Ratings Agencies Blasted in Hearings

Critics have suggested that with credit rating agencies being paid by the companies they rate to provide ratings — the issuer-pay model — undue influence and conflicts of interest have prevailed. Many of the subprime mortgage-backed securities that have been downgraded were initially given high ratings.

One congressman placed blame upon the credit rating agencies and loan originators. He said the agencies engaged in fraud — assigning “overly favorable” ratings to mortgage-backed securities because they could then market the securities they rated on the secondary market. He also blamed loan originators, telling hearing attendees that originators made six-figure loans to people who shouldn’t have been allowed to finance a television set.

Another congressman criticized the agencies for giving investment grade ratings to loan pools that include stated income and teaser rate loans. “Your own people called them liar loans,” the congressman chastised.

Another congressman blamed the ratings agencies and defects in the Truth in Lending Act. He said the rating agencies “have failed us many times in the past” and suggested that it is time to devise a more robust TIL.

Representatives from Moody’s Investors Service and Standard and Poor’s told lawmakers that the conflicts can be managed and explained the procedures they have in place to deal with them.

When S&P Executive Vice President Vickie A. Tillman offered to politicians that the country is in the midst of an unprecedented decline in housing prices, a congressman cut her short and asked her why the agency didn’t model for such a scenario. Asked what they would do differently, Tillman said S&P would look for more information and pointed out that the historically-based assumptions made about borrower behavior are not as reliable as in the past. She told the House subcommittee, as she did at a Senate hearing earlier this week, that borrowers with high FICO scores in loans made in 2006 behave more like borrowers in previous years with lower FICO scores. One congressman shot back: Haven’t you seen those ads on television that offer to fix credit scores? Tillman also responded that S&P is starting to look at the fraud protection that loan originators have in place. Panel attendees also criticized the rating agencies and suggested that more regulatory scrutiny is needed.

J. Kyle Bass, portfolio manager for the Hayman Capital Master Fund and a co-manager of the Subprime Credit Strategies Funds for Hayman Advisors L.P., told lawmakers that the current credit rating agency system is flawed on both a systemic and process level. He said fundamental conflicts of interest exist because the nationally recognized statistical ratings organizations are dependent on the issuers for their revenues. The credit rating agencies, designated by the U.S. Securities and Exchange Commission as NRSROs, play an integral role in the capital markets, including assessing the creditworthiness of structured finance products like mortgage-backed securities and collateralized debt obligations. Bass said regulators missed the problems in the credit market because the securitization market has no federal or state banking regulators to monitor its behavior.

He suggested additional disclosures requirements for the NRSROs and the sponsoring of a “buy-side” credit rating consortium funded by a limited fee on each transaction in the fixed income market.H. Sean Mathis, managing director for Miller Mathis, an investment banking firm, also testified that regulatory oversight of the credit rating agencies is lacking. He told Congress that a “slapped together regulatory matrix gave raters virtually unchecked power to designate what securities were deemed safe” for investment portfolios.

Related:

Borrower Behavior Shift Blamed for Bad Ratings
WASHINGTON, D.C. — The credit reporting agencies told Congress yesterday that a shift in borrower behavior prevented them from accurately predicting the performance of subprime loans backing residential mortgage-backed securities. One agency laid the blame on mortgage brokers and lenders for not doing their job. But senators suggested a major conflict of interest exists while the chief U.S. securities regulator is moving forward with an investigation.

Lisa D. Burden is a legal analyst for MortgageDaily.com and holds a law degree from the University of Maryland. She is currently a freelance journalist who previously wrote for Institutional Investor publications and the Baltimore Daily Record.

e-mail Lisa at: [email protected]