Alumni Spotlight

Jerome Fons, Ph.D.
At the Front Line of the Financial Meltdown

By Alex Morales

There’s no denying that the financial crisis of the late 2000s affected everyone on some level; however, the impact of the crisis was quite different for Jerome “Jerry” Fons, who was on the front line of the 2008 financial meltdown. In mid-2007, Fons left Moody’s Investor Service right as things were starting to derail. He later testified before Congress against his former employer. He’s since been interviewed by major news outlets, from BBC to Bloomberg, and appeared in the 2010 Academy Award-winning documentary film Inside Job.

Jerry Fons: Alumni Spotlight

Rating Countries and Financial Institutions

During his 17 years at Moody’s, Fons was part of groups that rated countries as well as financial institutions, which he described as “one of the most complex things that anyone could rate.” The process and analysis behind these ratings is extremely complicated. Rating countries involves interaction with the rated entity and dissemination of the results, while rating financial institutions follows a rating methodology, which prescribes factors indicative of credit risk.

Fons explained that when rating a large, complex financial institution, one would hope to have access to as much information as possible with financial reports that are as transparent as possible. Fons recognizes the difficulty of generating a reliable credit rating, prompting the question “Is the public, published information on large financial institutions detailed enough to come up with a reliable credit rating?” He notes that the answer is often no due to too much maneuvering of balance-sheet assets.

With so many factors at play, the ratings of complex institutions have not been on track in recent years. The mistakes of rating agencies — from AIG to Bear Sterns to MF Global — have all tallied up. Fons sees the legacy rating agencies as being at the eye of the crisis, “creating some of the toxic assets, in the form of structured securities, that wound up blowing up.”

Fons now serves as executive vice president at Kroll Bond Ratings, which is a company that has two businesses: a subscriber-supported division rating financial institutions and an issuer-paid division in New York focused on rating bonds. Fons continues to rate bonds but in a new and different way. Though most of the company’s business is in the structured finance area, rating commercial and residential mortgage-backed securities (few of which have been issued since the financial crisis), the company has also been hired to rate the bonds of major states.

When working through the rating process, Fons notes that “while there are few theoretical models of credit risk — Gambler’s Ruin and the Merton Model — there is no real theory of credit risk that links the propensity to default to fundamental (nonmarket) variables.” However, in the case of structure finance, Fons said that “we are able to rely to a certain extent on Monte Carlo techniques and the stressing of cash flows in order to see what would cause the transaction to fail.”

Inspiration at UC San Diego

Fons’ interest in banking and the financial system all started at UC San Diego in the early 1980s, during his time as a doctoral student in the Department of Economics. It was, in part, his experience as a teaching assistant — working with former Professor Herb Kaufman and others — that got him excited about finance as well as money and banking. Additionally, his work with Professor Ross Starr spurred his interest in the field of credit risk. Through a series of jobs at the Federal Reserve Bank of Cleveland, Federal Reserve Bank of New York and Chemical Bank in New York, Fons eventually found his way to Moody’s.

With such a high-pressure job, there’s certainly a question of how Fons relaxes while sitting ringside, watching the ratings of countries teeter and plunge. With a house in upstate New York in the country, Fons makes it a point to get out of New York City every weekend with his wife. His getaways to nature with deer, turkeys, coyotes, hawks and even bears provide an alternative to the urban financial jungle. Though he lives and works in the cultural and economic epicenter, Fons still considers San Diego a second home and UC San Diego as the beginning of his journey as an economist.