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Senate panel: Ratings agencies rolled over for Wall Street

WASHINGTON — A Senate panel investigating the causes of the nation's financial crisis on Thursday unveiled evidence that credit-ratings agencies knowingly gave inflated ratings to complex deals backed by shaky U.S. mortgages because of the fees they earned for giving such investment-grade ratings.

The Senate Permanent Subcommittee on Investigations will hold a detailed hearing on Friday, where its chairman, Sen. Carl Levin, D-Mich., will introduce email records in which executives from Standard & Poor’s and Moody’s Investors Service acknowledge compromising the integrity of ratings in order to win business from big Wall Street firms.

“They did it for the big fees they got,” Sen. Levin told reporters on Thursday after outlining the broad strokes of what he’d pursue Friday when he puts current and former ratings agency officials on the hot seat.

The documents to be released Friday confirm what a McClatchy investigation revealed last October _ that pressure from top ratings-agency executives to retain market share and the fees that brought meant that ratings on complex deals were malleable. Some fees were as high as $1.4 million.

The agencies rate the quality of financial products such as bonds and serve as guides trusted by investors. Many bonds they rated as top-quality in the recent crisis turned out to be junk. The fallout from their rollover to Wall Street’s financial firms was a housing collapse that triggered a global financial crisis.

In one example obtained by the committee, a Moody’s employee sent an email to a banker at Merrill Lynch in June 2007, pressuring the investment bank to lock down a big fee in exchange for a positive rating.

“We have spent significant amount of resource on this deal and it will be difficult for us to continue with this process if we do not have an agreement on the fee issue,” said the Moody’s employee.Merrill Lynch acquiesced, but not without conditions.

“We are okay with the revised fee schedule for this transaction. We are agreeing to this under the assumption that this will not be a precedent for any future deals and that you will work with us further on this transaction to try to get to some middle ground with respect to the ratings,” the Merrill Lynch employee said, leaning on Moody’s.

In another email obtained from Standard & Poor’s, an employee complains of the shifting criteria used in models for rating complex deals.

“Screwing with (the model’s) criteria to ‘get the deal’ is putting the entire S&P franchise at risk – it’s a bad idea,” said the employee.

Last year’s McClatchy investigation revealed how top management at Moody’s pressured analysts to find ways to get deals done to prevent the business from going to a competitor. The practice was not exclusive to Moody’s.

Another email to be unveiled by Levin’s subcommittee features a Standard & Poor’s employee angrily complaining to a Morgan Stanley banker about ratings agencies being played off of each other.

“How many millions does Morgan Stanley pay us in the greater scheme of things? How many times have I accommodated you on tight deals? Neer, Hill, Yoo, Garzia, Nager, May, Miteva, Benson, Erdman all think I am helpful, no?” the employee said, naming all the Morgan executives who had received accommodative ratings.

Friday’s hearing will feature current and former executives from both major ratings agencies who worked on the complex deals called collateralized debt obligations. CDOs involve giant pools of U.S. mortgages packaged together for sale to investors as a complex security with high risks and high reward.Wall Street’s pooling and packaging loans did not involve due diligence of the underlying quality of the loans.

Since underwriting standards by mortgage lenders had dropped precipitously, many of these complex deals given top investment-grade ratings went bust within months in 2007.

That alone is evidence of the industry’s falling standards. Prior to these problems, the mathematical chances of a default on a top investment grade rating were less than 1 percent. What changed is that structured finance became popular _ the practice of pooling together loans and offering slices to investors at different risk levels.

“What we ended up with was high-risk securities in bottles with low-risk labels,” Levin said.

The hearing will spotlight three particular deals involving CDOs. One, a $1.5 billion issuance underwritten by Swiss bank UBS, involves a company with close ties to Bank of America, Vertical Capital.

This massive deal received an investment grade rating from Standard & Poor’s on March 10, 2007, and from Moody’s on March 26. But by October, the deal had been downgraded by Moody’s, and one month later by Standard & Poor’s.

A similar $1 billion deal to be spotlighted by the committee was arranged by Goldman Sachs and was downgraded within eight months.

In another bit of explosive evidence, the panel on Friday will release an email from a Standard & Poor’s employee acknowledging complicity in building up a doomed market.

“Rating agencies continue to create an even bigger monster _ the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters,” the employee wrote on Dec. 15, 2006.

That was about half a year before both big ratings agencies began massive write-downs on mortgage-backed deals, the prelude to the deepest financial crisis since the Great Depression.Friday’s emails will show how leaders of both ratings agencies saw big trouble on the horizon. An email from a Standard & Poor’s managing director on March 18, 2007, told of a pending meeting with Terry McGraw, CEO of publishing giant McGraw-Hill Companies, the parent company to Standard & Poor’s. The meeting was to cover “how we rated the deals and are preparing to deal with the fallout (downgrades.)”

Another Standard & Poor’s email on March 20, 2007, tells of a meeting with the company’s president, Kathleen Corbet, in which “she requested that we put together a marketing campaign around the events in the subprime market, the sooner the better. {S}he didn’t feel that we are being proactive enough in communicating our thinking to the market as well as proactively protecting ourselves against bad press.”

Corbet stepped down as ratings downgrades caused the sophisticated deals to crater. She’ll appear before the panel on Friday, joined by Moody’s Corp. Chairman and CEO Raymond McDaniel. Unlike most captains of Wall Street firms implicated in the meltdown, he still has his job.

Asked whether he believed McDaniel still belongs at the helm, Levin was circumspect.

“I don’t think either of these companies has served their shareholders or the nation well,” Levin said.

On the Web

Where was Moody's board when top-rated bonds blew up?

How Moody's sold its ratings - and sold out investors

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