Levin Committee Slams Ratings Agencies
The Senate Permanent Subcommittee on Investigations, headed by Sen. Carl Levin (D-Mich.), held its third hearing on the financial crisis today, and up to bat were the credit ratings agencies. These companies — just three players, Moody’s, Fitch and Standard & Poor’s, dominate the market — take financial products issued by banks and other financial firms, perform thorough investigations and assign a rating to them based on the chance that the product will default. Or, at least, that’s how it’s supposed to work.
In practice, “[the] agencies allowed Wall Street to impact their analysis, their independence and their reputation for reliability,” Levin said this morning. “They did it for the money.” In short: The banks gamed the ratings agencies, and did it well. Here’s from the summary of the Levin report:
“Investors trusted credit rating agencies to issue accurate and impartial credit ratings, but that trust was broken in the recent financial crisis,” said Levin. “A conveyor belt of high risk securities, backed by toxic mortgages, got AAA ratings that turned out not to be worth the paper they were printed on. The agencies issued those AAA ratings using inadequate data and outmoded models. When they finally fixed their models, they failed for a year — while delinquencies were climbing — to re-evaluate the existing securities. Then, in July 2007, the credit rating agencies instituted a mass downgrade of hundreds of mortgage backed securities, sent shockwaves through the economy, and the financial crisis was on. By first instilling unwarranted confidence in high risk securities and then failing to downgrade them in a responsible manner, the credit rating agencies share blame for the massive economic damage that followed.”
From 2002 to 2007, the credit rating agencies earned record profits, reporting $6 billion in gross revenues in 2007. They also allowed the drive for profits and market share to affect ratings. Knowing that Wall Street firms might take their business elsewhere if they didn’t get investment-grade ratings for their products, the agencies were vulnerable to pressure from issuers and investment bankers. As one Moody’s executive wrote in October 2007: “It turns out that ratings quality has surprisingly few friends: issuers want high ratings; investors don’t want rating downgrades; short-sighted bankers labor … to game the rating agencies.”
The credit rating agencies still, three years into the crisis, have a conflict of interest at the heart of their business. The financial firms that *produce *the financial products, not the financial firms that buy them, pay for the supposedly independent ratings. In a released email, one S&P employee describes colleagues in the company’s mortgage unit: “They’ve become so beholden to their top issuers for revenue they have all developed a kind of Stockholm syndrome which they mistakenly tag as Customer Value creation.” The Dodd bill creates an office of credit ratings within the Security and Exchange Commission, and increases oversight. But it does little to change the underlying problem.