The Credit Ratings Blame Game
As agencies like S&P are blasted for the disconnect between mortgage-backed securities’ ratings and results, experts lament the SEC’s weak oversight authority
The mortgage market crumbled. Now, assessing blame has become one of the hottest games around. And in Washington, they’re looking for someone to pay, which is bad news for the credit-rating agencies that gave what now appear to be unrealistically high grades to mortgage securities that quickly faltered with the weakening housing market. “Everyone is looking for someone to blame,” Securities & Exchange Commission Chairman Christopher Cox told reporters following a Sept. 26 Senate hearing.
The SEC is focusing on whether the fees that big Wall Street bond issuers pay Moody’s Investors Service (MCO), Standard & Poor’s, and others to grade their securities “unduly influenced” those ratings, Cox told lawmakers. “There’s a mismatch between the ratings and the results,” he said.
Former Senate Banking Chairman Richard Shelby (R-Alabama) was even more blunt about the agencies: “They’re central to this whole debacle. They’re conflicted. It’s driven by money, not responsibility and ethics.”
Oversight Law Discounted
Even after the ratings agencies botched their calls on Orange County and Enron, the industry escaped most of the civil lawsuits, regulatory penalties, and legislative punishments borne by the rest of Wall Street. And despite all the current rhetoric and a new ratings law passed last year, the SEC has very little authority to supervise or sanction the industry. “If you look at the legislation that passed last year, it is so weak,” says former SEC Chief Accountant Lynn Turner. “The SEC doesn’t even have the power to go in and inspect these agencies. There’s very, very little oversight.”
The power Congress gave the SEC last year to regulate national ratings agencies was designed to increase competition against the three big agencies that held the SEC’s coveted approval as Nationally Recognized Statistical Rating Organizations (NRSRO). The designation is needed to rate most securities and only Fitch, Moody’s, and S&P had it until a few weeks ago. The idea is that more competition would lower costs and improve the quality of the ratings. The new law streamlines the registration and approval process for smaller ratings agencies such as Egan-Jones, which has been waiting nine years for the SEC’s approval. “Our application is actively being worked on right now,” says the firm’s co-founder Sean Egan. “It wasn’t before, now it is.”
The new law also gives the SEC some authority to look at the policies and procedures set by the ratings agencies, but virtually no power to review or penalize firms if the quality of the ratings is poor (BusinessWeek, 10/1/07). “Congress intended and the statute is clear that the SEC is not supposed to impose its own judgments on how credits are assessed,” says one SEC official who requested anonymity to avoid angering lawmakers. “It’s a more procedures-based approach. We’re supposed to check that they have policies and procedures in place to assess how credits are applied.”
Pointing Fingers Elsewhere
Cox plans to maximize the little authority Congress gave his agency. “We’re focused on how this all came about,” he says, noting the SEC can inspect the agencies for conflicts of interest, abusive and unfair practices, and insufficient resources to do the job. And if fraud is discovered, Cox says he thinks the SEC can use its antifraud regulations to limit a ratings agency’s authority or revoke its NRSRO status.
“These are real and serious problems. Not only have many people lost their homes, many lenders absorbed more risk than they anticipated, many holders of structured products faced serious problems with their instruments,” Cox told reporters after the Sept. 26 hearing. “But the sheer complexity of the products means that there are a lot of people involved at different stages of the production. That provides the opportunity for almost everybody to point the finger elsewhere, and that’s been part of this problem.”
Executives from S&P and Moody’s conceded to lawmakers Sept. 26 that they might have miscalculated on their mortgage ratings, but it was unintentional and not influenced by their fees.
Mortgage Industry Crackdown?
Lawmakers, however, were skeptical and are now debating whether the SEC needs more power to crack down on the industry. In addition, several states with aggressive new attorneys general, such as Ohio’s Mark Dann, are banding together to take on the industry themselves as part of several broader mortgage fraud investigations.
“They are one cog in the machinery. They’ve developed more of a collaborative relationship with the investment banks that are their customers. They get paid for every rating they give,” Dann tells BusinessWeek. “At some point in time, everybody in the country knew or should have known that many of these loans were being fraudulently obtained. They knew or should have known that the loans they were endorsing were fraudulently obtained.”