Showing posts with label Credit Rating Agencies. Show all posts
Showing posts with label Credit Rating Agencies. Show all posts

Wednesday, August 5, 2009

Hearing on Examing Proposals to Enhance the Regulation of Credit Agnecies(Jui Kai Li)

On Aug 5th, the US Senate Committee on Banking, Housing, and Urban Affairs held a hearing on Proposals to enhance the Regulation of Credit Rating Agencies.

Testifying were Michael S. Barr-U.S. Department of the Treasury, Professor John C. Coffee, Jr.-Columbia University Law School, Dr. Lawrence J. White-New York University ,Mr. Stephen W. Joynt-Fitch Ratings, Mr. James Gellert-Rapid Ratings, Mr. Mark Froeba-PF2 Securities Evaluations, Inc.

The testimony is summarized below and copies of the written statements are available at;
http://banking.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=89e91cf4-71e2-406d-a416-0e391f4f52b0

Credit Rating Agency blamed for Financial Stress

In credit markets, borrowers often know more than lenders. While lenders may buy a portion of debt issued, borrowers often issue debt to many borrowers. Thus, rating agencies are traditionally assumed to address this information asymmetry. They help lenders evaluate the credit worthiness of borrowers. However, many researches show that investors’ over reliance on these rating agencies causes financial stress. These researchers believe that a severe conflict of interest and lack of transparency in the rating process led to overly optimistic ratings. A wave of sudden CDO downgrades in July 2007 not only led investors to lose confidence in rating agencies but also led to an increase in risk aversion and to low liquidity afterwards.

Conflicts of interest and a lack of transparency have led to increased Corporate Governance risk, a key factor socially responsible investors examine. Due diligence issues, accountability and liability factors aroused a lot of debate at the hearing. In highlights from the testimony, we will see how the administration proposes to regulate credit rating agency and gain different perspectives on the proposal.

Highlights from Testimony:
Senators’ Support for the Proposal

Most Senators think reform is necessary. “I strongly believe that the credit rating agencies played a pivotal role in the collapse of our financial markets. Any regulatory reform effort must take that into consideration,” said Senator Shelby.

The Senators agree to give SEC more authority to regulate disclosures and conflicts of interest, as well as unfair and abusive practices. However, the agreement between the Senators and the Administration is not a coincidence. Before the Administration’s proposal was submitted, the Banking Committee proposed and helped passed the Credit Rating Agency Reform Act of 2006. The act gives the SEC more authority to regulate credit rating agencies. According to the Assistant Secretary’s testimony, “This Committee, under the leadership of Senator Shelby, Senator Dodd and others, took strong steps to improve regulation of rating agencies in 2006. That legislation succeeded in increasing competition in the industry, in giving much more explicit authority to the SEC to require agencies to manage and disclose conflicts of interest, and helping ensure the existence and compliance with internal controls by the agencies.”

Industry’s Perspective on the Proposal
On the other hand, from an industry perspective, many disagree with key points in the proposal. They do not believe that due diligence and greater liability should be the responsibility of credit rating agencies.

“In that regard, we support the concept that issuers and underwriters ought to be required to conduct rigorous due diligence on the underlying assets that comprise asset backed and mortgage backed securities….. Congress ought not to hold rating agencies responsible for such due diligence or for requiring that others do it,” said Stephen W. Joynt, President and Chief Executive Officer, Fitch Ratings. “Unlike other gatekeepers, the credit rating agencies do not perform due diligence or make its performance a precondition of their ratings. In contrast, accountants are, quite literally, bean counters who do conduct audits,” said Professor John C. Coffee, Jr.
,Professor of Law Columbia University Law School.

Both industry and academic perspectives point out that rating agency should not be held to a standard that might lead to greater credit rating agency liability. “A credit rating is an opinion about future events – the likelihood that an issue or issuer will meet its credit obligations as they come due. Imposing a specific liability standard for failing to accurately predict the future in every case strikes us as an unwise approach,” said Mr. Joynt. “Also, Professor Coffee maintained that”We have to face the simple reality that the rating agencies have a built-in bias: they are a watchdog paid by the entities they are expected to watch. “

Thursday, March 5, 2009

SEC to Discuss Rules Governing Credit-Rating Agencies

According to the Washington Post, "The Securities and Exchange Commission is planning to announce Thursday it will hold a roundtable to discuss how to revamp the rules governing credit-rating agencies, according to people familiar with the matter.

This would be the first step toward addressing problems in the industry and the first public policy initiative taken by new SEC Chairman Mary L. Schapiro since she started at the commission.

Schapiro has raised concerns about credit-rating agencies, which are private firms that have been blessed by the SEC to judge the credit-worthiness of securities. Credit-rating firms gave high grades to many of the mortgage-related securities that turned out to be toxic and have wreaked havoc in the financial crisis.

