As the great credit crisis of 2007-2008 finally begins to lose steam, most people still don’t understand what the heck happened. For good reason. It’s confusing stuff. The terminology is complicated. The people aren’t well known. The pieces move around quickly.

To the rescue comes Roger Lowenstein, author of When Genius Failed and, significantly, a fine article in this past weekend’s New York Times Magazine. In a nutshell, Lowenstein explains methodically, and in some of the simplest declarative sentences you’ll find written in business journalism, how conflicts of interest at the credit-rating agencies — Moody’s (MCO), S&P (MHP) and Fitch — misled investors in mortgage-backed securities.

The conflict is straightforward, and I’ve written about it here before: The agencies make most of their money from fees paid by bond issuers and their banks rather than from the investors who rely on the ratings. Lowenstein neatly dismisses the credit agencies’ explanation that they did the best they could with the information they had at their disposal. In a pivotal passage, Moody’s walks readers through an actual portfolio of subprime mortgages that was packaged by an investment bank and rated by Moody’s. The actual names are obscured as “Subprime XYZ,” which is how Moody’s was willing to share the illustrative example with Lowenstein. Consider this passage:

The loans in Subprime XYZ were issued in early spring 2006 — what would turn out to be the peak of the boom. They were originated by a West Coast company that Moody’s identified as a “nonbank lender.” Traditionally, people have gotten their mortgages from banks, but in recent years, new types of lenders peddling sexier products grabbed an increasing share of the market. This particular lender took the loans it made to a New York investment bank; the bank designed an investment vehicle and brought the package to Moody’s.

Moody’s assigned an analyst to evaluate the package, subject to review by a committee. The investment bank provided an enormous spreadsheet chock with data on the borrowers’ credit histories and much else that might, at very least, have given Moody’s pause. Three-quarters of the borrowers had adjustable-rate mortgages, or ARMs — “teaser” loans on which the interest rate could be raised in short order. Since subprime borrowers cannot afford higher rates, they would need to refinance soon. This is a classic sign of a bubble — lending on the belief, or the hope, that new money will bail out the old.

Moody’s learned that almost half of these borrowers — 43 percent — did not provide written verification of their incomes. The data also showed that 12 percent of the mortgages were for properties in Southern California, including a half-percent in a single ZIP code, in Riverside. That suggested a risky degree of concentration.

On the plus side, Moody’s noted, 94 percent of those borrowers with adjustable-rate loans said their mortgages were for primary residences. “That was a comfort feeling,” Robinson said. Historically, people have been slow to abandon their primary homes. When you get into a crunch, she added, “You’ll give up your ski chalet first.”

This shows Moody’s understood full well that the mortgages were all subprime. This means
that, by definition, the mortgage holders had inferior credit, and that a giant percentage didn’t supply documentation to back up their income claims on their mortgage applications. Moody’s and others say they were victims of fraud. Yet they’ve admitted to Lowenstein that they were willing victims of fraud. A final note to Claire Robinson, the veteran Moody’s executive quoted at the end of that passage: People who can’t afford prime mortgages typically don’t have ski chalets.

It’s worth taking a step back here and asking what can be done about the conflict. I met Monday with Bill Hambrecht, the founder of the old Hambrecht & Quist [now part of JPMorgan Chase (JPM)] as well as his current firm, the dutch-auction promoter WR Hambrecht + Co. He told me it’s not simply that the ratings agencies curry favor with the banks. It’s also that the analysts at the agencies, who might make in the neighborhood of $100,000 a year, cozy up to the bankers they meet with because they’re interested in going to work for the banks, where they can earn a lot more money. Hambrecht’s solution: Empower the government to rate bonds, especially if the government requires certain kinds of fund managers to own only officially-rated bonds. Lowenstein, by the way, comes to essentially the same conclusion, though he doesn’t directly advocate a government-run ratings regime.

Mighty Microsoft (MSFT) held its annual shareholders meeting today in Redmond, Wash. I know this because the company sent me a press release about it.

