Financial Crisis Committee Grills Moody's on Ratings Failures

The Financial Crisis Inquiry Committee (FCIC) grilled executives from Moody’s on Wednesday, June 2, in New York about the pressure on analysts to produce ratings that would help investment banks pump out mortgage-backed securities. These securities were often AAA-rated initially, and then often downgraded to junk status during the housing debacle which led to the ongoing economic crisis.

Revenue and margin pressure was so great on managing directors at Moody’s that their performance evaluations depended on the market share of securities deals they rated. We “could not turn a deal down,” testified Eric Kolchinsky, a former team managing director at Moody’s.

The veritable alphabet soup being thrown about during this hearing, the fifth in a series by the Congressionally appointed FCIC, includes residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), collateralized debt obligations (CDOs), and credit default swaps (CDS).

All of these securities affected the economic swoon in part by supplying available credit to fuel the housing bubble, and by deflating after purchase as the underlying mortgages collapsed. This led to the inability of banks and other investors that bought these securities, often with massive amounts of leverage, such as hedge funds and institutions, to mark them to market or sell much of what remained on–or off–their books.

Some of these types of securities are part of an ongoing investigation by the SEC and its charges of fraud against Goldman Sachs’s Abacus deal. Some observers have asked whether the buyers did proper research on the underlying mortgage securities selected by a third party hedge fund–which took a short position on that deal–on the basis that they were most likely to fail.