WASHINGTON (Reuters) - Lawmakers criticized the three largest credit rating agencies for their role in the worst financial crisis in decades, and the agencies admitted they didn’t see it coming.
“The story of the credit rating agencies is a story of colossal failure,” Rep. Henry Waxman, chairman of the House of Representatives Oversight and Government Reform Committee, said Wednesday at a hearing.
Moody’s Corp, McGraw-Hill Cos Inc’s Standard & Poor‘s, and Fimalac SA’s Fitch Ratings have been blamed for failing to flag problems with mortgage securities that have spread through the financial system.
“The rating agencies broke this bond of trust, and federal regulators ignored the warning signs and did nothing to protect the public,” said Waxman, a California Democrat. “The result is that our entire financial system is now at risk.”
Rep. Tom Davis, the top Republican on the committee, said the credit rating firms’ triple-A credit ratings are meant to insulate investors against nasty shocks. “Many are asking how and why ... they got it so wrong,” said the Virginia congressman.
Rep. Stephen Lynch, a Democrat from Massachusetts, said his constituents did not have the ability to scrutinize the various tranches that make up an asset-backed security, but said that they did know what a triple-A meant.
“They rely on them and are reduced to relying on them. A lot of people feel like they have been defrauded,” Lynch said.
Waxman’s committee obtained roughly 400,000 pages of documents and e-mails from S&P, Moody’s and Fitch showing how many rating downgrades were issued from 2000 to 2008, the accuracy of those ratings, and their top executives’ compensation for the same period.
According to documents Waxman distributed at the hearing, Moody’s Chief Executive Raymond McDaniel told directors that Moody’s was facing a dilemma in trying to maintain both market share and ratings quality.
McDaniel told directors that industry competition forces rating agencies to provide the lowest credit enhancement needed for the highest rating, which “can place the entire financial system at risk.”
Documents also revealed that a portfolio manager with big mutual fund company Vanguard Group Inc told Moody’s over a year ago that the rating agencies “allow issuers to get away with murder.”
A former S&P executive, Frank Raiter, said that the rating agencies have focused on maximizing short term profits and that money from rating asset-backed securities became so great that managers lost focus.
Raiter, who was S&P’s managing director and head of residential mortgage-backed securities ratings from March 1995 to April 2005, said S&P had failed to implement a model that could have given earlier warnings about many new products.
He said cost was one reason the agency did not keep the model current.
The rating agencies themselves acknowledged some responsibility. “We did not ... anticipate the magnitude and speed of the deterioration in mortgage quality or the suddenness of the transition to restrictive lending,” Moody’s McDaniel said in prepared remarks.
“We see missed opportunities, as we imagine every participant in the mortgage origination, securitization and investment process does,” McDaniel said.
Fitch Ratings Chief Executive Stephen Joynt said Fitch did not foresee the magnitude of the decline in the U.S. housing market or the dramatic shift in borrower behavior.
S&P President Deven Sharma said it is now clear that a number of assumptions used in preparing ratings on mortgage-backed securities issued between 2005 and mid-2007 did not work.
U.S. and European regulators are crafting rules to rein in credit raters and have already proposed a series of reforms, such as forcing raters to disclose more information about their underlying assumptions used to rate products.
Since the subprime mortgage market collapsed, credit raters have come up with some of their own solutions.
S&P is implementing more safeguards against potential conflicts of interest by establishing an office of the ombudsman and is increasing the amount of information it publishes about the stress tests for ratings.
Fitch’s Joynt said that to win back investor confidence, ratings must be more predictive and must tell the market about what might happen, instead of what happened yesterday.
Editing by John Wallace, editing by Gerald E. McCormick