Hey, wait a minute. My nephew is an investment banker. And I told him to become one, as he needed to have an income sufficient to support his aunt and uncle in the style to which they wished to become accustomed. Now he never realized that I was kidding, and wanted him to become an artist who worked in metal, had a studio in a dicey neighborhood and required that his relatives purchase the pieces and then locate them somewhere where we wouldn't be impaled by them.

But he's just respectful of the stated wishes of his aunt, not too dumb to breathe.

The people at fault for such modeling are the rating agencies.

The rating agencies are often the dumbest people involved in any deal.

There are good (well, perhaps not good, but understandable) reasons for this.

Bankers (at Lehman, Goldman, etc) are paid more than folks at credit agencies (S&P, Moody's, Fitch).

However, rating agency employees get wide exposure to the bankers whose deals they rate.

So what happens? If you're at a rating agency, and you're any good at all, you'll be quickly hired away by a bank.

Which means that the folks who work for rating agencies are either inexperienced (relative to the bankers whose deals they rate) or somehow too dumb, deficient or damaged to be hired by the banks.

It's a structural issue that's won't be fixed until folks who work for rating agencies are paid more or less on par with bankers. Don't hold your breath.

Enplaned? The credit rating agencies do consider debt to market equity ratios in their credit rating models. I would hope FT understands this. Now one can quibble as to how reliable these models might be but to suggest that they don't consider loan to value ratios displays an ignorance of what the credit models do.

Money makes people do funny things.

Dr. Baker,

A paper recently published by the Levy Institute deals with this problem with an reevaluation of Minsky's financial fragility theory. It discusses how the current credit evaluation system departs from Minsky's theory in assessing risk.
It's called "Minsky's Cushions of Safety: Systemic Risk and the Crisis in the U.S. Subprime Mortgage Market" by Jan Kregel, Public Policy Brief No 93, 2008.

This is incredible, though not surprising. Several months back it was discovered (and blogged about by Michael Shedlock) that Fitch's ratings model assumed perpetual home value increases. Seriously.

I am familiar with Kregel's work, although not this paper. It is unfortunate that it has not gotten more attention.

LTV isn't a consideration unless mortgage debt is pari passu with all other debt. (Shelter value of the house is non-negative, even if the financial value of the property is, and transaction costs are higher than those involving quick assets.)

So it's not unreasonable to assume that they either didn't think through the terms of the Bankruptcy Bill or they didn't modify their models in time.

What's worse is that they were relying on credit scores--which are lagging indicators at best, and don't tend to correlate with default rates.