Analysts at Moody’s Investors Service, Standard & Poor’s and Fitch Ratings had doubts about many of the mortgage-backed securities they rated, but gave them a thumbs-up because it was so lucrative to do so, according to documents released by a U.S. House panel.
“Let’s hope we are all wealthy and retired by the time this house of cards falters,” one analyst at Standard & Poor’s said in an email. “It could be structured by cows and we
would rate it,” wrote another.
By issuing top ratings for many of those securities, raters relayed a false sense of security to investors, even as they themselves raked in millions from the issuers of the securities.
But as delinquencies on mortgage loans mounted, they were forced to downgrade ratings by the thousands, contributing to the collapse of Bear Stearns Cos. and Lehman Brothers Holdings Inc., and spurring a global credit freeze as institutions lost faith in the ratings and refused to lend to one another.
“The story of the credit rating agencies is a story of colossal failure,” Chairman Henry Waxman, a California Democrat, said yesterday in a hearing reviewing the role played by Moody’s, Standard & Poor’s and Fitch Ratings in the financial crisis. “The result is that our entire financial system is now at risk.”
Top executives of the rating agencies acknowledged some responsibility to the House Oversight and Government Reform Committee in Washington, but said they had not anticipated the scope of the downturn.
Raymond W. McDaniel, chairman and CEO of Moody’s Corp., said his company observed weakening conditions as early as July 2003, and took some corrective actions.
“We did not, however, anticipate the magnitude and speed of the deterioration in mortgage quality or the suddenness of the transition to restrictive lending,” he said.
But Waxman challenged that argument, releasing a confidential briefing McDaniel have given directors in fall, 2007 warning of trends that could “place the entire financial system at risk.” In the document, McDaniels tells managers:
It turns out that ratings quality has surprisingly few friends. Issuers want high ratings; investors don’t want ratings
downgrades; short-sighted bankers labor short-sightedly to game the ratings agencies. . . Unchecked, competition on this basis can place the entire financial system at risk.
Waxman blamed the bad judgment calls on the thirst for profits, noting that revenues for the three firms doubled from $3 billion in 2002 to over $6 billion in 2007. At Moody’s, profits quadrupled between 2000 and 2007 – and Moody’s had the highest profit margin of any company in the S&P 500 for five years in row, he said.
Yet S&P has had to downgrade more than two-thirds of its investment-grade ratings; Moody’s, over 5,000 mortgage-backed securities.
Several former top officials at the rating firms pointed to conflicts of interest among the reasons for the bad judgments.
The fact that issuers of securities pay rating firms creates “inherent conflicts,” testified Jerome Fons, a former managing director for credit policy at Moody’s.
He called for “wholesale changes” in how rating firms are governed and managed, and for rating firms to serve the buyers, rather than the issuers, of bonds.
A former S&P executive, Frank Raiter, said the rating agencies focused on maximizing short-term profits. As a result, he said, S&P failed to implement a model that could have given earlier warnings about many new products. The reason he gave for the company’s decision to forego developing new models was cost.
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