Until now, the pricing of risks linked to housing and subprime mortgages remained something of a mystery, as risks remained hidden in the complex world of credit derivatives. But changes in ratings will force a re-pricing of the roughly $800 billion in subprime-mortgage bonds sitting in investment portfolios across the globe.
"Whenever you have such a massive growth in derivatives, as we had with housing, it's [used] to hide the losses," said Smith of Smith Affiliated Capital. "Nobody knows the true counterparty risks."
Some market players believe that, with the rating agencies making their moves so late in the game, they're seeing a replay of the Enron and WorldCom debacles, which played significant parts in popping the 1990s stock-market bubble.
Both Enron and WorldCom had used "creative" accounting methods to artificially boost earnings, until the bursting of the stock bubble revealed their overwhelming debt was more real than much of their projected revenue. Yet the main credit-rating agencies had kept an investment-grade rating on both companies' debt until days before they went bankrupt.
In particular, so-called liar loans, or mortgages that were backed by dubious documentation -- if any -- from borrowers, still ended up receiving high-grade ratings from the agencies.
Peter Shiff, president of Euro Pacific Capital, said the rating agencies' moves this week were too little, too late. He said lenders knowingly relied on inaccurate data. "If the lenders themselves call them liar loans, why should we think they're boy scouts?"
Schiff added: "And it's not just people with bad credit that lied on their mortgages."