A turn for the worse this week in the subprime home loan meltdown has pundits and investors playing the blame game.
This week lots of fingers were pointed at the rating agencies. Many investors castigated the credit assessment firms, which made lots of money reviewing and grading bonds tied to these risky home loans, for being late with warnings on these securities.
Two weeks before, Wall Street firms were the culprits -- for buying these risky securities and then making them into multitiered credit cakes with a punch and selling them to funds and investors.
And earlier in the year, it was greedy home loan brokers and lenders, and naive or desperate consumers looking to buy a home with risky loans who were the instigators of the subprime crisis.
The turmoil in the U.S. home loan market was triggered by tens of thousands of home loans going bad. These loans, known as subprime, were offered during the housing boom to borrowers with slim or shaky credit histories. As the loans began to default, the impact roiled a slumping housing sector, banks, homeowners, markets investors and the economy.
The tale of woe that has evolved in the risky housing loan sector has a cast of characters and a number of chapters and reads like an epic encompassing struggling homeowners, Wall Street mavens and a few of the Seven Deadly Sins.
Frankly it's the greed factor all over again, said Bill Featherston, a managing director at broker-dealer J. Giordano Securities Group, which is based in Stamford, Connecticut.
WHERE TO BEGIN
Lawyers are sharpening litigation knives and politicians are calling for reforms, investigations and someone to blame.
But it is unclear who will ultimately pay.
The rating agencies, after weeks of taking heaping abuse, this week slashed ratings and earlier forecasts on deteriorating subprime loans and reassessed billions of dollars of debt, much of which had received a clean bill of health due to their rosy outlooks for U.S. housing.
Standard & Poor's cut ratings on $6.4 billion of debt and Moody's Investors Services downgraded $5.2 billion. Both now project losses for subprime loans originated in 2006 to reach as high as 14 percent, more than double at the start of the year.
But S&P, Moody's and Fitch Ratings reveled during the boom years when credit raters stoked record growth in a $1 trillion debt market that included CDOs and the underlying subprime loans. The newfangled bonds contributed to as much as half of the raters' total revenue growth.
A growing chorus of critics say raters were irresponsible in giving their stamp of approval to bonds that should have been rated much lower.
This is like selling liquor to a minor without carding them, or selling a hand gun and saying they're not being used to kill people, said Joseph Mason, an associate professor of finance at Drexel University in Philadelphia. They are selling these ratings, and the label says don't use it for investment purposes. That's clearly not the case.
Mason, who co-authored a study detailing the risks of subprime loans and CDOs, says rating companies are involved in much more than just rating securities.
They work intimately with the underwriting team to determine the size of each tranche, or groups of rated debt, and are active in the entire structuring of CDOs to achieve a rating target, he said.
S&P, Moody's and Fitch have declined to comment. They have argued that they offer opinions and not investment advice.
WALL STREET REACHING FOR PROFITS
Subprime lenders provided the raw material for Wall Street to manufacture securities products snapped up by pensions, hedge funds and other institutional investors. Critics say the emphasis was on pumping out volume, not quality.
With Wall Street's backing, lenders mass marketed mortgage products that disguised onerous prepayment penalties and teased borrowers with low initial payments that later soared. No money down mortgages and so-called liar loans, obligations that didn't verify a borrower's income, became common fare.
Wall Street grabbed loans pooled and packaged into securities that were sold to pensions, hedge funds and global investors.
But this process, called securitization, may have put the regulation of the subprime mortgage industry in the hands of the investment banks and ratings agencies, critics charge.
Wall Street and rating agencies, rather than state regulators or even lenders, largely decide what types of borrowers obtain subprime loans and how the loan products offered to borrowers are designed, Kurt Eggert, a Chapman University law professor, told a Congressional committee earlier this year.
The banks that securitized the debt didn't worry about escalating late payments because they didn't hold the loans; the risk was spread thinly over a diverse group of investors.
And Wall Street's demand for subprime loans emboldened mortgage brokers, who were rewarded for drumming up business and pushing volume through the pipeline.
INVESTORS REACHING FOR YIELD
Investors also are taking it on the chin. A growing number of hedge funds, investment banks and insurance companies face losses on their subprime-linked investments.
Last month investment bank Bear Stearns roiled markets after two of its hedge funds that had used billions in borrowed money to buy CDOs almost collapsed. The hard-to-value securities rarely trade but some had the highest rating: AAA.
Have we forgotten what happened during the tech-telecom bubble days? said Andrew Harding, chief investment officer of fixed-income at Allegiant Asset Management in Cleveland. These products weren't transparent to me and difficult to analyze and understand and yet they got triple-A credit ratings!
James Grant, editor of the widely read Grant's Interest Rate Observer, said past financial panics show that increased regulation is an unlikely cure. And while many people might be deserving of blame, Grant said he'd be careful to assign it.
Capital markets are great amphitheaters of human action, he said. I admit it's not very helpful to say that humanity is really at fault in this. But markets test extremes, they test limits. They test limits to the upside or the downside.
(Additional reporting by Jennifer Ablan, Walden Siew and Tim McLaughlin)