We will be spending the next several years trying to understand the various causes of the financial collapse. As most agree, there’s plenty of blame to go around.
There’s no doubt that the credit rating agencies played a huge role in this crisis. I worked on bond deals in the 90’s that were very similar to the mortgage-backed securities at the root of this scandal. The role of the rating agencies was very clear. It was up to them to assess the risk tied to each security, and that process involved quite a bit of due diligence regarding the underlying income streams.
It has been clear for years that the rating agencies were not doing their jobs with respect to pooled mortgages. Now Congress is holding hearings in order to learn more about what happened. Needless to say, you can learn quite a bit by following the money.
Conflicts of interest were largely responsible for the disastrous performance of credit rating agencies in assessing the risks of mortgage-backed securities, two former high-ranking officials at Moody’s Investors Service and Standard & Poor’s said in Congressional testimony on Wednesday.
The agencies are paid to issue ratings by the securities issuers, whose interests can eclipse those of investors, Jerome S. Fons, former managing director of credit policy at Moody’s until 2007, told the House Committee on Oversight and Government Reform.
“While the methods used to rate structured securities have rightly come under fire, in my opinion the business model prevented analysts from putting investor interests first,” he said.
And Frank L. Raiter, former head of mortgage ratings at Standard & Poor’s for 10 years, characterized the failures at that company by saying simply: “Profits were running the show.”
This reminds me of the problems we had with the accounting firms in the 1990’s. It was impossible to expect accounting firms getting huge deal fees to be objective when they were auditing the same client. Efforts were made to block this conflict of interest back then, but Congress blocked the reforms. Things didn’t get fixed there until we had the Enron and Worldcom debacles.
With the rating agencies, it’s painfully clear that more regulations are needed here as well. Let’s hope that we get it right going forward.
