Moody's World

The recent expansion of debt may be good or bad, depending on your point of view. For Moody's (MCO), the expansion has been highly profitable as their traditional business has been rating issues. However, their non-traditional business of structured finance has also profited from and heavily contributed to the expansion of debt.

Structured finance is the "largest, least understood area in finance" according to Brian Clarkson, Co-COO of Structured Finance and Public Finance for Moody's. Originated in 1984, structured finance now makes up over 52% of their ratings business. Extrapolating growth rates out, MCO will basically be in the structured finance ratings business. So, what is causing such extraordinary growth?

When MCO begin work in structured finance, "securitization" (which is the essential work of structured finance) was described as "the transfer and pooling of cash flows and assets to remove operating risks of the originator from (or by means of) issued securities." In this way, securitization allowed for "originators," such as banks to remove operating risks, such as credit cards, so that they would not be clawed into bankruptcy by retention of concentrated risk. So far, so good; banks could diversify their risk.

By the mid-90s, the description of "securitzation" has evolved to "the pooling of current or potential cash flows which may or may not be transferred and may or may not remove operating risks of the originator from issued securities." Securitization began to allow for the monetization of such assets as film or music royalties. At this level, exposure to certain types or risks and/or cash flows could be calibrated.

Currently, Moody's describes "securitization" as "an ever-changing set of financial techniques, engineering or modeling using by market participants to achieve a specified goal." In the same way that paper money ultimately became the means to transact between widely differing products over differing periods of time, so too has "securitization" produced securities which are tailored to the needs of the investor, the lender and the borrower.

Look at the growth rates of collateralized debt obligations (CDO) done by MCO alone:

MCO is not only profiting from the advances in financial technology and debt demand, but is creating growth by "blessing" these complex structures. Apparently, MCO does not have any real "skin in the game" as MCO has no actual financial investment in these structures.Questions do remain about the level of MCO's responsibility: is it as a journalist or as an auditor?