"Surely, they saw that these securities would blow up if house prices started falling. Why did they not call baloney sandwich? "

Arnold Kling wants to ask a clear, concise, and pointed question to Fannie/Freddie. Apparently, he doesn't know that asking such questions will keep him off dinner lists and wine tasting lists, and certainly keep him miles away from any Congressional Hearing:

"Gretchen Morgenson writes,

The safest slice of the security held $165 million in loans. When it was issued on Aug. 17, 2006, Moody's and S.& P. rated it triple-A. Just eight months later, Moody's alerted investors that it might downgrade the top-rated tranche. Sure enough, it dropped the rating to Baa, the lowest investment-grade level, on Aug. 16, 2007.

Then, on Dec. 4, 2007, Moody's downgraded the tranche to a "junk" rating. On April 15 of this year, Moody's downgraded the tranche yet again; today, it no longer trades. The combination of downgrades and defaults hammered the securities.

One question that I would like to see asked at next Tuesday's hearing on Freddie Mac and Fannie Mae is what those two firms were thinking while the rating-agency nonsense was going on. I imagine that they ran some of these securities through their stress tests, the way any manufacturing company would test a competitor's products. Surely, they saw that these securities would blow up if house prices started falling. Why did they not call baloney sandwich?"

Arnold hasn't read my blog, so he doesn't know that these folks become keen epistemologists when questioned about reality. Here's a sample answer:

Suppose Moore points to his left hand and says, "That's my right hand". Now, is that a mistake in perception, or, rather, simply the misuse of a word? And can we or Moore ascertain an answer to that question even in theory?

Well, suppose Moody's says, "That Tranche is AAA...". Surely you see my point.

Here's another answer:

It's like that blasted duck/rabbit monstrosity, don't you see? Is it a rabbit, or is it a duck? You can see it as either one, but not at the same time, and, yet, it's the very same drawing. The exact same drawing. Don't you see? Now, take a Mezzanine Tranche, for example. For one thing, you immediately envision Escher's staircase, don't you? I certainly do. And a Tranche is like that damned duck/rabbit. I mean, you can see it as AAA, or as complete crap, and it's the same tranche. The very same tranche, don't you see.

Well, I, for one, certainly do see.

"In the final few months of 2007, Moody’s downgraded more bonds than it had over the previous 19 years combined"

Interesting post on the FT by Sam Jones on Moody's and the rating system:

"Then, on August 16 last year, after an internal revision of its ratings practices, Moody’s made an announcement that heralded the beginning of the credit crunch."

And:

"The action was the first in a series of surprises for the credit markets. In each of the succeeding weeks, it seemed, Moody’s and the other rating agencies had more bonds to downgrade. And each set of downgrades was a convulsive shock. In the final few months of 2007, Moody’s downgraded more bonds than it had over the previous 19 years combined. Panic gripped trading floors. Titanic structured vehicles, created by banks to warehouse their “riskless” mortgage bonds, became untouchable for short-term investors. As a result, two big German banks revealed that they were within a whisker of collapse, and virtually overnight all the world’s banks stopped lending to one another."

Please read it.