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subprime situation and how we rated the deals and are preparing to deal with the fallout (downgrades).”16 At Moody’s, the story was similar. The company’s own subsidiary, Economy.com, issued a prescient report in October 2006 called “Housing at the Tipping Point,” in which it reported, “Nearly twenty of the nation’s metro areas will experience a crash in house prices: a double-digit peak-to-trough decline.” A double-digit decline in housing prices is precisely what the rating agencies’ models said could never happen. In addition, big investors had started complaining that the ratings were flawed. At one point, Josh Anderson, who managed asset-backed securities at PIMCO, the giant bond manager, confronted Moody’s executive Mary Elizabeth Brennan. In an internal e-mail, Brennan reported, “PIMCO and others (he mentioned BlackRock and WAMCO) have previously been very vocal about their disagreements over Moody’s rating methodology.” She continued, “He cited several meetings they have had... questioning Moody’s rating methodologies and assumptions. He found the Moody’s analyst to be arrogant and gave the indication that ‘We’re smarter than you’...” Anderson went on to say, Brennan wrote, that “Moody’s doesn’t stand up to Wall Street... In the case of RMBS, its mistakes were ‘so obvious.’”

And still the agencies continued to stamp their triple-As on mortgage-backed securities. The evidence didn’t seem to matter. In late December 2006, Moody’s analyst Debashish Chatterjee was shocked by his own graph of the number of mortgages at the top ten issuers that were more than sixty days delinquent. Fremont Investment & Loan, in particular, was drowning in them. “Holy cow—is this data correct? I just graphed it and Freemont [sic] is such an outlier!!” he wrote in an e-mail to colleagues. A month later, when S&P was rating a Goldman CDO that contained Fremont loans, the analyst on the deal asked a colleague, “Since Fremont collateral has been performing not so good, is there anything special I should be aware of.” The response: “No, we don’t treat their collateral any differently.” Both Moody’s and S&P rated five tranches of that offering triple-A; not surprisingly, two of the five were later downgraded to junk, according to analysis by the Senate Permanent Subcommittee on Investigations.

It wasn’t until July 2007—the same month the Bear hedge funds collapsed—that the rating agencies made their first major move toward downgrading. E-mails imply that they had been considering such a move among themselves for months. It also appears that they were discussing it with at least some Wall Street firms as well. “It sounds like Moody’s is trying to figure out when to start downgrading, and how much damage they’re going to cause—they’re meeting with various investment banks,” a UBS banker had written back in May. A judge overseeing a lawsuit involving UBS would later find “probable cause to sustain the claim that UBS became privy to material non-public information regarding a pending change in Moody’s rating methodology.”

Yet even in July, the rating agencies still weren’t ready to go all in and actually downgrade triple-A tranches. Instead, on July 10, 2007, S&P placed 612 tranches of securities backed by subprime mortgages on “review” for downgrade; almost immediately, Moody’s followed, placing 399 tranches on review. Both agencies made a great point of saying that the downgrades affected only a sliver of the mortgage-backed securities they had rated.

Why had it taken so long? Sheer overwork played a part, as did paralysis. But it was also because the rating agencies feared the consequences of a widespread downgrade of mortgage-backed securities. With ratings so embedded in regulations, downgrades would force many buyers to sell. That forced selling, in turn, would put more pressure on prices, which would create a downward spiral that would be nearly impossible to reverse. With subprime mortgages, that situation was exacerbated a thousandfold, because the flawed ratings of residential mortgage-backed securities had been used to create countless