October 22, 2008 -- Angry lawmakers from both parties assailed the top dogs of the big three credit rating companies Wednesday morning, assigning severe blame for the financial crisis on their firms' failure to assess the risk of trillions in subprime-mortgage related investments.
"You're the gatekeepers, you're the guys," chided a visibly frustrated Rep. Elijah Cummings, D-Md. "You're the ones who make all the money. That's why you're there. Now we face a situation where we've got a house of cards that has fallen, and here we are trying to resurrect it."
"The story of the credit rating agencies is a story of colossal failure," Rep. Henry Waxman, D-Calif., chair of the House Oversight and Government Reform Committee told the men who appeared before his committee this morning. "The result is that our entire financial system is now at risk."
The top executives – Moody's Corporation CEO Raymond W. McDaniel, Standard & Poor's president Deven Sharma, and Fitch Ratings' president and CEO Stephen Joynt – said in prepared statements that the meltdown of mortgage-backed securities was "unanticipated" and "unprecedented."
"It's clear greed led to not just, 'see no evil, hear no evil,' but 'report no evil,'" charged Rep. Mark Souder, R-Ind. "I believe there is possible legal culpability."
Rep. Dennis Kucinich, D-Ohio, agreed, calling the situation "criminal."
Rep. Chris Shays, R-Conn., charged the firms, which took fees from the investment banks which were packaging and selling the mortgage-backed securities they were rating so highly, had "sold their independence to the highest bidder."
Confidential documents obtained by Waxman's investigators show that the firms' executives anticipated much of what has happened, and were aware that their ratings were quite possibly shaky, according to the chairman.
"It could be structured by cows and we would rate it," one Standard & Poor's employee wrote in a company email cited by Waxman. "Let's hope we are all wealthy and retired by the time this house of cards falters," wrote another in an email obtained by Waxman's committee.
As Moody's CEO McDaniel explained in an October 2007 presentation obtained by Waxman's staff, shaky ratings came because few of the players – investors, banks or the firms which issued the securities – truly want an accurate assessment of an investment, if it isn't going to be good news.
"Ratings quality has surprisingly few friends," he observed. "I should restate the public comments I've made previously, which is that our ratings are not influenced by commercial considerations," McDaniel said Wednesday when asked by Rep. Carolyn Maloney, D-N.Y., about the presentation. "Our ratings are on the basis of our best opipino based on the available information at the time."
"But that's not what you said to your board members," Maloney said.
"It's not inconsistent with what I said to our board members," McDaniel insisted.
"It is hard for me to read this document and believe that you believed what you were saying in public," Maloney told the CEO.
At all three ratings firms, profits in recent years have been among the fattest on Wall Street, Waxman is expected to note. One firm, Moody's, rang up profit margins three to four times those of Exxon Mobil Corp. while assuring investors that complex mortgage-backed investments were safer bets than they really were, according to Bloomberg News.
In recent financial filings noted by the investor web blog Footnoted.org, however, Moody's confirmed it had "errors in the model" it used to rate some investments, and is "cooperating with. . . investigations and inquiries" by "states attorneys general and other governmental authorities," including the Securities and Exchange Commission.
Two former rating company employees who took issue with their firms' practices also testified Wednesday.
Frank Raiter was a former managing director at Standard & Poor's who left in 2005, after he says he refused to go along with several questionable arrangements. "They thought they had discovered a machine for making money that would spread the risks so far nobody would ever get hurt," Raiter told a Bloomberg reporter last month. Raiter could not be reached for comment.
Raiter told the committee that the models Standard and Poor's used to assess the riskiness of mortgage-related investments was flawed, but the firm resisted replacing it with a more complex -- and expensive -- model, which Raiter believed would have been more accurate. But the new model was deemed too expensive and unlikely to result in more business for the firm, Raiter told lawmakers.
"It is my opinion that had these models been implemented we would have had an earlier warning" of the foreclosure crisis, he said.
Asked about Raiter's comments, Standard and Poor's president Sharma said Raiter's new model had been tested and found unsuitable. Since then, he said, the company's model has been updated eight times. "We have been committed to updating the models," he told the committee.
The other former executive to testify, Jerome Fons, has become an advocate for reforming the rating industry since leaving Moody's Corp. last year. Fons has pointed out the glaring conflict of interest on which the rating firms are based – they are paid by the firms who will profit if their investment product gets a stellar rating – and has even suggested the lucrative industry should be replaced entirely.
A Securities and Exchange Commission investigation in June found the companies faced conflicts of interest, stemming from the fact that the investment banks trying to sell the mortgage-backed securities were the ones paying the firms to rate their products. Emails uncovered by investigators showed analysts were concerned that negative ratings would hurt their firms' income.