[Roger Lowenstein] gives an inside view of the Sub Prime Credit Rating process. The Securities and Exchange Commission (SEC), faced with the question of how to measure the capital of broker-dealers, decided to penalize brokers for holding bonds that were less than investment-grade (the term applies to Moody's 10 top grades). This prompted a question: investment grade according to whom? The SEC opted to create a new category of officially designated rating agencies, and grandfathered the big three - S.&P., Moody's and Fitch. In effect, the government outsourced its regulatory function to three for-profit companies... [Joseph Mason], of [Drexel University], compared default rates for corporate bonds rated Baa with those of similarly rated collateralized debt obligations until 2005 (before the bubble burst). Mason found that the [CDO]-s defaulted eight times as often. One interpretation of the data is that Moody's was far less discerning when the client was a Wall Street securitizer... From 2002 to 2006, Moody's profits nearly tripled, mostly thanks to the high margins the agencies charged in structured finance. (Market Distortion)

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