Moody’s Cooperates with Financial Crisis Panel Subpoena

Moody’s Corporation began handing over documents one day after the Financial Crisis Inquiry Commission issued the company a subpoena for failing to comply with requests for documents. Moody’s missed a March 23 deadline to release documents that the panel requested months earlier.

The panel’s chairman, former California state treasurer Phil Angelides wouldn’t specify what the documents were, stating only that they were “essential documents and emails relevant to our investigation.”

The commission had cause to worry about how quickly documents were supplied: They only have until December 15 to complete their investigation and report on the causes of the financial crisis.

Moody’s said in a statement that it “continues to devote substantial resources to producing documents and making our people available” to the committee.

Former Employees Speak Out Against Rating Agencies

Former executives at Moody’s Investors Service and Standard & Poor’s criticized the firms at a hearing before the Senate Permanent Subcommittee on Investigations. They testified that the companies allowed a competitive culture and conflicts of interest to compromise their ratings of complex securities.

“It was an unspoken understanding that loss of market share would cause a manager to lose his or her job,” said Eric Kolchinsky, a former managing director at Moody’s. He said that he was suspended after warning in September 2007 that a batch of securities “being hyper-aggressively pushed by the bankers” had been assigned an inflated rating.

Several current managing directors also testified, including Kathleen A. Corbet, who was president of Standard & Poor’s from 2004 to 2007; and Raymond W. McDaniel Jr., the chairman and chief executive of Moody’s.

Cuomo Suspects That Banks Lied to Ratings Agencies

On May 12, New York Attorney General Andrew Cuomo subpoenaed eight banks in an effort to discover whether they had intentionally misled rating agencies to inflate the grades of certain mortgage securities.

The banks involved are Goldman Sachs Group Inc., Morgan Stanley, UBS AG, Credit Suisse, Deutsche Bank AG, Citigroup Inc., Credit Agricole SA and Merrill Lynch & Co (recently acquired by Bank of America Corp.). The major ratings agencies, Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, were also subpoenaed.

Since 2008, New York State and federal regulators have been looking into why the agencies gave top grades to subprime-mortgage backed securities and collateralized debt obligations that later fell dramatically in value.

Reportedly, Mr. Cuomo is also interested in learning why bank mortgage desks hired former rating agency analysts. He is examining whether the analysts’ experience and relationships at the rating agencies contribute to inflated ratings for these mortgage deals.

Data that banks provide to the ratings agencies to evaluate their securities is generally verified through third-party due diligence. It is not known whether these third parties will also be subpoenaed.

No New Business Model for Credit Rating Agencies

While both the House financial reform bill approved in December and the current Senate bill call for tighter regulation of credit rating agencies, critics are upset that neither improves on the “issuer pays” business model.

Because most of the agencies’ revenue comes from issuers of bonds and other debt that the agencies evaluate and rate, critics say this is an unacceptable conflict of interest — that ratings could too easily be tainted by business needs.

Congressional aides defended the bill, saying that the business model could not be changed without destroying the industry. The Senate bill is now on its way to the floor for debate and a final vote.

Let’s let the ratings agencies alone. You can’t legislate morality or virtue in a free market. If nobody trusts the NRSROs, the companies will cease to exist. Let’s let the market participants decide the usefulness of ratings, not Congressmen.

Goldman Sachs Hit With Civil Fraud Charge

The Securities and Exchange Commission (SEC) has announced a lawsuit against Goldman Sachs for creating and selling a mortgage investment that was secretly intended to fail. Goldman repudiated the charges, calling them “completely unfounded in law and fact,” and that it would “vigorously contest them and defend the firm and its reputation.” Furthermore, Goldman pointed out that it lost money on the transactions in question.

Central to the SEC’s case against Goldman and numerous others is how credit-rating firms downgraded 99% of the underlying mortgage securities by January 2008.

Though the SEC had informed Goldman as far back as the middle of last year of a possible suit, the fact that it was a civil fraud lawsuit came as a surprise. Goldman was not given the normal opportunity to discuss a settlement or prepare for the announcement.

Politicizing the SEC isn’t good for anyone. The market demands a level playing field. That the SEC terms some actors as worse than others is not good public policy. Everyone should get the same treatment, neither better nor worse.

Standard & Poor’s Striving to Change Bill

McGraw-Hill, which owns Standard & Poor’s, wants to change language in a Senate financial overhaul bill. It believes the current language would put credit-rating companies at a disadvantage in court.

