Published January 13, 2015
Executives from major credit rating agencies on Wednesday were accused by senators of being hampered by conflicts of interest that may have contributed to the mortgage market turmoil rattling investors worldwide.
The biggest rating agencies, Standard & Poor's, Moody's Investors Service and Fitch Ratings, are under fire from critics who say they failed to give investors adequate warning of the risks associated with mortgage-backed securities. Those securities are now plummeting in value as home-loan defaults soar, particularly among "subprime" borrowers with weak credit histories.
Democratic and Republican senators said they are particularly concerned with a key aspect of the agencies' business models: they get paid by the companies whose bonds they rate. That's like a film production company paying a critic to review a movie, and then using that review in its advertising, Sen. Jim Bunning, R-Ky., said.
Several senators compared the agencies' lack of foresight about the risks inherent in the subprime mortgage market with their failure to anticipate the collapse of Enron and WorldCom.
"It seems to me that credit rating agencies are playing both coach and referee," in giving advice to issuers of debt. said Sen. Robert Menendez, D.-N.J.
In testimony prepared for Senate Banking Committee hearing, executives from S&P and Moody's said their methodology for monitoring the risk of mortgage-backed bonds was sound. But they also pledged improvement.
"We are taking steps to ensure that our ratings, and the assumptions that underlie them, are analytically sound in light of shifting circumstances," said Vickie Tillman, executive vice president of credit market services for S&P, a subsidiary of McGraw-Hill.
The Securities and Exchange Commission has begun a review of the agencies' practices, including whether conflicts of interest were created if rating agencies gave advice to issuers of mortgage-backed securities.
"We have as yet formed no firm views on any of the reasons put forth by the credit rating agencies, but are carefully looking into each of them," SEC Chairman Christopher Cox said.
The agencies are subject to SEC oversight enacted last year amid a push to encourage more competition in the ratings business.
Sen. Charles Schumer, D-N.Y., raised the idea of developing a new business model for the rating agencies by either promoting the entry of competitors that would be paid by investors in securities rather than their issuers. Or, he said, the existing agencies should develop a new funding model in which they would be paid by investors rather than bond sellers.
"To say nothing went wrong, that ain't going to fly," Schumer said.