Wednesday, February 27, 2008

Finance

Moody’s is a company that assesses risk. Moody’s lost half of its market value in 2007. Now why would a company that assesses risk tank in an era where risk assessment is more important than ever?

Collusion and resulting legal liability to investors.

In a proper system, a business enterprise would approach a bond attorney who would assess the enterprise's risk, and if his due diligence convinced him that the risk was manageable, would originate the bonds. A third-party assessment service like Moody’s would judge the judgments of the attorney and sell their judgment to the investing public.

In the boom, these three parties acted as a team and packaged investments that were attractive to investors. They would walk around together. The firms that got the work were the firms that would most reliably put a positive spin on the investment vehicle. Moody’s assessed the ‘sub-prime’ risk.

They sold out their reputations, and that will come home to roost.

Update: Another thought- Moody’s is a publicly-owned company, which means that institutional investors own the majority of it. Institutional investors have the most to lose by honest negative assessments. Wikipedia (take it for what it’s worth) states that Berkshire Hathaway is a major owner of Moody’s.

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