Staff at the credit ratings agency Moody's were bullied by Wall Street bankers, harassed by profit-hungry bosses and starved of the time and resources they could have used to check their disastrous ratings of mortgage derivatives, an inquiry into the causes of the credit crisis was told.
In testimony that provided a new glimpse into final period of the credit and housing boom from 2005 to 2007, former Moody's managers testified that they felt bullied and boxed into ascribing imperfect or artificially high ratings to billions of dollars of mortgage-related investments.
Thanks to their gold-plated ratings that Wall Street banks were able to parcel up even the most unlikely US mortgages for sale around the world to investors who believed they were buying bonds that were as safe as US government debt. While bankers earned huge fees for themselves from the trades, they ultimately poisoned the financial system when the US housing market collapsed.
The 11-month old Financial Crisis Inquiry Commission is zeroing in on the relationship between Wall Street and the credit ratings agencies. The hearing about Moody's also featured a star turn from one of the company's biggest investors, the billionaire investment guru Warren Buffett. But it was details of the interactions between the ratings agency and its clients on Wall Street that proved most illuminating at yesterday's hearing.
Eric Kolchinsky, managing director in the department that rated collateralised debt obligations (CDOs)– the derivatives created from mortgage-backed securities – said his bosses made it clear his main task was to raise the volume of business. That meant making concessions to bankers who created CDOs and paid for Moody's work.
"Concern about credit quality took a back seat to market share," Mr Kolchinsky said. "While there was never any explicit directive to lower credit standards, every missed deal had to be explained and defended. Management also went out of its way to placate bankers and issuers.
"The focus on market share inevitably lead to an inability to say 'no' to transactions. It was well understood that if one rating agency said no, then the banker could easily take their business to another."
He said analysts had growing suspicions that Wall Street was packing CDOs full of increasingly dubious mortgages, but in ways that were difficult for Moody's to detect. Gary Witt, another ex-managing director, said he argued repeatedly for more resources to properly investigate the underlying mortgages and to test more of the assumptions that went into the company's models. He quit when his requests were repeatedly denied.
Both men said Wall Street bankers would exercise their power as the rating agencies' clients. Mr Kolchinsky said they were granted requests to bar unsympathetic analysts from particular projects, though this was denied in later testimony by the company's chief executive, Raymond McDaniel. Mr Witt said bankers would go over analysts' heads to appeal to their superiors to improve ratings. "They would pull any lever they could," he said.
Mr Kolchinsky called it "a chess game which we kept losing", and he said the balance of power shifted even further in the bankers' favour after they stepped up the pace of CDO creation in 2006, using derivatives of derivatives.
On both sides of the Atlantic, politicians and regulators are considering ways to reform the rating process. In the US, Congress is examining proposals that will force investors to do more of their own research, instead of relying on ratings to make buying decisions. And the European Commission yesterday proposed an EU-wide securities watchdog to regulate the rating agencies and force firms to disclose payments from Wall Street banks and other bond issuers.