22 October 2008

House Committee of Government Oversight and Reform hearing on Credit Rating Agencies

The hearing examined the actions of the three largest credit rating agencies. “The story of the credit rating agencies is a story of colossal failure”, Chairman Henry Waxman said in his opening remarks.

The Committee held a hearing on “Credit Rating Agencies and the Financial Crisis” which examined the actions of the three largest credit rating agencies, Standard & Poor’s, Moody’s Corporation, and Fitch Ratings, leading up to the current financial crisis.

 

Committee was particularly interested in the rating process, conflicts of interests and possible issues of fraud.

 

In their testimony today, the CEOs of Standard and Poor's, Moody's, and Fitch will tell us that "virtually no one ... anticipated what is occurring." But the documents the Committee obtained tell a different story, Chairman Henry Waxman said in his opening remarks. “The story of the credit rating agencies is a story of colossal failure.”

 

The Committee referred among others to internal confidential information, that warned that company employees sometimes "drink the Kool-Aid" and gave in when pressured to inflate ratings, even as the weaknesses of the mortgage-backed securities were becoming apparent.

 

Another document cited states that: “It could be structured by cows and we would rate it.” In another, an employee asserts: “Rating agencies continue to create [an] even bigger monster — the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.”

 

A large part of the blame can be placed on the inherent conflicts of interest found in the issuer-pays business model and rating shopping by issuers of structured securities, Jerome Fons, former managing director for credit policy at Moody’s until 2007 said and called for a wholesale change at the governance and senior management levels of the large rating agencies. “The reforms announced to date are grossly inadequate”, he said.

 

Rating agencies could have known earlier, Frank Raiter former head of mortgage ratings at Standard & Poor’s, who left 2005, said. However, existing new models were not used. The three CRAs “have concentrated on maximizing short-term profits rather than maximizing longer term financial benefit from accuracy of their credit ratings and surveillance reviews”, he said. “I do not believe any meaningful improvement will occur until this culture is dramatically refocused on analysis and providing accurate and timely information on the performance of outstanding ratings.”

 

Mr. Egan, of Egan-Jones, said that "the current credit rating system is designed for failure". Change would come only if institutional investors no longer made investment decisions based on ratings produced by agencies that take money from issuers.

 

Summing up, Chairman Waxman said that the rating agencies “sacrificed their rating standards - and their credibility - for shortterm gains in sales volumes.”

 

Further information

Video of the hearing

 

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