MODULE 56: The Mortgage Meltdown – Big Investors
Core Module Issues:
• What are ratings agencies?
• Do ratings agencies share more or less blame than investment houses
and investors themselves when ratings do not accurately reflect
investment risk?
Module Teaching Notes
This module compliments the last one, and narrows the focus to exotic investments.
The basic story to set up here is:
1. Moody’s and similar ratings agencies are in business to assess the relative risks of different
kinds of investments.
2. Investors rely upon ratings to help them make investment decisions.
3. The ratings agencies made poor assessments in parts of the “00s”of investments that bundled
sub-prime mortgages.
4. Investment houses created ever-more-complex types of mortgage-based investments, like
collateralized debt obligations, and synthetic CDOs.
5. Investors, regardless of any outside influence, are always of course free to remember that
investments that seem too good to be true are in fact too good to be true.
The scenario is different – it is a little three act play that is meant to make the basic relationship
between investment houses, ratings agencies, and investors more clear.
My students seem to really like it.
Discussion Points for Scenario Questions
1. Do you blame the investment banks that sold CDOs and other complex real estate
investments for contributing to the current economic mess? Did they act any more or less
wrongfully than the casino in the scenario that created the difficult–to-understand game of Super
Ultra Poker?
A. MORE BLAME – BUTAREN’T THEY ENTITLED TO SELL WHATEVER
PRODUCTS PEOPLE WILL BUY?
2. Do you blame the ratings agencies that rated complex investments as AAA when in fact they
were often largely comprised of ultra-risky subprime mortgages? Did they act any more or less
wrongfully than Tex, who declared Super Ultra Poker to be a good bet in the scenario?
A. MORE BLAME – BUT AREN’T PEOPLE RESPONSIBLE FOR THEIR OWN
ACTIONS?
3. Do you blame investors for being greedy and contributing to the recession by purchasing
complex investments? Do you have any more or less sympathy for them than for Roger in the
scenario?
A. MORE SYMPATHY FOR ROGER – BECAUSE HIS IS
UNSOPHISTICATED?
B. NO MORE SYMPATHY FOR ROGER – WHY?
4. For this question, ignore the overall economy and focus only on the losses on the CDOs and
other complex real estate investments themselves. Assign a percentage of blame to each of the
investment banks, ratings agencies, and investors so that the total equals 100 percent. (So, for
example, you might say 50 percent to one group, 50 percent to another, and 0 percent to the
third.) Now do the same thing for the casino, Tex, and Roger from the scenario.
[LET THE STUDENTS GIVE THEIR RATINGS AND RESPOND TO ONE
ANOTHER]
5. Should the government create new regulations to address any of the three groups in this
module? Should investment banks be more regulated and less able to offer complex investments?
Should ratings agencies that miss the mark on their ratings face greater legal liability? Should
investors be restricted in their ability to purchase complex investments until they show (perhaps
through passing an exam) that they fully understand what they are investing in?
A. REGULATION – WHAT TYPE? IMAPCTING WHICH GROUPS?