The cause for our current global economic crisis can be attributed to a culmination of many different factors; three being the three largest independent U.S. credit rating agencies- Standard and Poor’s, Moody’s, and Fitch Ratings. However, this is no new revelation. Agencies with a business model that allows them to get paid by security issuers has raised causes for concern for awhile now.
The Committee on Oversight and Government Reform held on hearing on October 22nd titled, “Credit agencies and the Financial Crisis.” At the hearing, executives from S&P, Moody’s, and Fitch all denied that conflict of interest affected judgment when rating mortgaged securities. Frustrated lawmakers and investors beg to differ. Chairman of the committee, Rep. Henry Waxman stated, “Millions of investors rely on them for independent, objective assessments. The rating agencies broke this bond of trust.”
At the hearing, an instant- message conversation between two Standard & Poor’s employees on a particular mortgage-backed investment was read:
Employee 1: By the way, that deal is ridiculous
Employee 2: I know, right. The model definitely doesn’t capture half the risk.
Employee 1: We should not be rating it
Employee 2: We rate every deal. It could be structured by cows and we would rate it
Employee 1: There is a lot of risk associated with it. I personally don’t feel comfy signing off as a committee member.
This is blatant evidence of independent rating agencies assigning safe ratings to products that in reality were risky or of no value. Sean Egan, managing director of Egan-Jones Ratings, an independent proxy voting and corporate governance advisory firm that provides credit analysis through a subscription based service targeted to investors, argued investment decisions cannot based on ratings produced by agencies that take money from issuers. “Institutional investors know darn well that ratings are paid for by the issuers,” he said, “so why do they have all their investment guidelines geared to conflicted ratings?”
Last July we wrote, “In the particular case of the rating agencies, their willingness to adopt the SEC’s recommendations is a first encouraging step in retaining their credibility. We will now witness whether this expressed willingness translates in reality.” The EU is currently in the midst of drafting a law that would end self regulation for European credit rating agencies. We will watch closely to see what unfolds here in the US but I think (and hope) it is safe to say big changes are in store.