Moody's and the chocolate factory

A chocolate bubble is developing at Wednesday's hearing on ratings agency failings.

How did Moody's (MCO) get its ratings so wrong during the housing bubble? The answer, according to members of the Financial Crisis Inquiry Commission, lies in an episode of the 1950s sitcom I Love Lucy that finds Lucille Ball's character working on the assembly line at a chocolate factory.

As the assembly line speeds up, Lucy falls further and further behind. Madcap hilarity ensues.

This, chairman Phil Angelides said, is similar to the experience of beleaguered Moody's analysts as top executives focused on gaining market share and boosting profits -- at the expense of whatever integrity the firm might at one point have had.  Except in this case, the end result is the near collapse of the economy, which both takes longer and is less funny.

Eric Kolchinsky, a former managing director at Moody's, told the panel that management's focus on market share meant the firm could never say no to a deal the bankers proposed. As a result, bankers who once submitted documents for a deal a month or two ahead of closing, giving Moody's ample time to "weigh the deal," Kolchinsky said, did so just days before -- or even afterward.

This had the effect of reducing the usefulness and accuracy of the ratings, Kolchinsky said with some understatement.

Asked whether he felt like Lucy in the chocolate factory, Kolchinsky said, "Oh yes, we had a conveyor belt."

Not content to leave it at that, vice chairman Bill Thomas (right) then likened the deals the bankers were putting together and submitting to Moody's for a rating to different kinds of chocolate. The best candies in this metaphor are solid, deals filled with performing loans. The lesser ones are filled with who knows what.

"You start with caramels, those look solid," Thomas said. "But the cremes, you've got to be fairly careful."

Kolchinsky allowed that one did need to be careful with the cremes. For example, he noted a collateralized debt obligation sold in 2006 by Merrill Lynch, now part of Bank of America (BAC), that has defaulted and suffered an 87% collateral value decline. Much of it was initially rated triple-A; now it is all junk-rated.

Kolchinsky added that as the housing bubble progressed, bankers sent along more such deals -- that is, chocolates -- that were "more and more empty" of valuable collateral.

By the time the end of the bubble loomed in 2006 and 2007, he concluded, there was "less cocoa content."