McGraw-Hill Executive Vice President Ted Smyth issued a statement Wednesday that said the bill “creates a discriminatory pleading standard for credit rating agencies, with many unintended consequences for the market.”

Smyth was referring specifically to the portion of the bill that would enable investors to take legal action against rating firms that “knowingly or recklessly” fail to conduct a reasonable investigation of a company when developing ratings.

Instead McGraw-Hill argues that a credit rating agency could be sued for failing to predict a bankruptcy, for example, which occurred without fraud while auditors, lawyers, bankers and equity analysts would have no liability. The firm wants the provision altered to remove this discriminatory language and instead retain the agencies’ current liability standard that requires that fraud be present.

If we are trying to create a Full Employment Act for class action securities lawyers, this will do it. Can’t we just use a simple, elegant age-old solution? Fully disclose any conflicts of interest and then its caveat emptor.

Shopping for Ratings

Good piece from the WSJ on how things have changed…or not…with regard to the conflict of interest that exists when the issuers are the ones that pay the fees of the rating agencies.  Whether ratings shopping, biases, etc. actually exist or not, the perception and possibility of this sort of behavior will always be present as long as the issuer pay system prevails.  A user pay system – where investors fit the bill for the ratings they use, not the issuer – removes all possibilities of this type of conduct. But is it viable as a commercial enterprise?

‘Ratings Shopping’ Lives as Congress Debates a Fix – Wall Street Journal, May 24, 2010

Senator Reed Blasts Credit Rating Agencies

Bloomberg News obtained an email by a McGraw-Hill lobbyist urging Senators Bob Corker (R-TN) and Judd Gregg (R-NH) to come out against financial regulatory reform.

In response, Senate Banking Committee member Jack Reed (D-RI) said, “This cynical attempt by Wall Street lobbyists to kill Wall Street reform before it has a chance to see the light of day must be resoundingly rejected. Credit rating reform addresses one of the systemic failures that caused the financial crisis.”

High standards regarding negligence have until now protected rating agencies from lawsuits. But under Mr. Reed’s proposed “narrowly tailored” legislation, investors would be able to sue ratings agencies if they could prove they had “knowingly or recklessly failed to review key information in developing ratings.”

Current “reform” measures for rating agencies will make the ratings worthless, as the rating opinion will be about the creditworthiness of the asset, and eluding legal liability. Ratings will all be warm, generic vanilla pudding.

Greenspan: Rating Agencies Major Factor in Crisis

At a congressionally appointed panel investigating the causes of the financial crisis, Former Federal Reserve Chairman Alan Greenspan criticized credit rating agencies for doling out high marks to securitized subprime mortgages, inculpating them for their role in creating the current financial crisis.

“All I will say is what I can say for myself, [which] is that the ratings that were developed by the credit rating agencies were a major factor in the cause of the problems,” he told questioners.

Many fingers have been pointed at credit rating agencies for the top grades they assigned to securities based on subprime mortgages that then ran into repayment problems or defaulted.

However, this is a mistake. There were bad bonds and bad structures. But the rating system downgrades were driven by what the ratings measured: the first dollar cost. By the way, don’t investors bear some responsibility for their own investment decisions?

Corporate Scorecard Gets Green Light

Corporate Scorecard (CSC) has joined Australia’s credit ratings market after getting the official go-ahead from Australian Securities and Investment Commission (ASIC) to operate as a licensed credit rating agency.

The company joins Standard & Poor’s, Moody’s Investors Service and Fitch Ratings as credit rating agencies licensed by ASIC. Says General Manager Brad Walters, “CSC has invested heavily in fulfilling all of the regulatory requirements and ongoing monitoring obligations.”

Corporate Scorecard is paid by clients such as governments, companies and investors to assess the risk of counterparties, rather than by issuers to rate the securities they are selling.

“Whether it’s a wholesale investor looking at a particular issuer, or a government department assessing a particular company, they are our client and so the remuneration line for us is direct to them,” said Walters. “Therefore, we don’t have that inherent conflict of interest of being paid by the issuer.”

CSC is the first Australian-owned credit rating agency to obtain an Australian Financial Services License to provide credit ratings. Operating at various levels within government and private sector, the company has been in business since 1987.

Hooray for the free market! A “new” rating agency, with a new pay model emerged from the wreckage. No government subsidy, legislation, government ownership was needed.

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