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Steve Chiotakis: This might sound like a story from before the financial crisis. Ratings agency Standard & Poor’s is giving higher ratings — AAA ratings — to securities backed by subprime home loans. This after S&P lowered the U.S. credit rating, citing debt and political issues.
Zeke Faux is reporting the story for Bloomberg News and he joins us now from New York. Good morning.
Zeke Faux: Hi Steve.
Chiotakis: I’m getting flash backs here, Zeke — subprime bundles with AAA ratings? This sounds like something that happened right before the financial crisis.
Faux: People think that all this stopped after the financial crisis, but in fact, banks are still packaging together loans and selling them to investors, and paying for ratings — just like before, but on a much smaller scale.
Chiotakis: What kind of loans are we talking about here?
Faux: These loans are to homeowners across the country with bad credit scores and who owe I think on average, 97 percent of the value of their homes. That doesn’t leave much margin for error.
Chiotakis: So how do the ratings agencies justify what they say about these loans? I mean, especially in the wake of the downgrade to U.S. credit rating?
Faux: The idea is that through careful mathematical calculations, a portion of anything can be made AAA. But the people that we talked to thought that this was frankly, laughable, since U.S. debt is viewed as a risk-free benchmark. But, it seems that the market didn’t put much stock in the downgrade. They’re buying up the lower rated Treasury bonds. And these higher rated mortgage bonds are having to pay much more interest than Treasury bonds, suggesting that investors think they’re riskier even though the rating says the opposite.
Chiotakis: Do these folks — these ratings agencies — do they have any credence? Do people really believe what they have to say anymore?
Faux: Yeah. And I think that the decision to downgrade the U.S. has brought more pressure from the government to do that, but on the other hand, it’s very difficult for people to evaluate complicated investments like this and they depend on the ratings agencies to look at them.
Chiotakis: So we’re stuck with these ratings, right? I mean, we really can’t do anything about it?
Faux: With the Dodd-Frank Act, it was designed to cut reliance on ratings. It said that regulators should try to strip any reference to ratings from rules about what investments banks can hold, what funds can buy. But, regulators are having difficulty finding an alternative, so they haven’t changed any of the rules yet.
Chiotakis: Zeke Faux is a reporter for Bloomberg, and Zeke, I appreciate your time.
Faux: Thanks, Steve.
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