Any smart gambler, amateur or professional, knows that you only risk what you can afford to lose. That may be $1, $100, $500, or even a million dollars in a real estate or other major transaction. But only a fool bets the farm. Only a fool risks all.

What made so many bright minds all around the world foolishly bet the farm? One after another, that is what they did. Now we are all paying for it, some more than others. It was not just greed. It was something else.

How did this happen? I call it 'The Great Disconnect'.

When the managers of public companies do not suffer the same fate or consequences as their shareholders you have a disconnect! When politicians give lip service to understanding the pain of their constituencies but accept huge contributions from the enterprises they are supposed to regulate and oversee creating gargantuan conflicts of interest, you have a great disconnect.

When investment houses create financial instruments that are so complex that they cannot fathom the risk and the ratings agencies put candy coated frosting on them, you have a great disconnect!

I would propose that legislators not be allowed to accept any contribution creating a conflict of interest based on the committees they sit on. $700 billion reprise: Conservative bankers? Surely you jest!

I might even consider creating an independent committee of citizens selected from the willing, be placed in a position to review such matters.

Analysts at some of the large credit ratings agencies may have had their eyes on the cash register instead of paying attention to the quality of their work. So says the SEC.

According to The Wall Street Journal, "The 10-month examination uncovered poor disclosure practices, a lack of policies and procedures guiding the analysis of mortgage-related debt, and insufficient attention paid to managing conflicts of interests."

That revelation all but buries the already damaged reputations of the ratings firms.

Making money is OK, but the practices may have lost investors billions of dollars. The big credit rating shops like Standard & Poor's have the job of evaluating the risk of products like mortgage-backed securities. Investment banks and their clients thought this paper was fairly safe. It did not turn out that way, not by a long shot.

If an enemy sworn to the destruction of the global economy was given free reign, it would follow the strategies of its current leaders.

One key to destroying an economy is to break its pricing mechanism. What does an effectively functioning pricing system do? It creates a market of buyers and sellers who can meet, agree on a price, conduct the transaction, and create an information trail that permits future market participants to judge what might be a fair price for their transactions.

Another key to destroying an economy is to put too low a price on risky behavior. Why is it important to price risk accurately? Because if decision-makers do not assess the risk at the time of their decision, the economy will end up paying for the under-priced risk long after those decision-makers have left office.

So how have current leaders broken the pricing mechanism and under-priced risk? Here are three ways:

Reuters reports that Warren Buffett, whose Berkshire Hathaway (NYSE: BRK.A) controls 19.6% of Moody's Corp. (NYSE: MCO), is saying that he thinks Moody's will be around a long time. Even though Berkshire Hathaway's $188 billion market capitalization is more than 20 times that of Moody's -- Buffett's $1.8 billion loss -- the 50% drop in the value of his 19.6% Moody's stake from its February 9, 2007 peak -- has to sting.

Moody's was already under fire over the U.S. mortgage market crisis when it took a fresh blow on Wednesday -- launching an investigation into a report that it had wrongly assigned triple-A ratings to about $4 billion of complex European debt products -- Constant Proportion Debt Obligations (CPDOs), funds that used borrowed money to bet on credit-default swaps -- and had then not downgraded them. Buffett's comment: "I don't think one day will permanently change the franchise value of Moody's."

As I posted, the ratings agencies competed for lucrative fees from investment banks that created and sold these asset-backed securities. Moody's took in $3 billion for such structured finance ratings between 2002 through 2006. The agencies that offered the best ratings won the business.

Moody's (NYSE:MCO) made a mess of rating subprime debt and other risky instruments. It also said that some bonds help by municipal bond insurers was safe and that these companies should have "Aaa" ratings. Most of that turned out to be wrong and it helped cost investors, banks, and brokerage firms tens of millions of dollars.

Everyone from Moody's customers to Congress wants to know how the ratings could have been so wrong.

Now, the rating company has come up with a novel excuse for another series of mistakes. According to the FT , "Moody's awarded incorrect triple-A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models." Several Moody's executives may have known about the mistake some time ago.

Comments from Moody's downplayed the problem. The company said that it adjusted its models from time to time.

