Credit-ratings agencies get earful on Capitol Hill over subprime securities

WASHINGTON — There's plenty of blame to go around for the ongoing credit crisis, and a House panel investigating the meltdown today cast much of it on credit-ratings agencies like Standard & Poor's for giving good-as-gold ratings to securities backed by subprime mortgage loans.

Internal company documents revealed by a House investigative panel show that company executives were well aware that there was little basis for giving AAA ratings to thousands of increasingly complex mortgage-related securities but that the companies often vouched for them anyway.

The big credit ratings agencies — Standard & Poor, Moody's and Fitch — made enormous profits as they issued ratings on a ballooning number of mortgage-related securities, many of which were given top ratings so long as housing prices went up. Now, S&P has downgraded more than two-thirds of its AAA-rated securities, while Moody's has downgraded more than 5,000 mortgage-backed securities.

"The story of the credit rating agencies is a story of colossal failure," said Rep. Henry Waxman, chairman of the House Oversight and Government Reform Committee.

The California Democrat said, "Millions of investors rely on them for independent, objective assessments,. The rating agencies broke this bond of trust, and federal regulators ignored the warning signs and did nothing to protect the public. The result is that our entire financial system is now at risk."

The panel heard former ratings agency executives say there's an inherent conflict of interest in the industry because they're paid by bond issuers instead of investors who trust their ratings to make smart investments.

Internal company documents revealed by the panel show executives were aware that credit ratings were inflated.

At a presentation made to the Moody's board of directors a year ago, top 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.

"It turns out that ratings quality has surprisingly few friends: issuers want high ratings; investors don't want ratings downgrades; shortsighted bankers labor shortsightedly to game the ratings agencies," McDaniel told the Moody's board.

Top credit-rating company executives said that they were unprepared when housing prices fell and their ratings models proved flawed.

"It is by now clear that a number of the assumptions we used in preparing our ratings on mortgage-backed securities issued between the last quarter of 2005 and the middle of 2007 did not work," Standard & Poor's chief executive Deven Sharma said.

The ratings agencies are so important because the ratings offer assurances to investors that their money should be safe. The inflated ratings awarded to securities backed up by subprime loans led investors to buy them in enormous numbers. But now, most of these securities have been downgraded and the market for them has largely evaporated, contributing to the current crisis.

Another problem is that securities issuers would give their business to the company with the most lax standards, giving competitors incentive to go easy as well.

"Fitch and S&P, went nuts. Everything was investment grade," McDaniel told a gathering of Moody's employees last September. "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."

"Like the 'UL Approved' tag on electric appliances, an AAA credit rating is meant to insulate investors against nasty shocks," said top panel Republican Tom Davis of Virginia. "But as the collapse of the mortgage-backed securities boom has seen billions in once high-grade investments fall quickly to junk status, many are asking how and why the ... credit rating agencies got it so wrong."