One can hardly escape the home-buying process without passing several important milestones. During the closing of our own house purchase several years ago, the attorney said he was very concerned about the steady stream of "strange" mortgages being approved for buyers who would otherwise not qualify for traditional home loans.

He openly questioned, for instance, whether some buyers would be able to continue paying off their mortgage debt once interest rates reset, based on the incomes that they reported. Of course, buying a series of subprime MBS and CDOs is infinitely more sophisticated. The market, however, had frequent and increasingly nervous discussions about the underlying risks of the $2.3 trillion of subprime loans, according to data from Inside Mortgage Finance, that were extended to borrowers between 2002 and 2006.

As early as last February, Standard & Poor's said it increased credit surveillance on 18 subordinate classes of 11 subprime and Alt-A MBS deals closed in 2006, citing what it called a new paradigm of subprime credit losses. Around the same time, Moody's Investors Service openly questioned the servicing operations of several subprime lenders, and threatened to lower the ratings of such venerable operators as Accredited Home Lenders and New Century Financial Corp., among others.

In light of all this, last week's outpouring of fury from some - but certainly not all - members of the investor community was confusing.

Rating agencies usually operate deep behind the scenes of the capital markets, methodically examining reams of data before assigning carefully stated opinions on the chances of bonds defaulting over time. As one market investor noted, however, such opinions are guidelines, and ultimately, investors are responsible for doing their own research to become comfortable with the soundness of the securities that they are buying, relative to their tolerance of risk.

"People who are new [to the structured finance markets] just got scared and are looking around for someone to point fingers at," said one buy-side professional. "Those of us who are experienced do not rely [solely] on the rating agencies. You have to take the next step and do your own credit homework."

Judging by their reactions to the rating agencies' news last week, the newest crop of investors in MBS and CDOs relied too heavily on rating opinions to make their buying decisions. During a couple of conference calls last week to discuss ratings actions by S&P and Moody's, investors pointedly and repeatedly questioned the companies about why their initial credit ratings on MBS and CDO deals were so optimistic, and why it took them so long to downgrade the securities.

Those are legitimate concerns, but they raise some inescapable questions. Shouldn't MBS and CDO investors remember that they are basically helping people buy their houses? It is worth taking the time to ask penetrating questions about the servicers, originators and the borrowers who generate the securities' underlying loans. Take a walk around the property and kick the tires, so to speak. If anything questionable crops up in the due diligence process, then negotiate hard with the issuers until they come back with more tolerable terms.

Also, doesn't the prevailing rating agency model call for issuers - the same parties selling the bonds - to pay the fees by which the rating agencies generate their revenue? If investors feel that the current rating agency methods deliver flawed opinions to begin with, then they should demand alternate models, and be willing to pay for them.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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