Congress Saves Best for Blasting Rating Agencies
At the end of a five-hour excoriation of CEOs at credit-rating agencies, Rep. Chris Shays (R-Conn.) said to the heads of Moody’s, Standard’s & Poor’s and Fitch: “Remember, we’re speaking from an institution, Congress, with lower ratings than yours.”
Congress doesn’t know what its next step will be in regulating Wall Street after the financial meltdown. But the House Oversight and Government Reform Committee accomplished an authoritative takedown today of the credit ratings agencies. Through documents obtained by the committee and unusually sharp questions from committee members, we learned this:
- During the housing bubble of 2002-2006, there was virtually no government regulation of the credit-rating agencies. The Securities and Exchange Commission proposed rules in 2002 to monitor them. That’s when bond issuers were securitzing subprime mortgages and collateralized debt obligations at ever increasing rates. By the time Congress finally passed a reform act, it was 2006 and the housing bubble was about to burst.
- The credit-rating agencies were even more tardy in responding to the housing market collapse than the SEC and Congress. Moody’s CEO Raymond McDaniel continually issued reassurances that the mortgage-backed securities and credit default swaps his firm was rating AAA deserved the rating. Even privately, McDaniel only began to identify the problem in Sept. 2007.
A transcript (pdf) of a Moody’s “town hall” company meeting shows that McDaniel told his employees in September that it was time “to speak as candidly as possible about the subrpime market.” But the discussion mostly centered on “extensive outreach to the media” to disentangle the rating company from the subprime mess.
Just one month later, McDaniel wrote to his board of directors (pdf) that the company’s business model needed to have a “careful postmortem” evaluation.
- The credit rating agency industry is in tatters. Moody’s has been around for 100 years, but it wasn’t until the late 1970s that the company had to rely on the issuers of bonds for its profits. The obvious conflict of interest– will an issuer come back to a credit-rating agency if the agency unfavorably rates the bond?– finally caught up with the industry in the subprime mortage market.
None of the rating companies developed a credible model to rate mortgage instruments, and there was a race to the bottom to rate risky bundles of subprime loans as AAA.
“In my [Baltimore] district,” said Rep. Elijah Cummings (D-Md.), “students are not able to get loans, businesses are closing and seniors are going back to work. You’ve lost our trust.”
The CEOs didn’t respond to Cummings’ remarks or numerous other accusations that they have lost the public’s trust.
But it was clear that the credibility of an entire financial industry had been destroyed in just five hours.