The roundtable is scheduled for April 15. The three major credit- raters, including -- Standard & Poor's, Fitch Ratings and Moody's, -- and others have been invited to speak.

Schapiro has criticized the way credit-rating firms are paid. Currently, the issuers of securities pay the firms to rate them, which Schapiro has called a conflict-of -interest. She has said it might be better for financial firms to contribute to a pot of money that would be used to pay for calculating ratings."

Wednesday, December 3, 2008

SEC Approves Measures to Strengthen Oversight of Credit Rating Agencies

The SEC today "approved a series of measures to increase transparency and accountability at credit rating agencies, and ensure that firms provide more meaningful ratings and greater disclosure to investors.

The new measures impose additional requirements on credit rating agencies, whose ratings of residential mortgage-backed securities backed by subprime mortgage loans and of collateralized debt obligations linked to subprime loans contributed to the recent turmoil in the credit markets. The SEC also proposed additional measures related to transparency and competition concerning credit rating agencies."

We think these reforms are important first steps, and are mindful of the fact that politics and regulation are the "art of the possible."

As we said in 2005, fradulent practices by credit rating agencies

"threaten the integrity of securities markets. Individuals and market institutions with the power to safeguard the system, including investment analysts and NRSRO’s, have been compromised. Few efficient, effective and just safeguards are in place. Statistical models created by the firm show the probability of system-wide market failure has increased markedly over the past eight years. Investors and the public are at risk."

See http://www.sec.gov/rules/proposed/s70405/wcunningham9442.pdf

Thursday, October 23, 2008

Credit Agencies grilled on the Hill (Tian Weng)

Members of Congress held the third in a series of hearings on the financial crisis titled “Credit Rating Agencies and the Financial Crisis.” The hearing, held on Wednesday in 2154 Rayburn House Office Building, examined the roles and responsibilities of credit rating agencies in the current financial turmoil. Top credit rating agency executives also testified before the House Committee on Oversight and Government Reform.

In his opening statement, Committee Chairman Henry Waxman briefly outlined the sequence of events which lead to today’s crises. “The story of the credit rating agencies is a story of colossal failure,” Mr. Waxman said. He pointed out that leading credit rating agencies are essential financial gatekeepers. However, the agencies assigned triple-A ratings to securities and CDOs backed by risky subprime mortgage loans. As a result, the entire financial system is now at risk.

The three largest credit rating agencies - Standard & Poor’s, Moody’s, and Fitch Ratings control over 90% of rating market. They contributed substantially to the financial crisis by failing to warn investors of risk. They cannot evade their responsibility. The three current executives of the leading rating agencies were subject to major criticism:

Unsound rating and model failure. Undoubtedly, ratings are key. The methodologies used for rating CDOs are complex, arbitrary, and opaque. Credit rating agencies rely primarily on quantitative models to develop these ratings. However, these quantitative models cannot accurately reflect the specific credit characteristics of a particular security or issuer. A number of the assumptions they used were not realistic. A representative questioned agencies’ rating methodologies and assumptions because the CDO model seemed far from capable of capturing true risk. The witnesses responded that the business model they were using failed and definitely needed adjustments, but they explained the models were very complex, and hence had to go through several empirical tests. A Democrat read a message from an unnamed S&P's employee: “We rate every deal. It could be structured by cows and we would rate it.” Mr. Egan, Managing Director of another rating agency, admitted that’s ridiculous. “If you don’t understand it, then don’t rate it.” He said.

Fraud. There is an inherent conflict of interest in the industry. Agencies were paid by bond issuers whose debt they were rating instead of by investors who use and trust their ratings. This inhibits agencies from providing accurate and honest ratings. Someone posted questions to executives, “Investment banks got high ratings. Credit Agencies got investment banks’ fees. What did investors/taxpayers get?” Another Democrat cited profit charts of big agencies to strengthen her argument. It showed that S&P’s revenue from US RMBS and CDOs ratings drastically increased, by 25% to 35% as a percentage of total rating revenue, since 2002. Moody’s revenue from structured financial transactions skyrocketed over the same time period. Hence, it is clear that profits play a huge role in rating. But the three executives of credit agencies denied that conflicts of interest had impaired their judgment on mortgage securities. Mr. Fons, former executive of Moody’s, claimed that the analysts took their responsibilities seriously and demonstrated high moral character.

Another concern addressed was next steps going forward to ensure a crisis like this would not happen again. Efforts are needed to restore faith in the system. Rating Agency executives acknowledged that their companies' reputations had been harmed. Nevertheless, they expressed their fervent belief that substantive reforms can restore the integrity and stature of the bond rating industry.

(Tian Weng,
Master of Economics' 09
George Washington University)