The news may get the ratings agency into some real trouble, and it should. If the company was aware of the problem, why wasn't the information passed along to customers who rely on the ratings to make purchases?

Moody's ought to be dragged before regulators and be forced to give an entire accounting of the problem. Perhaps it should pay back customers who made bad decisions because of the errors. Of course, Moody's does not have that kind of cash.

Douglas A. McIntyre is an editor at 247wallst.com.

CNNMoney reports that McGraw-Hill Co.'s (NYSE: MHP) Standard & Poor's (S&P) forecasts the possibility of a $1 trillion bailout of Federal National Mortgage (NYSE: FNM) and Federal Home Loan Mortgage (NYSE: FRE) -- government sponsored purchasers of pools of loans which package them into securities. Specifically, S&P forecasts that a bailout of these two -- known as Fannie Mae and Freddie Mac -- would cost -- in a worst case scenario -- between $420 billion and $1.1 trillion of taxpayer's money. This would represent several times the $250 billion Savings & Loan bailout by the first President Bush.

It's a bit ironic for S&P to be issuing this report. After all, it was among the ratings agencies that contributed to the problem in the first place. As I posted last August, the ratings agencies competed for enormous fees from investment banks to put their AAA ratings on issues of mortgage-backed securities (MBS). Those AAA ratings caused naive MBS buyers to skip the kind of detailed analysis of their purchases that might have stopped the flow of dumb money into the MBS bubble that is now putting Fannie and Freddie at risk.

How did S&P arrive at this scary conclusion? Both companies are forecast to report more losses this year due to declining home prices and rising mortgage defaults. And according to Yale professor, Robert Schiller, "The real fundamental problem is real estate prices have been falling and they might fall substantially more. The Office of Federal Housing Enterprise Oversight (OFHEO) and Fannie and Freddie never considered the possibility of a massive real estate correction."

Given that the big credit rating agencies -- Moody's (NYSE: MCO) and McGraw-Hill's (NYSE: MHP) Standard & Poors -- completely failed in their assessment of risk when it came to mortgage-backed securities, it's no surprise that the SEC is being asked to take a look.

Senator Charles Schumer (D-NY) has met with SEC Chairman Chris Cox to discuss conflicts of interest and disclosure problems. The Wall Street Journal quotes (subscription required) the senator as saying that "There has to be a lot more done about conflicts of interest at the agencies."

Among the worst of the rating agency abusers has been MBIA (NYSE: MBI) which, back in March, had the gall to ask Fitch to drop its coverage of the firm because they didn't like Fitch's opinion. To its credit, Fitch stayed strong and later downgraded the company's credit rating.

But wait, there's more: In a devastating piece on Friday, The Wall Street Journal reported (subscription required) on Moody's efforts to cozy up to issuers in exchange for more business, possibly at the expense of the integrity of their ratings.

This is essentially a replay of the issues involving conflicted analysts like Henry Blodget who, at the height of the internet stock bubble, sacrificed his research to the investment banking arm of his firm. It will take a tough regulator to clean up this mess, and I seriously doubt that Chris Cox is the man for job.

The good news is that MBIA (NYSE: MBI) saved its S&P "AAA" rating, meaning bonds it insures will not lose their value. A drop in the rating could have caused write-offs at banks that own paper covered by the bond insurer.

MBIA also announced yesterday that it will, sometime in the next five years, break its muni-bond insurance business from its structured finance operations, forming two companies. Structured finance bonds have lost much of their value because they include CDOs and mortgage securities.

The move may have helped save the company, but it comes with a huge cost. MBIA is eliminating its dividend to save $174 million a year. For investors taking advantage of the company's 10% yield, the news could hardly be worse.

MBIA may have bought itself some time, but it put the wood to shareholders to stay afloat.

Douglas A. McIntyre is an editor at 247wallst.com.

Standard & Poors, a division of McGraw-Hill (NYSE: MHP), has joined Moody's (NYSE: MCO) and Fitch in announcing reforms in the wake of the criticism for their role in the subprime fiasco.

