Ratings Agencies Culprits in Subprime Fiasco

Senate hearing explores ratings agencies' role in subprime disaster

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The nation's credit ratings agencies did indeed have a role to play in the subprime lending fiasco, members of the Senate Committee on Banking, Housing and Urban Affairs said during a hearing September 26.

Some reform to the way credit ratings agencies operate came with The Credit Rating Agency Reform Act of 2006, which gave the SEC authority to oversee credit ratings agencies registered with the Commission as nationally recognized statistical rating organizations (NRSROs). The act also gave the SEC the broad power to examine all books and records of NRSROs. When asked by Senator Jack Reed (D-RI), a member of the committee, whether the SEC has a plan to regularly examine ratings agencies, SEC Chairman Christopher Cox replied that examinations of NRSROs are now underway. Cox told the committee that SEC examiners are focused on ratings agencies' resources--making sure they have adequate capitalization, and are "serious and not fly by night" players. SEC examiners are also looking at ratings agencies' conflicts of interest and how they are managed, Cox said. Senator Robert Menendez (D-New Jersey) pointed out that ratings agencies are "not paid for the research, they are paid for the actual rating." If the client doesn't like the rating, he continued, "they don't have to pay a dime" to the ratings agency. This unsettling fact "must be looked at" by Congress and the SEC, he said. What's more, a more glaring conflict is the fact that ratings agencies are paid by the firms they are rating. The SEC is also assessing ratings agencies' unfair and abusive practices, Cox said.

The SEC granted on September 24 the registrations of seven credit rating agencies as NRSROs. The firms are the first to be registered with the Commission under the Credit Rating Agency Reform Act of 2006. The seven firms registered as NRSROs are: A.M. Best Company, Inc.; DBRS Ltd.; Fitch, Inc.; Japan Credit Rating Agency, Ltd.; Moody's Investors Service, Inc.; Rating and Investment Information, Inc.; and Standard & Poor's Ratings Services. The Reform Act and the Commission's new rules require registered credit rating agencies to disclose their procedures and methodologies for assigning ratings. The NRSROs, the SEC says, are also required to make public certain performance measurement statistics including historical downgrades and default rates.

Senator Richard Shelby (R-Alabama) ranking member of the committee, said that the SEC never expected that ratings agencies would be relied on so much, and Cox agreed. "Is it appropriate to reconsider the reliance on the SRO ratings agency," Shelby asked Cox. Cox said the SEC is now examining its own rules on credit ratings agencies to assess this.

Over the summer, ratings agencies downgraded a number of mortgage bond ratings, which some critics say helped to exacerbate the credit markets' problems. During her testimony, Vickie Tillman, EVP of Credit Market Services for Standard & Poor's Rating Services, said credit ratings are "Not a promise of performance but an evaluation of the risk of default. ...Credit ratings speak to one topic and one topic only--the likelihood that rated securities will default. When we rate securities, we are not saying that they are 'guaranteed' to repay but the opposite: that some of them will likely default." Michael Kanef, group managing director of Moody's Investors Service, said Moody's has improved its ratings process by "expanding the mortgage loan data we request from the issuer to include depth and breadth of borrower's credit history" as well as increasing "our delinquency and loss expectations as well as the resulting credit enhancement we look for to support our various ratings."

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