Dr. Joseph Mason, associate professor of finance at Drexel University’s LeBow College of Business, testified on Thursday, September 27, 2007 before the U.S. House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises Washington, D.C.. The hearing addressed the role of credit rating agencies in the structured finance market.
Dr. Mason is an internationally renowned expert on the impact of subprime mortgage lending. His academic research papers, "How Resilient Are Mortgage-Backed Securities to Collateralized Debt Obligation Market Disruptions?" and "Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions", co-authored with Joshua Rosner, managing director, Graham Fisher & Co., accurately predicted the broader economic effects of the slumping housing industry.
"Many are tempted to characterize the current market conditions as a bursting of a classic asset bubble," Dr. Mason wrote in his prepared testimony. "The central question, however, is not whether recent market conditions were a bubble, but why markets are in their current state of turmoil despite very favorable Federal Reserve rate cuts and a variety of other measures."
Dr. Mason served three years in the Office of the Comptroller of Currency studying structured finance and has offered advice to banks, securities market regulators and industry groups on the recent difficulties of structured finance. He has been quoted in national and international publications and has appeared on various television and radio news programs addressing the subprime crisis.
He also explained how conflicts of interest in NRSROs (Nationally Recognized Statistical Rating Organizations) contribute to investors being uninformed. NRSROs are paid by those they rate; and, Dr. Mason contends, NRSROs claim that they are protected by free speech and bear no responsibility for accurately reporting risk. His testimony demonstrated that during the recent credit crunch, NRSROs were late in downgrading the ratings of residential mortgage-backed securities and collateralized debt obligations.
Dr. Mason asserted that the current economic crisis was caused by the lack of foresight in financial engineering rather than subprime lending. "New and complex debt products need simple funding structures, but the NRSROs simply rated the new instruments like old corporate debt."
At the hearing, Dr. Mason opined that "Much needs to be done to effectively increase transparency and liquidity in what is now a crucially important structured finance sector. Ensuring ratings are both valid and transparent and that they are changed promptly over time with credit quality will begin to reduce information differences, prospectively.
"Existing securities need to be rerated so that investors can get on with evaluating risk and making appropriate investment decisions in today’s markets while regulators and legislators develop a unified approach to structured finance that can carry markets into the future without unnecessary interruptions."
Also testifying at the hearing were H. Sean Mathis, managing director, Miller Mathis; J. Kyle Bass, managing partner, Hayman Capital; Mark Adelson, Adelson-Jacob Consulting; Michael Kanef, group managing director, Asset Finance Group, Moody’s Investors Services; and Vickie Tillman, executive vice president, Credit Rating Services, Standard & Poor's.
To read Dr. Mason’s testimony in its entirety, click here.