Ratings Industry Targeted In Subprime Wreck

While the big mortgage lenders have drawn the most fire in the subprime mortgage market collapse, theirs is not the only industry feeling the heat from Congress. 

And the mortgage lenders may not be the first to get burned.  

Congress has also begun questioning the role of the credit rating industry in the subprime crash and subsequent credit crunch. Lawmakers are looking into what they see as Enron-esque conflicts of interest and a veritable monopoly held by ratings giants Moody’s and Standard & Poor’s. 

Politically, the companies are in a tough spot. Ideologically, Democrats tend to favor more regulation, while Republicans abhor consolidated markets. And unlike the mortgage brokers, the credit rating agencies are based in New York and don’t enjoy the advantage of employing people in congressional districts throughout the country. 

“It looks like these are the guys who are going to get hit first,” said financial services lobbyist Sam Geduldig, who is not representing a rating agency. 

“It looks like Chairman Dodd and Chairman Frank have decided that the credit rating agencies are the low-hanging fruit. They’re the layup, and they’re going to go first.” Sen. Chris Dodd (D-Conn.) is chairman of the Senate Banking Committee, and Rep. Barney Frank (D-Mass.) is chairman of the House Financial Services Committee. 

So far, the relatively low-profile credit rating industry hasn’t begun a splashy lobbying blitz. Moody’s and S&P, the nation’s two biggest agencies, say they’re taking a more academic approach and are working to educate lawmakers about how they rate the risk of securities. 

Some insiders say the agencies have more work to do. 

“They really don’t have a good defense,” said a senior financial committee staffer, who added that the companies aren’t well-represented on Capitol Hill. 

During the first half of this year, Moody’s paid Akin Gump $300,000 in lobbying fees, and S&P paid Patton Boggs $60,000, according to the Center for Responsive Politics. 

Moody’s and S&P spent two days last month in Senate and House committees answering variations of the “Office Space” classic: “What would you say ya do here?” 

The answer is complex and goes something like this: After a home buyer takes out a mortgage, the bank often resells the loan to investors, who in turn repackage it and sell it as a security. To help investors understand the new bond’s risk of default, the bond often must be evaluated by credit rating agencies. 

The problem that got Congress’ attention is that rating agencies gave high marks to hundreds of bonds that included subprime mortgages before downgrading them as the market crashed. 

Critics have charged that the downgrades came too late and didn’t provide investors with enough warning. 

“They had to do all of these massive downgrades, yet there will be no accountability because companies [that need a rating] have nowhere else to go,” the staffer said. 

Because Moody’s and S&P control 80 percent of the market and issue 99 percent of the ratings of corporate debt, companies have little choice but to go back to the ratings giants, said the staffer. 

Lawmakers have also called the companies’ revenue structure a conflict of interest. The agencies make their money by charging the companies whose securities they rate.

“They get paid a substantial fee by the person wanting to get rated, who then uses that rating as a reason to buy their product. That is like a movie studio paying a critic to review a movie and then using a quote from his review in the commercial,” Sen. Jim Bunning (R-Ky.) said during last month’s Senate Banking Committee hearing, according to a transcript. 

Some say the agences also provide advice to companies on how to receive better ratings. That situation has lawmakers drawing comparisons between the credit rating agencies and the accounting firms that were auditing and advising companies such as Enron, which collapsed after accounting irregularities were discovered. 

With Moody’s and S&P at the hearing, Sen. Jack Reed (D-R.I.) quoted former Securities and Exchange Commission Chairman Arthur Levitt, who said credit rating agencies are “playing both coach and referee in the debt game.” 

Anthony Mirenda, a spokesman for Moody’s, told Politico the company does not provide consulting services or advice on how to improve ratings. 

Michael Kanef of Moody’s acknowledged at the hearing that there are conflicts, but he insisted that the company has procedures to “insulate” the process. The company makes its ratings decision through a committee, and analyst pay is based on the quality, not quantity, of work, Kanef said. 

If the system were changed and investors were to pay for the ratings instead of the debt issuers, there would still be conflicts of interest. Also, a new revenue model could mean that ratings would no longer remain public, Kanef said. 

Still, Sen. Richard Shelby (R-Ala.) didn’t seem to buy Kanef’s argument. “It seems to me that money is trumping ethics in this area of ratings,” Shelby said. 

For their part, Moody’s and S&P are staying largely silent. In interviews, representatives for the Big Two said little other than that they are working to help lawmakers understand their business. They referred most questions to the congressional testimony of company officials. 

In addition to Congress, the SEC and an advisory group named by President Bush are investigating the agencies’ role in the subprime crash. In fact, Eric Mindich, the head of the presidential working group, said investor confidence in the agencies has been “severely damaged” and has suggested splitting the agencies’ rating and advisory functions. 

On the House side, members are waiting to see what the president’s working group and the SEC find, said a staffer to a Republican who sits on the financial services subcommittee that heard testimony from the rating agencies.
  • CBSNews

Comments