Rating Agencies Draw Fire on Capitol Hill
Members of Congress leveled sharp criticism at the major credit-rating agencies Wednesday morning, as the House Committee on Oversight and Government Reform held a hearing on these firms' role in the current economic crisis.
Several lawmakers vented their frustration over what they considered to be egregious lapses at the agencies, Fitch, Standard & Poor's and Moody's.
Mark E. Souder, a Republican from Indiana, described their conduct as "gross incompetence." Another lawmaker read from a series of instant messages, sent by employees of S&P, in which one analyst said they would rate a deal even if it were "structured by cows."
In many cases, these ratings agencies assigned super-safe, triple-A ratings to structured products that later turned out to be extremely risky, and in some case, worthless.
These investment products, such as mortgage-backed securities, were created by financial institutions ostensibly to mitigate risk by pooling loans and selling parts of them off to investors. But many of the loans that were packaged in these securities were made to people with poor credit histories, little equity in their homes or overstated income.
As borrowers defaulted or fell behind on their payments, the value of the securities collapsed. That led to billions of dollars in write-downs, many of which were taken at the biggest Wall Street firms, not to mention painful losses for investors.
Henry Waxman, the California Democrat who is chairman of the committee, said Wednesday morning that the rating agencies began assessing complex securities without fully investigating the underlying risks associated with them in order to gain more business from issuers of the securities. This allowed the rating agencies to become cash machines, he said in a live Webcast of the hearing.
"Total revenues for the three firms doubled from $3 billion in 2002 to over $6 billion in 2007," Mr. Waxman said. "Moody's had the highest profit margin of any company in the S&P 500 for five years in row."
In some cases, analysts were forced to rate products without full access to loan data needed to make an accurate assessment.
One of the witnesses, Frank Raiter, a former employee of Standard and Poor's, was asked in 2001 to rate a collateralized debt obligation that was backed by home loans. When he asked his superior, Richard Gugliada, for loan data to rate the security, he received the following response in an e-mail that Mr. Waxman included in his opening statement:
Any request for loan level tapes is TOTALLY UNREASONABLE!!! Most investors don't have it and can't provide it. Nevertheless we MUST produce a credit estimate. It is your responsibility to provide those credit estimates and your responsibility to devise some method for doing so.
Devan Sharma, president of S&P, said in a written statement, "It is by now clear that a number of the assumptions we used in preparing our ratings on mortgage-backed securities issued between the last quarter of 2005 and the middle of 2007 did not work."
John A. Yarmuth, a Democrat from Kentucky, chose to read aloud from an instant-message conversation between two S&P employees in the firm's structured product division.
Official 1: By the way, that deal is ridiculous
Official 2: I know, right. The model definitely doesn't capture half the risk.
Official 1: We should not be rating it
Official 2: We rate every deal. It could be structured by cows and we would rate it
Official 1: There is a lot of risk associated with it. I personally don't feel comfy signing off as a committee member.
"What they say is extremely disturbing," Mr. Yarmuth said at the hearing. "Their attitude seems to be casual acceptance that they rate deals that they should not be rating - deals that are too risky."
(The "cows" comment was mentioned in a July report on the credit rating agencies from the Securities and Exchange Commission. But the analyst had not previously been identified as working for S&P.)
Mr. Yarmuth then posed this question to Mr. Raiter: "If somebody says that they are not assessing half the risk, would that mean that somebody that was relying on the rating to make an investment in those securities would not be getting an accurate picture of the risks that was involved?"
Mr. Raiter replied, "I would presume that's an interpretation."
Mr. Yarmuth than asked what the analyst in the instant message meant when she said "it could be structured by cows."
Another witness, Sean Egan (pictured above), a managing director at Egan-Jones Rating, an independent rating agency, said, "It means - that it's ridiculous! If you don't understand it, then don't rate it."
The secuity in question was later rated by S&P.
10/22/08
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