Rating Agencies Repeatedly Caved To Banks' Demands And Helped Cause Crisis, Report Finds
NEW YORK -- The major credit rating agencies repeatedly sold out to Wall Street banks, so addicted to short-term profits that they sacrificed the accuracy of their reports to maintain a competitive edge, a two-year government investigation has concluded.
Rather than assess risk accurately, two major rating agencies sold their top seals of approval to their investment bank clients, blessing products that the agencies themselves knew to be undeserving, the Senate Permanent Subcommittee on Investigations concluded in a report released Wednesday. By repeatedly debasing their standards, these agencies helped banks sell shoddy securities to unsuspecting investors, inflating the value of assets that turned out to be worth far less, the report has found.
The senate panel, led by Carl Levin (D-Mich.) and Tom Coburn (R-Okla.), levels a two-part charge against the rating agencies: Not only did these companies help inflate a dangerous bubble, the report says, but they also bear responsibility for popping it, as their abrupt downgrades of mortgage-linked securities in 2007 helped set off the panic that caused markets around the world to collapse.
These downgrades, the report says, were the "most immediate trigger" to the financial crisis, forcing a parasitic financial apparatus of lenders, regulators, rating agencies and investment banks to reckon with the weak economic underpinnings of its profits. The basic outline of this catastrophe has been widely reported, but Wednesday's release presents in vivid detail the roles of the key players, including those of Moody's Investors Service and Standard & Poor's Financial Services, the two leading rating agencies.
Like the banks they served, these two rating agencies focused on short-term profits above the integrity and long-term health of their institutions, a trove of internal documents uncovered by the Senate panel show.
"We are meeting with your group this week to discuss adjusting criteria for rating CDOs of real estate assets this week," reads a 2004 email from an S&P manager, "because of the ongoing threat of losing deals."
Edward Sweeney, a spokesperson for S&P, said in an emailed statement that the company has worked to improve the independence of its ratings since the financial crisis, adding that the sudden downgrades in 2007 were a reflection rather than a cause of poor credit quality. A spokesperson for Moody's Investors Service did not immediately respond to a request for comment.
To a certain extent, the agencies were hamstrung by a system in which conflict of interest is seemingly endemic. The biggest rating agencies, whose assessments are to this day taken at face value by investors around the world, are paid by banks to rate the securities that the banks issue. Complicating matters further, these ratings have legal status: Banks and other institutional investors are required by law to hold a certain percentage of highly rated securities, which gives these institutions an additional incentive to encourage rating agencies to bestow their highest blessing.
But despite the system's flaws, the Senate panel accuses specific people of corrupting the credit rating business, leaving it a twisted version of what it had been years earlier.
Brian Clarkson, who worked at Moody's between 1990 and 2008 and eventually became the company's president and chief operating officer, promoted this change, the report says. Starting around 2000, under Clarkson's watch, the formerly "academically oriented" culture of Moody's began to morph. Clarkson used intimidation tactics to encourage his employees to cooperate with the wishes of investment banks, according to testimony from Mark Froeba, a former senior vice president at Moody's.
"The fear was real, not rare and not at all healthy," Froeba told the Senate panel. "You began to hear of analysts, even whole groups of analysts, at Moody's who had lost their jobs because they were doing their jobs, identifying risks and describing them accurately."
People who worked at S&P and Moody's during this time described a situation in which the companies' independence eroded almost entirely, so that they perpetually granted the wishes of banks that requested high ratings. A 2006 email from an S&P employee cast the banks as kidnappers, saying the rating agencies "have all developed a kind of Stockholm syndrome," meaning they sympathize with their captors.
And the banks knew exactly how to play the agencies, emails suggest. In 2006, a UBS banker warned an S&P senior manager that if the rating agency didn't go easy on it, the bank would take its business elsewhere.
This habit, once it started, was nearly impossible to break. Bankers would point to precedent, saying that the agency had granted a concession in the past. With the threat of losing market share always looming, the agencies repeatedly capitulated.
"I would rather not drop S&P from the upcoming deal," a Nomura investment banker wrote in 2005, when it looked like the bank wouldn't get the high rating it wanted.
In at least one case, the two parties actually bargained for higher fees. Merrill Lynch wanted Moody's to rate one of its securities in 2007, but the agency insisted on an unusually high fee, according to emails.
Initially, there was hesitation. "Could you point us to a precedent deal where we have approved this?" a Merrill Lynch employee emailed.
But after a brief email exchange, the two sides came to an agreement.
"We are okay with the revised fee schedule for this transaction," the Merill Lynch employee emailed. "We are agreeing to this under the assumption that this will not be a precedent for any future deals and that you will work with us further on this transaction to try and get to some middle ground with respect to the ratings."