Credit rating agencies should not be dupes

By Dan Wilchins – Analysis

NEW YORK (BestGrowthStock) – New York Attorney General Andrew Cuomo is looking at whether investment banks duped credit rating agencies, but a bigger question is why the rating agencies failed to prevent the financial meltdown.

Banks may indeed have misled Moody’s Investors Service, Standard & Poor’s, and Fitch into giving higher ratings than some securities really merited, but rating agencies should have done more to avoid being fooled, critics said.

Until the structural problems with rating agencies are fixed, new credit bubbles will likely be inflated.

Those problems may be closer to getting fixed. The U.S. Senate voted on Thursday to impose tighter regulations on credit rating agencies, taking steps including letting regulators decide which agency will assign ratings to an issuer.

That Senate proposal follows years of hearings into problems at rating agencies, which essentially assign grades to bonds to help investors evaluate the securities.

The rating agencies’ holding companies, including Moody’s Corp, S&P parent McGraw-Hill Cos Inc and Fitch parent Fimalac, made millions of dollars from rating repackaged mortgage bonds that later proved to be much more fragile than they initially appeared.

The market for these repackaged securities mushroomed over the last decade, and employees at rating agencies knew they were struggling to keep up with the demand, according to document released in an October 2008 congressional hearings.

S&P analyst Shannon Mooney said in an instant-message conversation with a colleague in 2007 that her firm was struggling to assess the risk of a deal, but added, “it could be structured by cows and we would rate it.”

In September 2007, Moody’s Corp held a town hall meeting to discuss the subprime meltdown that was unfolding. The next day, a Moody’s employee offered feedback on the meeting, arguing “It seems to be that we had blinders on and never questioned the information we were given.”

That is the nub of the issue, critics say. Banks that lied to rating agencies ought to be censured, but ratings analysts should not be just plugging banks’ data into models.

“A rating agency should be a reasonable arbiter of credit quality, even if people are lying,” said Sean Egan, principal at Egan-Jones Ratings, a rating agency that receives payment from investors rather than issuers.


In fact, rating agencies sometimes discouraged analysts from asking too many questions, critics have said.

In testimony last month before a Senate subcommittee, Eric Kolchinsky, a former Moody’s ratings analyst, claimed that he was fired by the rating agency for being too harsh on a series of deals and costing the company market share.

Rating agencies spent too much time looking for profit and market share, instead of monitoring credit quality, said David Reiss, a professor at Brooklyn Law School who has done extensive work on subprime mortgage lending.

“It was incestuous — banks and rating agencies had a mutual profit motive, and if the agency didn’t go along with a bank, it would be punished.”

The Senate amendment passed on Thursday aims to prevent that dynamic in the future, by having a government clearinghouse that assigns issuers to rating agencies instead of allowing issuers to choose which agencies to work with.

For investigators to portray rating agencies as victims is “far fetched,” and what needs to be fixed runs deeper than banks fooling ratings analysts, said Daniel Alpert, a banker at Westwood Capital.

“It’s a structural problem,” Alpert said.

Investment Analysis

(Reporting by Dan Wilchins; Editing by Gary Hill)

Credit rating agencies should not be dupes