Thursday, October 8, 2009

Rating Agency Snake Oil

"Regulators of some of the biggest bond buyers in the world are considering cutting credit-ratings firms' role in the market in response to botched ratings of complicated mortgage securities. Ratings firms including Standard & Poor's and Moody's Investors Service [MIS] are facing fresh dissent from state insurance regulators, who are cosidering moving away friom the firms ratings' are a way of measuring the health of insurer portfolios of mortgage-backed bonds. The move is a notable challenge to a ratings system that has long embedded itsdelf in the markets. Insurers are among the most important users of band ratings, collectiv ely holding some $3 trillion in rated bonds in their porfolios. ... The challenge from insurance regulators reflects the relentless criticism directed at ratings firms since the credit crisis began in 2007. ... Regulators say they have no plans now to move away from the leading agencies for corporate and other bonds considered less-difficult to rate. The regulators' action could subject them to criticism from consumer-advocacy groups that they are bending over backward to help insurers look good on paper, at the possible expense of policy holders", Leslie Scism & Aaron Lucchetti at the WSJ, 17 September 2009, link:

"California Attorney General Edmund G. Brown Jr. began an investigation into three major US credit-rating companies and their role in the financial crisis, in part to determine whether the firms violated California law", Tess Stynes at the WSJ, 18 September 2009, link:

"Throughout the financial crisis, the major credit-ratings firms were criticized for their overly rosy ratings of complex debt securities, which deteriorated soon after and led to billions of dollars of investor losses. ... The analyst, Eric Kolchinsky [EK], said [MIS] gave a high rating to a complicated debt security in January 2009 knowing it was planning to downgrade assets that backed the securities. Within months, the securities were put on review for a downgrade. ... The [MIS] spokesman declined to comment on the January rating that Mr. Kolchinsky questioned because a review of the matter 'is in progress.' Before he resigned, Mr. Kolchinsky was a managing director in a nonratings unit and wasn't involved in ratings of the securities in question. He was previously a Moody's rating analyst for six years and had experience with complex securities. ... In December, according to internal memos reviewed by Mr. Kolchinsky, Moody's executives approved changes to their ratings methodology that they expected to lead to the downgrades of many securities backed by corporate loans. The notes issued in January were tied to those types of securities, but Moody's analysts still gave the deal a high rating. ... In October 2007, Mr. Kolchinsky was told there was no role for him because the CDO ratings group was downsizing. He joined Moody's Analytics, a separate unit. ... A Moody's spokeman says that the firm 'has a strict nonretaliation policy' and that Mr. Kolchinsky 'has made an evolving series of claims of misconduct within the company and we have conducted multiple separate reviews.' In each case, Moody's 'found that his claims were unsupported,' the spokesman said", Serena Ng and Aaron Luchetti at the WSJ, 23 September 2009, link:

"[EK], the former Moody's Corp. analyst who this week went public with allegations of inflated credit ratings, plans to tell a congressional committee on Thursday that the ratings industry is still hampered by conflicts of interest. He also believes the 'credit policy' and 'compliance' groups at [MIS] lack independence and are short-staffed, and analysts get 'routinely bullied' by business line managers, according to a draft of his testimony. ... Over the past year, he has given presentations within and outside Moody's on the causes and lessons of the financial crisis, detailing problems such as 'ignored incentives,' and overreliance on quantitative models, the highly complex nature of many financial instruments, and regulations that were inconsistently applied, according to a copy of his presentation", Serena Ng at the WSJ, 24 September 2009, link:

"Credit-rating firms came under pressure as lawmakers and regulators renewed scrutiny of the ratings process. ... A Moody's spokesman said the company 'takes very seriously all allegations of impropriety,' and a review into Mr. Kolchinsky's most recent claims is in process. The spokesman said Mr. Kolchinsky's previous claims were found ny Moody's to be unsupported. ... [EK] also wrote that he fears that conflcits of interest, which arise bwecause Moody's is paid by debt issuers to rate securities, have become worse in recent months. the group that rates complex securities takes 'analytical short-cuts in their quest for revenue,' he wrote", Serena Ng, Sarah Lynch and Leslie Scism at the WSJ, 25 September 2009, link:

This is another example of why we need federalism. It will be more difficult to capture all 50 state insurance regulators than the "systemic federal regulator".

Brown, good luck.

Aren't we impressed with MIS internal investigations. Did John Ashcroft do them? David Kotz may have a place at MIS if he gets pushed out of the SEC. CPAs have had SAS 22 since March 1978, now superceeded by SAS 108. So? SAS seemed to prohibit retaliation against CPAs for holding differences of opinion. Hahahahahahaha.

What? Incentives Count? How dare you? Analysts getting "bullied"? It sounds like EK worked for a Big 87654 firm.

As long as ratings agencies are paid by issuers, the conflcts of interest will remain. It like how CPA firms are paid. I'm sure MIS takes allegations of impropriety seriously. After they become lawsuits.


Anonymous said...

Basically the raters are putting an usa guarantee on the bonds they rate highly, defacto or not.

Anonymous said...

It is an "in the event of a collapse ben bernanke will buy them" system.

Anonymous said...

Well the confidence factor in rated products went from 110% to -100% through this crisis (of course a few smarty pants like John Paulson hit home runs from the corrupted ratings on MBS)

The credit crisis won't start to heal till this issue is resolved. I hope someone has a good idea.

And Edgar you are right -- Bernanke can just onboard all these assets and park them on his balance sheet till they runoff... Super Hedge Fund Fed.