Wednesday, October 22, 2008

Rating agencies 'broke bond of trust'

(FT) Credit ratings agencies were fully aware that their conflicts of interest were giving unduly high scores to risky assets, threatening the stability of the entire financial system, lawmakers from a key Capitol Hill committee claimed yesterday.

Henry Waxman, chair of the House of Representatives oversight committee, said the agencies were wrong to insist that the huge downgrades of mortgage-based and other assets during the financial crisis were unforeseeable.

Questioning executives from the three leading ratings agencies, Moody's, Standard and Poor's and Fitch, Mr Waxman said: "The credit rating agencies occupy a special place in our financial markets. The ratings agencies broke this bond of trust."

High ratings given to low-quality assets, particularly those based on risky mortgages, have been criticised by authorities round the world for contributing to the credit market bubbles that have collapsed in the crisis.

Mr Waxman cited internal documents obtained from Moody's and Standard and Poor's which, he said, showed they were clearly aware of the problem of conflict of interest.

The committee released a copy of an internal presentation from Raymond McDaniel, chief executive officer at Moody's, to directors at the company in October 2007. Under a part of the present-ation titled "conflict of interest", a section marked "Market Share" says the entry of a third ratings agency, Fitch, into an industry previously dominated by Moody's and Standard and Poor's had -created competitive pressures that put downwards pressure on ratings quality.

"The real problem is not that the market does underweights [sic] ratings quality but rather that, in some sectors, it actually penalises quality by awarding rating mandates based on the lowest credit enhancement needed for the highest rating," Mr McDaniel's report says. "Unchecked, competition on this basis can place the entire financial system at risk."

He adds: "Moody's for years has struggled with this dilemma."

The company had various mechanisms in place to prevent such conflicts of interest, including assigning ratings by committees and preventing anyone with "market share objectives" from chairing such a committee.

"This does NOT solve the problem, though," Mr McDaniel writes. Ratings in the securities that have helped cause the financial crisis "are simply the latest instance of trying to hit perfect rating pitch in a noisy market place of competing interests".

While acknowledging that Moody's did not foresee the size and speed of the -deterioriation in the subprime mortgage market, Mr McDaniel told yesterday's hearing the company had a raft of policies to prevent conflicts of interest. Shifting to a different business model where investors rather than issuers of an asset paid the agency to give it a rating would simply create other distortions. "If the industry adopted an alternative business model in which investors rather than issuers pay for ratings, this would not relieve the perceived conflict - it would only shift it," he said. An "investor-pays" model would give preferential information for bigger and wealthier investors.

"Potential conflicts exist regardless of who pays. The key is how well the rating agencies manage the potential conflicts." Mr McDaniel and the other executives present - Deven Sharma, of Standard and Poor's, and Stephen Joynt, of Fitch Ratings - said their companies were co-operating with reviews of the agencies' performance by the Securities and Exchange Commission and other authorities. But they stressed that many parts of the financial system had underperformed, and said it was disproportionate to blame the ratings agencies for their role.

1 comment:

VaneSSa said...

The world's leading credit rating agencies may have been practicing irresponsibly some form of financial alchemt - i.e. turning toxic assets into something akin to gold. And yet they haven't got the wherewithal to tell us that there could be terrible consequences - i.e. the global credit crunch.
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