In the months leading to the collapse of WorldCom Inc., its shares were in a nose-dive, traders were selling its bonds at junk levels and its chief executive was forced out. But not until investors lost several billion dollars did Congress and others begin to rivet attention to a little-known player in this unfolding drama: the credit raters.
WorldCom rose to prominence through voracious acquisitions, including the bold 1998 purchase of MCI, the District-based long-distance telephone company. And it couldn't have done it without the rating companies. WorldCom borrowed money through the sale of bonds, which the rating firms approved by giving them good grades, a signal that they were relatively safe investments.
As it turned out, nothing could have been further from the truth. But the rating firms were among the last to recognize it. It wasn't until weeks before WorldCom disclosed massive fraud and filed the biggest bankruptcy in U.S. history in 2002 that the credit raters finally cut the firm's debt to junk status.
The rating companies say they are not in the business of detecting fraud; rather, they say they give an opinion of the creditworthiness of a company, municipality or nation. But some critics say the WorldCom case highlights a broader problem: that the world's big three credit raters -- Moody's Investors Service, Standard & Poor's and Fitch Ratings -- have become some of the most important gatekeepers in capitalism without the commensurate oversight or accountability.
From their Manhattan offices, they can, with the stroke of a pen, effectively add or subtract millions from a company's bottom line, rattle a city budget, shock the stock and bond markets and reroute international investment. Without their ratings, in many cases, factories can't expand, schools can't get built, highways can't be paved. Yet there is no formal structure for overseeing the credit raters, no one designated to take complaints about them, and no regulations about employee qualifications.
The big three ostensibly function as a disinterested priesthood. When a company, town or entire nation wants to borrow money by selling bonds, the market almost always requires that the rating companies bless the move by running a kind of credit check. Bonds they deem safe get a good rating. The higher the rating, the lower the interest rate the borrower must pay.
But at the heart of the increasingly profitable business is a conflict: The rating companies get the bulk of their revenue from the fees they charge to the very entities they are rating. Industry insiders say the desire of a rater to hold on to a paying client -- or recruit a new one -- at times has interfered with the objectivity of a rating.
Dozens of current and former rating officials, financial advisers and Wall Street traders and investors interviewed by The Washington Post say the rating system has proved vulnerable to subjective judgment, manipulation and pressure from borrowers. They say the big three are so dominant they can keep their rating processes secret, force clients to pay higher fees and fend off complaints about their mistakes.
Many of those interviewed declined to criticize the credit raters publicly, saying they did not want to anger those who hold so much sway over their financial fortunes.
Those who disagree with a rating have little recourse. Lawsuits generally have been unsuccessful because courts have upheld the rating companies' argument that they are publishers of opinions, like newspapers, and that their views are protected by the First Amendment.
With little public debate about the industry, the rating business has eluded a series of reforms that have been imposed on other parts of the U.S. financial system. For example, while hundreds of companies and institutions, such as the New York Stock Exchange, have eliminated potential conflicts on their boards, Moody's directors continue to serve on the boards of companies that also are Moody's clients. (Moody's officials say that their directors play no role in ratings decisions.)