S&P Risk Models
There was an interesting segement on NPR this morning, “Economy Got You Down? Many Blame Rating Firms” that covered amongst other things the risk model that Standard and Poors used to rate bonds and in specific mortgage backed ones. There are a few choice quotes in the story about how the organizations approached the models in the face of branching out to new classes of customers with whom they had little to no experience:
The new bonds were based on pools of thousands of mortgages. If you bought one of these bonds, you were basically loaning money to people for their houses. What the equation tried to predict was how likely the homeowners were to keep making payments.
The system made sense, Raiter says, until loan issuers started offering mortgages to people who didn’t have great credit and in some cases didn’t have a job.
Raiter says there wasn’t a lot of data on these new homebuyers. He says he told his bosses they needed better data and a better model for assessing the riskiness of the loans.
He remembers them telling him, “You’ve got 94 percent market share. You’re not going to get any more if you build a new model.” He adds, “To them it was just a tool. And we were making a lot of money with it. So why change it?”
This is a common theme throughout the story and while S&P claims they changed their models it also appears that they weren’t willing to discuss this in detail with NPR. Assuming this is in fact accurate what we have here is not failure of models, but rather an unwillingness to pay attention to what the models were telling them. What do you think?