Journalism in the Public Interest

Banks Pressured Credit Agencies, Then Blamed Them

Just about everybody agrees that credit rating agencies played a part in the meltdown by making a habit of giving top-notch ratings to lousy investments. That criticism has come from a curious corner lately: the big financial firms. As a spokesman from Goldman Sachs told Bloomberg earlier this week, “Goldman Sachs and others relied upon the rating agencies to supply independent analysis and ratings.”

It’s an interesting argument, because Goldman and other firms often seemed to have pressured the agencies to give good ratings. E-mails released last week by the Senate investigations subcommittee give a glimpse of the back-and-forth (PDF).

"I am getting serious pushback from Goldman on a deal that they want to go to market with today," wrote one Moody's employee in an internal e-mail message in April 2006.

The Senate subcommittee found that rating decisions were often subject to concerns about losing market share to competitors. The agencies are, after all, paid by the firms whose products they rate.

Standard & Poor's certainly felt the pressure. One employee even tried to push back:

"The right thing to do is to educate all the issuers and bankers and make it clear that these are the criteria and that they are not-negotiable," wrote one S&P employee in June 2005. "Screwing with criteria to ‘get the deal' is putting the entire S&P franchise at risk -- it's a bad idea."

Jim Cox, a professor of securities law at Duke University, told me it's disingenuous for banks to pin the blame on the rating agencies, when they knew those ratings were compromised.

"They knew full well that those credit ratings were without meaning," said Cox. "They were paying for them. They knew the credit rating agencies were not conducting any form of due diligence."

But that's not a defense of the rating agencies, either, which often caved to the pressure while increasing risk to the financial system. From one S&P internal e-mail in December 2006:

"Rating agencies continue to create and [sic] even bigger monster -- the CDO market," one employee wrote. "Let’s hope we are all wealthy and retired by the time this house of cards falters. :0)"

In prepared testimony before the subcommittee, the CEO of Moody's, Raymond McDaniel, said the company is "certainly not satisfied with the performance of our ratings during the unprecedented market downturn of the past two years." He said that "neither we -- nor most other market participants, observers or regulators -- fully anticipated the severity or speed of deterioration that occurred in the U.S. housing market."

An S&P spokesperson told Reuters that the firm has "learned some important lessons" from the crisis and has made changes "to increase the transparency, governance and quality of our ratings."

Financial reform bills in both the House and the Senate would have rating agencies register with the Securities and Exchange Commission. The SEC is currently prohibited from overseeing them. Sen. Christopher Dodd's bill would create a new office within the SEC for this purpose. The bills would also allow investors to sue rating agencies for failure to properly analyze investments.

Neither the House nor the Senate bills, however, change the fact that credit rating agencies will continue to be paid by the firms whose products they rate. To that end, some, like The Washington Post’s Ezra Klein, have even suggested making the agencies public.

Disingenuous at best, for banks to blame the credit rating agencies, who nevertheless have to answer for their complicity.
I’ve written about the issue a few times for

Mortgage related investments deserved high ratings - assuming that there could never be a general deflation in housing prices.  Why would rating services operate under that assumption?  On November 21, 2002, Federal Reserve Governor Ben S. Bernanke addressed the National Economists Club in Washington, D.C where he said:

“the chance of significant deflation in the United States in the foreseeable future is extremely small ... a particularly important protective factor in the current environment is the strength of our financial system…our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape. .... The second bulwark against deflation in the United States….is the Federal Reserve System itself. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation…..I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief” “.

If you were grading mortgage debt, you would certainly imagine that the government would move heaven and earth to ensure that there was no general deflation of housing prices since housing represents the most significant asset of most citizens.  If house prices cannot decline; then it is perfectly safe to give mortgages to subprime borrowers - if some of them default, you just foreclose them and sell their house for enough to cover their mortgage obligations.  By the same reasoning, it is also safe to provide cheap insurance against mortgage default.

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