The system for assigning credit ratings to complex mortgage derivatives, which handed out gold-plated ratings to investments that have turned out to be worthless, was damned as "nuts" and as having created "a monster" – and that was just by senior employees at the rating agencies.
US politicians hauled bosses of the three main agencies before Congress for hearings into the causes of the credit crisis, and attacked them for presiding over a corrupt and possibly fraudulent system.
In front of a packed meeting room, members of the House oversight committee unveiled internal emails and instant messages that showed how senior executives at Standard & Poor's, Moody's and Fitch warned that their firms were engaged in a "race to the bottom" that compromised standards for a share of the profits from the boom-time credit markets. The agencies were paid by the issuers of the derivatives, a conflict of interest that a committee member, Jackie Speier, called "a bone-chilling definition of corruption".
Trillions of dollars of mortgage derivatives were given the highest ranking of creditworthiness, AAA, despite containing toxic sub-prime loans that have subsequently gone bad. The resultant losses, which now top $500bn, have been spread throughout the financial system, including to investors who believed what the rating agencies told them, namely that their investment was as safe as US government bonds.
"The story of the credit rating agencies is a story of colossal failure," said Henry Waxman, committee chairman. "They broke a bond of trust... and the result is that our entire financial system is now at risk."
Stephen Lynch, a Massachusetts Democrat, said his constituents were not sophisticated enough to examine the creditworthiness of complex derivatives for themselves, "but they knew what AAA meant and what it has meant for 75 or 100 years. They think someone should go to jail and the more I hear, the more I agree."
Mr Waxman revealed that, at a presentation made to the Moody's board of directors a year ago, the chief executive, Raymond McDaniel, warned the board that company employees sometimes "drink the Kool Aid" and accede to pressure for undeservedly high ratings, even as the weaknesses of the securities were becoming apparent. "What happened in '04 and '05 with respect to subordinated tranches [of mortgage derivatives] is that our competition, Fitch and S&P, went nuts. Everything was investment grade. We tried to alert the market. We said we're not rating it. This stuff isn't investment grade. No one cared because the machine just kept going."
Jerome Fons, a former managing director of credit policy at Moody's, testified that derivatives issuers "typically chose the agency with the lowest standards, engendering a race to the bottom in terms of rating quality".
The chief executives of the three agencies told lawmakers that they believed the derivatives were sound at the time they were rated. "We have learned important lessons from these fast-changing market conditions," Mr McDaniel said. The company has refined its rating methodologies, increased transparency of its analysis, and adopted new policies to avoid conflicts of interest, he said.
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