Congressional hearings: the ratings agencies get their turn

“The operation was a success but the patient died.” Sound familiar? We’ve heard much the same excuse from UBS and other banking companies lo these many months. “Our risk assessments and investment strategies were rigorous and accurate and worked exactly how they were supposed to. It’s just that the market didn’t behave properly.”

Now we’re hearing the same thing from the credit ratings agencies, whose executives are getting their turn before Congress. Moody’s, Fitch Ratings, and Standard & Poor’s all gave high ratings to mortgage-backed securities, despite internal misgivings. The following is from testimony from Devin Sharma, president of Standard & Poor’s, on what happened and why:

“We have been in this business for over one hundred years and studies on rating trends and performance … have repeatedly confirmed that S&P’s ratings — whether of corporate debt, municipal bonds, structured finance, or the like — have been highly effective in informing the markets about both deterioration and improvement in credit quality. That legacy — which is our most valuable asset — has been challenged by recent events.”

So did we all get that? It wasn’t their ratings systems or conclusions that were at fault. It was the market’s fault for  being “challenging.”

It’s unfortunate that Congress also heard a less formal kind of testimony. Also quoted in these hearings were communications by Standard & Poor’s analysts, to wit,

“rating agencies continue to create an ever-bigger monster, the CDO market. Let’s hope we are all wealthy and retired by the time this house of cards falters.”

Sharma says in response,

“… despite how some may interpret the language in certain of these emails, there is no evidence of any misconduct by our analysts or that the fundamental integrity of our ratings process has been compromised. Indeed, the SEC itself concluded that it found no evidence during its examination that S&P had compromised its standards to please issuers. … Still, the language used in some of the emails is disappointing and we are redoubling our efforts to make sure our people appreciate the importance of professional conduct to our reputation, our business, and the markets we serve.”

Moody’s and Fitch come in for their share of embarrassment as well. Turns out that Moody’s CEO was well aware that the ratings game not as pure and objective as it likes to think it is:

“… the real problem is not that the market underweights rating quality, but rather that in some sectors it actually penalizes quality. It turns out that ratings quality has surprisingly few friends. Issuers want high ratings; investors don’t want ratings downgrades; short-sighted bankers let labor short-sightedly game the rating agencies …”

S&P’s Sharma goes on in his testimony to point out that S&P‘s credit ratings were being used by debt issuers in ways they were not meant to be used, i.e., as an opinion on a security’s value or liquidity, but if that’s not how a rating is meant to be used, then what good is it?

Hindsight is 20/20 and all that, but what would have happened if the ratings firms had stood pat and refused to rate these problematic CDOs? True, it’s not all on them, but it’s legitimate to look on these firms as a backstop, one level of safety that help keep the wheels from coming off. Too bad they got caught up in the madness too.