Ratings Agencies: Moodys, S&P, and Fitch (ORIGINAL)


Far from being objective arbiters of the credit worthiness of debt instruments, the three major agencies – Standard & Poors, Moody’s, and Fitch Ratings – conducted a form of “payola.” They were willing to play along, putting triple-A ratings on paper that turned out to be junk — if the price was right. Call it “pay for play.” Working closely with underwriters, they frequently rated paper AA and AAA that would (and will) eventually be revealed as near worthless. (In the spirit of full disclosure: Standard & Poor’s is a unit of The McGraw-Hill Companies, Inc., publisher of this book)

These three rating agencies were the key enablers in the housing crisis and the subprime debacle. They were the Pimps to the fixed-income fund managers’ Johns. The investment banks whored out junk paper, and the ratings agencies were extremely well compensated for their role in helping to create the entire subprime fiasco. But for their imprimatur of triple-A respectability on garbage paper, it could not have danced its way onto the laps of so many drooling buyers.

Considering the massive damage they are directly responsible for, the rating agenices have escaped relatively unscathed. Their reputation may be dinged, and their stock prices are down with the rest of the market. However, given their key role — were they corrupt, grossly incompetent, or both? — one might have thought an Arthur Anderson-like demise was a distinct possibility. Warren Buffett should consider himself lucky — he is Moody’s biggest shareholder, and is fortunate that the scandal hasn’t tarnished his reputation.

Jesse Eisinger was one of the first to call out the three ratings agencies for their role in the financial meltdown. In August 2007, Eisinger wrote wrote in Portfolio:

“The ratings agencies have had a bigger role in the subprime-mortgage meltdown than most people know. So far, irate investors have focused on—and upcoming congressional hearings and investigations will probe—the agencies’ overly optimistic ratings for packages of subprime mortgages, many of which are now blowing up. It’s becoming clear that the ratings agencies were far from passive raters, particularly when it came to housing bonds. With these, the agencies were integral to the process, and that could give regulators and critics the ammunition they’ve been looking for to finally force the Big Three to change. The credit-ratings agencies “made the market. Nobody would have been able to sell these bonds without the ratings,” says Ohio attorney general Marc Dann, who is investigating the agencies for possibly aiding and abetting mortgage fraud. “That relationship was never disclosed to anybody.” 22

Eventually, The Wall Street Journal, The New York Times and Bloomberg all caught on to the payola scam. For the longest time, the ratings agencies escaped blame. No more: In 2008, the Senate’s Permanent Subcommittee on Investigations opened a probe into the role of the bond-ratings agencies in the credit crisis.

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