WASHINGTON (Reuters) - Wall Street influence and an insatiable thirst for profits drove credit rating agencies to inflate ratings on subprime mortgage-related products, contributing to the financial crisis that led to a massive destruction of wealth, a U.S. Senate panel said on Thursday.
The U.S. Senate Permanent Subcommittee on Investigations pointed to a $1 billion securities offering backed by subprime loans that Goldman Sachs underwrote in 2007 as an example of questionable industry practices.
The Goldman collateralized debt obligation fetched top ratings from credit rating agencies Standard & Poor’s and Moody‘s, even though it was backed by subprime loans issued by a financial firm with a shoddy reputation.
By the end of the year, both Moody’s and S&P began downgrading their ratings on the securities. Today, two of the five AAA-rated slices of the collateralized debt obligation have been downgraded to junk status.
“The credit rating agencies allowed Wall Street to impact their analysis, their independence and their reputation for reliability,” Senator Carl Levin, chairman of the Senate investigations subcommittee, told reporters. “They did it for the big fees that they got.”
The Goldman collateralized debt obligation, or CDO, was one of thousands tied to high-risk loans that the credit agencies initially rated investment grade and then, as their underlying loans began to default in large numbers, downgraded.
The agencies’ favorable ratings are now widely blamed for contributing to the U.S. housing bubble. Their massive downgrades after housing prices stopped rising helped trigger the subprime mortgage debacle and subsequent financial crisis of 2007-2009.
The investigations subcommittee, which is examining the role of the ratings agencies in the crisis, concluded that their failure to properly gauge the risks of CDOs and other structured finance products resulted from a host of factors. Among them were undue influence by investment banks, flawed forecasting models, and inadequate resources, the panel said.
Investors, including insurance companies, banks, pension funds and endowment funds, rely on the agencies’ ratings to weigh the soundness of investments. The agencies have a quasi-official status as arbiters of credit risk in the financial system.
The subcommittee will take testimony on Friday from current and former officials of S&P and Moody‘s, the two biggest rating agencies. Those scheduled to testify include Raymond McDaniel, chairman and chief executive of Moody‘s, and Kathleen Corbet, the former president of S&P.
Previous subcommittee hearings have looked at the role of high-risk mortgages and regulators in the financial crisis. A final hearing next week will examine the role of investment banks and focus on Goldman Sachs.
The hearing comes amid a final push for financial regulation reform in Congress. Tighter regulation of the rating agencies is part of a House bill passed in December and a proposed Senate bill that is expected to be debated next week.
Neither bill, however, calls for fundamental change in the “issuer pay” business model that critics say poses an inherent conflict of interest for the rating agencies.
Levin, a Michigan Democrat, said that while he supported the bills, neither does enough to address the conflict-of-interest problem.
“I think they’ve got to either find a way or direct the regulatory bodies to end that inherent conflict of interest,” he said.
Both bills seek to enhance the U.S. Securities and Exchange Commission’s authority over the agencies. Current law bars the SEC from evaluating the rating agencies’ forecast models.
Editing by Leslie Adler