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Comment by JumpCrisscross | Hacker News Reader

> hard to take Moody's seriously following their ratings for garbage MBSs

Do you have evidence their MBS ratings failed?

Obviously, it's impossible to say given the massive government intervention. But AAA-rated mortgage products paid out as statistically expected. What they didn't do is hold mark-to-market value. That is what screwed people in banking who, seemingly repeatedly, can't get their heads around the difference between intrinsic and market value, on one hand, and liquidity, on the other hand. It's analogous to the hold-to-maturity debacle that felled Silicon Valley Bank.

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I think they're talking about what happened in 2008, not in 2023.

> they're talking about what happened in 2008, not in 2023

Yes. The AAA-rates tranches which traded pennies on the dollar in ‘08 largely paid out as expected. That didn’t help banks trying to rely on them as their capital. But it noisily validated the ratings quality of those tranches. (Noisily because, again, massive government intervention.)

That seems unlikely that they paid out as expecting considering we had record levels of default. The mark to market value of the MBSs didn't collapse because of increasing interest rates. They collapsed because of heavily increasing defaults.

The waybs were structured the upper tranches were more or less isolated from the defaults

> seems unlikely that they paid out as expecting considering we had record levels of default

Risk cannot be destroyed, but it can be moved. Tranching lets one control this. So if 95% of a pool default, and 5% don't, and you prioritize their payments to a premium tranche, that premium tranche will continue performing. (The specifics are more complicated [1].)

[1] http://quantlabs.net/academy/download/free_quant_instituitio...

Yes, but banks owned all the tranches. Not just the premium ones. So most of them did not pay out as expected.

> They collapsed because of heavily increasing defaults.

And when the borrowers defaulted on their mortgages, the property backing the mortgage went to the holders of the mortgages and got sold off to pay off the MBS holders.

Nevertheless, a 1% risk of default does not mean you might lose 1% of your money - it means 1% of the time you are going to lose 100% of your money, and 99% of the time you are going to lose 0%.

Wasn't part of the problem that the properties were worth less than the principal on the mortgages?

Yes, hence the term "underwater on your mortgage" entered the everyday American vernacular.

Serious question: why did their price crash if they were in fact still AAA quality in terms of long-run expected payout? Is the "they were overrated junk and everyone looked the other way" narrative not true in your eyes?

> why did their price crash

Confusion, uncertainty and a fire sale.

Nobody knew how bad defaults would get. Risk cannot be destroyed, simply moved. After a point it poisons the top tranche. The number of buyers who understood these complex instruments, moreover, was small. So if a bank held a bunch of them and needed liquidity fast, they would set off a fire sale.

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