This type of model is totally out of touch with the underlying economic reality." Here's an illustration of what Professor Jorion is describing. Let's say there are two models (#1 and #2). Each has a 75% probability of being correct if its input is correct. The situation that Professor Jorion describes would work as follows: Model #1 would generate output that has a 75% chance of being correct. That output would then become the input for Model #2, even as it has a 75% chance of being correct. Therefore, the output from Model #2 would have only a 56.25% chance of being correct (75% * 75%). That's barely better than flipping a coin. Overall, that kind of approach is very bad practice. Either the modelers had no big picture understanding of what they were doing or they were swept up in the euphoria of the time. I suspect the latter situation, as it has happened time and again in the historic experience.

09-29-08, 03:38 PM	#10
Mach Fully Functional Join Date: Oct 2006 Last Seen: Yesterday 05:29 PM Posts: 2,290 Thanks: 388 Thanked 615 Times in 443 Posts Lean: Centrist Gender:	Re: The man who wrecked Wall Street and our economy: Gary Witt Ah, the newest scapegoat! You're consistent if nothing else. It looks to me like this is all just a product of free-market capitalism. If the rules of our market were so loose that they allowed it, then they did their duty. And if we're so dumb that we can't make good rules, and enforce them, then we literally are letting individuals destroy our economy. I know some libertarians who are so caught up in small government, free-market rhetoric that they simply ignore the reality, and keep claiming less is more. It's mind-boggling. Capitalists will do what it takes to profit, even break the law, but sure as hell ethics are irrelevant. If they profited for years off this, and the economy collapses, you may forget: FOR THEM IT WAS STILL MORE PROFITABLE BECAUSE THEY ALREADY BANKED THAT MONEY. They love your free-market policies. They also hold you hostage with your own market. It's brilliant. -Mach

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