S&P says it will hire an ombudsman to investigate conflicts of interest and bring in an outside firm to look at compliance and ethics-related issues. Lead analysts will be rotated from time to time and the company will consider a slew of new factors: liquidity, volatility, correlation and recovery, and "worst-case scenarios."

But New York Attorney General Andrew Cuomo isn't buying it: "The supposed reforms announced today by Standard & Poor's and by Moody's on Tuesday are too little, too late. Both S.&P. and Moody's are attempting to make piecemeal change that seem more like public relations window-dressing than systemic reform."

From an investor's standpoint, I'm inclined to agree with Mr. Cuomo. Moody's carries a market cap of nearly $10 billion, but its entire business depends on the willingness of investors to take its ratings and analysis seriously.

But over the past year or so, the "work" of the ratings agencies has been exposed as pretty much a joke. It will take a lot more than this to recover the company's reputation.

Moody's (NYSE: MCO) is thinking of releasing a new ratings system that does not use letters, but has numeric ratings and "warning labels" for securities that may be difficult to analyze.

According to The Wall Street Journal, "one of the most significant changes being considered by the parent of Moody's Investors Service: a new, 21-point numerical scale to rate structured securities." The new system would also help investors look at CDOs and other risky investments differently from corporate bonds.

The whole exercise is bogus. Moody's could have employed a similar system long ago. Why are numbered ratings any different from those that use letters? Why didn't the firm have a systems that indicated the risks in complex securities such as CDOs and other structured investments?

The Moody's move is simply an attempt to try to hide and rectify the substantial flaws in the system that exists now. And, it is a feeble attempt to boot.

Douglas A. McIntyre is an editor at 247wallst.com.

Moody's Corp. (NYSE: MCO) Chief Executive Raymond McDaniel Jr. made a stunning admission at the World Economic Forum in Davos about the subprime mortgage crisis: "In hindsight, it is pretty clear that there was a failure in some key assumptions that were supporting our analytics and our models."

In other words, people lied to us because the 'information quality" the ratings agency got was lacking in "completeness and veracity," as Floyd Norris notes in the New York Times.

Come to think of it, this has a familiar ring to it. Back in 2002, Moody's and S&P whined to Congress about how they missed the implosion of Enron. Those meanies at Adelphia also bamboozled Moody's.

Question: Aren't Moody's and S&P paid a lot of money to check the "completeness and veracity" of the information people tell it so it can rate stuff?

Many on Wall Street think the credit rating agencies -- Standard & Poor's and Moody's (NYSE: MCO) -- have some serious s'plainin' to do, and the Congress agrees. The public outcry comes in the wake of the subprime meltdown, where high-risk loans ended in default far more frequently than the agencies had predicted they would.

The SEC is also investigating whether the agencies where inappropriately influenced by underwriters, and whether they bent their own criteria to give loans better ratings.

According to (subscription required) The Wall Street Journal, "New York Senator Charles Schumer, a senior Democrat on the Banking Committee, is expected to raise the idea that credit-rating agencies should switch back to having investors -- instead of issuers of the bonds -- pay for the ratings."

Exactly. When you have the person issuing a bond paying you to tell you how big of a risk they are, how objective could you possibly be? They're paying you! And in the end, investors end up paying the costs of the ratings anyway: They're lending the company the money.

If the subprime fallout continues, Schumer's suggestion could gain traction.

Ratings agencies have tremendous power in the financial markets because their ratings determine if a certain credit is "own-able" by funds, depending on their covenants. For example, low-risk pension funds can't own poorly graded credit simply because it increases the likelihood of losing money. When ratings agencies change their position on companies or sectors, the market listens. A perfect example of this was the recent subprime fall that resulted from S&P announcing it could downgrade some of the credit from the group.

Now the opposite has occurred -- Fitch announced that it has positive outlook for Doral Financial Corp. (NYSE: DRL). Fitch justified its optimistic outlook for Doral by mentioning the company's sale of a 90% stake in the company to Bear Stearns (NYSE: BSC) Merchant Banking, among other things.

Even though this upgrade was on the company's debt, the stock traded up as well. I think Doral is too speculative to play with, and the future of this company, especially the stock, is extremely up in the air at this point.