SOMETHING ELSE I DIDN'T KNOW ABOUT CREDIT RATINGS

(h/t Atrios)

Yves Smith of naked capitalism got his hands on a transcript of a talk by by David Einhorn, CEO of hedge fund Greenlight Capital. Einhorn noted that not all AAA ratings are the same:

According to S&P's long-term data the 10 year default rate on an A rated municipal bond is 1%, while a corporate bond's default rate is 1.8%, and a CDO's is 2.7%. An A rated muni has the same change of default as and AA/AA- rated corporate and a AA+ rated CDO. When municipal bonds default the expected recovery rate is 90% compared to 50% on corporates and CDOs.

[snip]

Without much fanfare, the rating agencies abandoned this process ..... Instead, for each type of bond, they use a different rating scale with a different so-called "idealized default rates" for each rating. The idealized default rate for a municipal bond at a given rating is less than the idealized default rate for a corporate bond, which is less than the idealized default rate for an asset backed security which is less than the idealized default rate for a CDO....

Nomura Securities pointed out that hypothetically, if you took an AA+ rated asset backed security and repackaged it all by itself and called the repackaged instrument a CDO, it becomes AAA because the CDO has a higher idealized default rate than the asset backed security.