By Stephen Foley in New York for The Independent
October, 23 2008
The system for assigning credit ratings to complex mortgage
derivatives, which handed out gold-plated ratings to investments
that have turned out to be worthless, was damned as "nuts" and
as having created "a monster" and that was just
by senior employees at the rating agencies.
US politicians hauled bosses of the three main agencies before
Congress for hearings into the causes of the credit crisis,
and attacked them for presiding over a corrupt and possibly
fraudulent system.
In front of a packed meeting room, members of the House oversight
committee unveiled internal emails and instant messages that
showed how senior executives at Standard & Poor's, Moody's
and Fitch warned that their firms were engaged in a "race
to the bottom" that compromised standards for a share
of the profits from the boom-time credit markets. The agencies
were paid by the issuers of the derivatives, a conflict of
interest that a committee member, Jackie Speier, called "a
bone-chilling definition of corruption".
Trillions of dollars of mortgage derivatives were given the
highest ranking of creditworthiness, AAA, despite containing
toxic sub-prime loans that have subsequently gone bad. The
resultant losses, which now top $500bn, have been spread throughout
the financial system, including to investors who believed what
the rating agencies told them, namely that their investment
was as safe as US government bonds.
"The story of the credit rating agencies is a story of
colossal failure," said Henry Waxman, committee chairman. "They
broke a bond of trust... and the result is that our entire
financial system is now at risk."
Stephen Lynch, a Massachusetts Democrat, said his constituents
were not sophisticated enough to examine the creditworthiness
of complex derivatives for themselves, "but they knew
what AAA meant and what it has meant for 75 or 100 years. They
think someone should go to jail and the more I hear, the more
I agree."
Mr Waxman revealed that, at a presentation made to the Moody's
board of directors a year ago, the chief executive, Raymond
McDaniel, warned the board that company employees sometimes "drink
the Kool Aid" and accede to pressure for undeservedly
high ratings, even as the weaknesses of the securities were
becoming apparent. "What happened in '04 and '05 with
respect to subordinated tranches [of mortgage derivatives]
is that our competition, Fitch and S&P, went nuts. Everything
was investment grade. We tried to alert the market. We said
we're not rating it. This stuff isn't investment grade. No
one cared because the machine just kept going."
Jerome Fons, a former managing director of credit policy at
Moody's, testified that derivatives issuers "typically
chose the agency with the lowest standards, engendering a race
to the bottom in terms of rating quality".
The chief executives of the three agencies told lawmakers
that they believed the derivatives were sound at the time they
were rated. "We have learned important lessons from these
fast-changing market conditions," Mr McDaniel said. The
company has refined its rating methodologies, increased transparency
of its analysis, and adopted new policies to avoid conflicts
of interest, he said.
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