Arent Moodys and Standard and Poors equally to blame for the subprime crisis?

We all have heard what the collapse of the real estate market has done eventually to the fate of the largest investment banks such as Lehman Brothers, Merrill Lynch, Bear Stearns and the large mortgage lenders Fannie Mae and Freddie Mac. The instruments behind this fall was the CDOs and mortgage backed securities that the whole world was rushing to invest in. Why was the whole world bullish on these instruments?

One party to blame is the credit rating agencies - Moody's and S&P. These are the guys who started to provide AAA ratings on these complex derivative instruments based on their own private research and provided the cue to the investment banks and others to invest in. However, there is a potential conflict of interest that needs to be pointed out. They were paid by the businesses whose products they rated.

Employee training lax?

Lets take a look at the employee numbers and the training practices of these agencies. From 2001 to 2007, the company's global employment more than doubled to 3,600 . Was there adequate training to these new employees to understand the products they were rating?

``It was very difficult to get people in, train them up sufficiently to really understand this stuff -- from structure to quantitative issues -- and then to keep them, because investment banks were very keen to get good people to help them optimize their trade ideas,'' says a former S&P quantitative analyst in London who left in April 2006. What do we expect these employees to do.

More revenue and higher margins

Looking at this picture from a financial angle. The rating agencies all stood to only gain by rating these complex derivatives. While prospectuses don't disclose fees, Moody's says it charged as much as 11 basis points for structured products, compared with 4.25 basis points for corporate debt. A basis point is a hundredth of a percent. S&P says its fees were comparable. Why would the rating agencies not take up this business???

Looking at financial figures, the rating companies earned as much as three times more for grading complex structured finance products, such as CDOs, as they did from corporate bonds. Through 2007, they had record revenue, profits and share prices. Moody's operating margins exceeded 50 percent for the past six years, three to four times those of Exxon Mobil Corp., the world's biggest oil company. Structured finance rating accounted for just under half of Moody's total ratings revenue in 2007.

Doesnt it all add up that the rating agencies were as careless with their work as were the investment banks who indulged in these exotic derivatives. Only when you ask them, a smart answer from the rating agencies claim that its their mere opinion (backed by private research). Hence they are not liable if the ratings go wrong. No wonder, most of the Mortgage bonds that enjoyed AAA ratings defaulted without any repercussions for these agencies.

Time can only tell whether we will see some actions against these rating agencies.