I quickly skimmed the blah, blah, blah about “positive customer momentum” and “strategy of investing in innovation,” and, for some reason, took a careful look at Mr. Softee’s board of directors, which the company printed in the release. Here’s the roster, with emphasis added to make the point I’m about to discuss:

Microsoft’s board of directors consists of William H. Gates, Microsoft chairman; Steven A. Ballmer, Microsoft chief executive officer; James I. Cash Jr., Ph.D., former James E. Robison professor of business administration at Harvard Business School; Dina Dublon, former chief financial officer of JPMorgan Chase; Raymond V. Gilmartin, former chairman, president and chief executive officer of Merck & Co. Inc.; Reed Hastings, founder, chairman and chief executive officer of Netflix Inc.; David F. Marquardt, general partner at August Capital; Charles H. Noski, former vice chairman of AT&T Corp.; Dr. Helmut Panke, former chairman of the board of management at BMW Bayerische Motoren Werke AG; and Jon A. Shirley, former president and chief operating officer of Microsoft.

I think you can see where I’m going. That’s six out of ten “formers” on the board, seven if you count Bill Gates, former CEO. Not counting CEO Steve Ballmer, there is precisely one current operating executive on the board, Reed Hastings, CEO of Netflix (NFLX), an innovative company that is nonetheless a pipsqueak in a narrow market niche.

Buzz words aside, Microsoft still hasn’t been able to shake itself from the torpor of having its butt kicked by Google (GOOG) in the online advertising world. By comparison, Google’s board includes the presidents of Princeton and Stanford, and the CEOs of Genentech (DNA) and Intel (INTC). Apple’s (AAPL) board includes the CEOs of Google, Genentech and J. Crew (JCG).

Could it be that Microsoft’s board of “formers” isn’t helping matters?

The tsk-tsking over Google’s (GOOG) investment in 23andMe, a new company started by Sergey Brin’s new wife, Anne Wojcicki, is rather amusing. And a bit annoying. Who really cares how Google invests a few million dollars, especially when it jumps through hoops such as Brin recusing himself from the conversation and Google disclosing that board member Art Levinson is CEO of Genentech (DNA), a 23andMe investor?

Wojcicki could have avoided the circus altogether simply by not taking Google’s money. But that’s the point people seem to be missing. Google is genuinely interested in the topic, which is getting all that information about the human genome into its database. In his 2005 book, The Google Story, David Vise reports a passage that rings true now:

Over dinner and plenty of wine in February 2005, Sergey Brin discussed the prospects for genetics and Google with the maverick biologist Dr. Craig Venter … Brin had brought along his friend Anne Wojcicki, a health care investor whose sister is a senior executive at Google. Seated nearby was early Google investor Jeff Bezos, CEO of Amazon.

Vise goes on to report that Venter tells him he wants to access Google’s massive computer network and that “Google will build up a genetic database, analyze it, and find meaningful correlations for indidviduals and populations.” Sounds somewhat similar to what Wojcicki’s company is doing, so it’s not a stretch to assume that she’s pursuing a portion of what they discussed and Google eventually will pursue the rest. Vise, who writes for the financial site Breakingviews.com, posted this today: “As wacky as it may sound, the investment may be justifiable, if not advisable. Pumping money into “23andme” fits with one of Google’s long-stated strategies to profit from the intersection of medicine and technology.” His full article, titled “Google’s bride,” can be found here. 

Interestingly, Venter has since disavowed Vise’s reporting (read about it here) and Google is mum on the subject. Venter will be a star attraction at Fortune’s iMeme conference in July in San Francisco. Perhaps we’ll get an opportunity to discuss this with him then.

A underplayed release out of Hewlett Packard (HPQ) this morning deserves a little more attention than it’s getting. HP, fresh off another killer quarter, named two new directors, entrepreneur Joel Hyatt and John Joyce, a former CFO of IBM (IBM) and currently a partner at the tech buyout shop Silver Lake. (Inside baseball alert: Note that Silver Lake is quietly but significantly dropping the “Partners” from its name. More on that another time.)

It’s been less than a year since the spying scandal at HP revealed the machinations of one of the most ridiculously messed up boards in the Fortune 500. After some months of effort it’s clear that HP CEO Mark Hurd finally has done something about that. Hyatt is a CEO, so he joins Wachovia (WB) CEO and HP board member Ken Thompson in adding that level of experience. (As a former political candidate and business partner of Al Gore, he also brings a little Democratic juice to an historically Republican company.) Landing Joyce is a huge coup. Even though he’s been out of IBM for two years, he’s got to have great insight into how HP’s arch-competitor ticks.

The HP turnaround story, for all its drama, is really extraordinary. The stock traded midday Friday at around $45.50. It seems like only yesterday that HP traded for $23 a share. Okay, it was two years ago, and read this if you’d like to join me as I pat myself on the back for calling it.