> nobody believes a AAA rating makes something risk-free.
In a world where every market participant took the time to think at all, you'd be on to something. But there's a special (and yet not in the sense of the word "rare" at all) kind of "investor" out there whose only real mandate is: don't get too risky. And the barometer they are given is: if it's fixed income, it can't be less than AAA. Given that, there's not a lot you can do. But if your broker comes up to you and says "I can get you 20 basis points more than you're getting, how about it?" all you really have to ask is: is it AAA?
The supply was increased to match the demand.
> According to this paper from Moody's, within any given 20-year window
> in the 1920-1999 era, about 2% of AAA-rated corporate bonds defaulted.
> http://www.moodyskmv.com/research/whitepaper/52453.pdf
Corporate bonds, sure. But off-brand MBS and CDO weren't corporate bonds, where quarterly profits matter and companies come and go. That's off limits to a cash management kind of investor already, AAA or not. The off-brand stuff -- that is, "non-Agency" (FRE, FNMA, etc.) -- was marketed as "just like that, only juicier" ... if you thought about it at all, you could easily craft an argument that it wasn't going to be much of a difference from the Agency paper, it was just going to make you look like a genius to your boss because you were 'beating the market' ...
Dont' forget, if you're getting 4% yield and you have a 2% default rate (which doesn't pay zero, it pays somewhat less than that average 4%), you're still probably better off than someone who is getting 2.5% in Treasures.
> A rating is not a recommendation about what precise interest
> rate investors should demand ...
No, but it is a filter on what you can buy. AAA? Maybe. No AAA? No.
>> In the US, the desire to mint more CDOs, after all conceivable
>> normal housing had been securitized, led necessarily to a huge
>> fall-off in loan standards and loan quality to meet the
>> accelerating volume requirements of demand.
>
> I strongly disagree. The only reason anyone ever bought a CDO
> is because they believed it would pay off.
I think you give far too much credit to people who really couldn't be bothered to read a 1400 page document. The phenomenon that Michael refers to is exatly what sunk places like Bear Sterns and Countrywide. Especially during the end-game -- from roughly mid-2005 through 2007 -- many of the new customers were typical late-bubble participants: last ones to the party who were only asking one question: is it really true? And they were treated to grissle, fat, and sawdust from the floor pushed together on the plate and sold as filet mignon.
/jordan