Did the ratings agencies play favorites in rating MBS bond risk? Were they more likely to grant “AAA” ratings to larger issuers of MBS bonds? Phil Strahan and his co-authors say “yes”. Here is their abstract:
“We examine whether rating agencies (Moody’s, S&P, and Fitch) reward large issuers of mortgage-backed securities, who bring substantial business, by granting them unduly favorable ratings. The initial yield on both AAA-rated and non-AAA rated tranches sold by large issuers is higher than that on similar tranches sold by small issuers during the market boom years of 2004-2006. Moreover, the prices of MBS sold by large issuers drop more than those sold by small issuers, and the differences are concentrated among tranches issued during 2004-2006. We conclude that large issuers receive more favorable ratings and that the market prices the risk of inflated ratings, especially during booming periods.”
For a copy of their technical paper click here. Page 2 offers a subtle discussion for why MBS assets are different than other assets and thus pose challenges on relying on free market competitive forces for achieving accurate risk assessment.