Fed Loans Guided by Raters Grading Subprime Debt AAA
By Alison Fitzgerald
Dec. 18 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke is basing hundreds of billions in emergency lending on credit ratings from companies that gave AAA grades to toxic securities.
The Fed has purchased $308.5 billion in commercial paper and lent $631.8 billion under eight credit programs, most of which require appraisals of short-term debt and loan collateral by “major nationally recognized statistical ratings organizations.” That, in effect, means Moody’s Investors Service, Standard & Poor’s and Fitch Ratings.
It is foolhardy to rely on the three New York-based companies, said Keith Allman, chief executive officer of Enstruct Corp., which trains investors in financial modeling and asset valuation. The major raters issued top marks to $3.2 trillion in subprime mortgage-backed securities at the root of the financial crisis.
“They’re outsourcing the credit assessment to a group of people whose recent performance has been unbelievably bad,” said Allman, the New York-based author of three books on structured finance and a former vice president in Citigroup Inc.’s securitized markets unit. “If their goal is to not take a loss on these assets, they should be hiring independent analysts.”
Rating companies are hired by debt issuers to analyze the quality of securities and the likelihood the borrowings will be repaid. Lenders demand higher interest when a rating is low. If the Fed is relying on unrealistic valuations, it may be charging too little and taking on greater risk than it intends, said Donald van Deventer, CEO of Honolulu-based Kamakura Corp., which provides financial software and consulting.