Discussion Questions:
1. What did Moody’s do wrong, if anything?
2. Which stakeholders were helped, and which were hurt, by Moody’s actions?
3. Did Moody’s have a conflict of interest? If so, what was the conflict, and who or
what were the principal and the agent? What steps could be taken to eliminate or
reduce this conflict?
4. What share of the responsibility did Moody’s and its executives bear for the
financial crisis, compared with that of home buyers, mortgage lenders, investment
bankers, government regulators, policymakers, and investors?
5. What steps can be taken to prevent a recurrence of something like the subprime
mortgage meltdown? In your answer, please address the role of management policies
and practices, government regulation, public policy, and the structure of the credit
ratings industry.
Discussion Questions and Answers:
1. What did Moody’s do wrong, if anything?
Moody’s misjudged the risk inherent in thousands of complex asset-backed securities,
particularly residential mortgage-backed securities that it rated during the mid-2000s. It
stopped rating RMBSs in mid-2007, and over the following year downgraded more than
5,000 of them, including 90 percent of those first rated in 2006 and 2007. The downgrades
represented an acknowledgment by Moody’s that its original ratings were inaccurate.
Arguably, Moody’s failed to consider the risk inherent in the loans underlying these
complex asset-based securities, putting investors and, indeed, the entire financial system at
risk. In its own defense, Moody’s would likely point out that ratings are simply an opinion
of the statistical probability of default. It would no doubt argue that when the ratings were
first issued, they were based on the best information and statistical models available and
therefore provided an accurate probability estimate at that time.
2. Which stakeholders were helped, and which were hurt, by Moody’s actions?
Stakeholders are those people and groups that affect, or are affected by, an organization’s
decisions, policies, and operations. Many stakeholders, both market and nonmarket, were
affected by Moody’s inaccurate ratings.
Initially, many stakeholders benefited from Moody’s high ratings of RMBSs.
•Moody’s shareholders benefited greatly from the company’s stellar financial results
during the early 2000s; as shown in Exhibit B, share value rose 354 percent over a
5-year period, well above the S&P 500 composite index and its comparison group.
•Institutions, governments, and individuals who invested in RMBSs benefited, since
these securities typically paid interest rates above those paid by other investments
with comparable investment grade ratings during 2004-2007.
•Mortgage originators and investment banking firms earned high fees from selling,
