More to blame

October 02, 2007

The players in the subprime mortgage mess keep increasing: an overinflated housing market, zealous mortgage brokers, homebuyers eager to cash in on the craze (and clueless about the fine print) and now the credit-rating agencies that valued bonds backed by subprime mortgages. With foreclosures mounting and the housing market in a downward slide, no one should escape scrutiny.

The Securities and Exchange Commission has begun an investigation of credit-rating agencies centered on a potential conflict of interest. And the commissioners are justified in inquiring: The rating agencies that reviewed mortgage-backed bonds are paid by the investment banks that issued them. Last Friday, Moody's Investors Service and Standard & Poor's were defending their rating practices before a Senate committee. A House panel questioned them last month.

Here is their role: The agencies gave mortgage-backed securities high marks, which surely helped their sales. Then in July, long after the extent of the subprime foreclosures was known, the rating agencies downgraded the bonds. Big deal; by then, everyone knew they were junk.

The question that needs answering is: How seriously did the rating agencies evaluate the risk of the bonds, which, after all, were supported by mortgages taken out by folks with poor or weak credit? Not very, if the investment firms paying their fees had a vested interest in the securities' selling well.

The SEC is trying to find out if the investment houses influenced the credit agencies' ratings of the bonds. The relationship between the agencies and the security issuers is less than transparent, and could be improved. Also, investors would benefit from knowing the default rates on credit-rated securities.

The credit-rating agencies have defended their actions, blaming fraudulent practices of some mortgage brokers and lax underwriting practices as the primary causes of the subprime fallout.

They have a point: Most of the initial discussion about the subprime problems has focused on homebuyers who were prey to unscrupulous brokers, the pace of home foreclosures and efforts to keep homeowners in their houses. But the implosion of the subprime market stemmed from a series of events, not one or two bad actors.

Policymakers and regulators have to get a handle on the entire picture to determine the appropriate remedies. The consequences of not being more disciplined, more watchful and more responsible are threatening the economy and the global markets today.

Subprime mortgages weren't inherently bad; they did help many Americans buy their first homes and they remain in them. The focus now should be on reforming any and all aspects of the industry that contributed to the fallout now under way.

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