Rating Agencies Agree to Changes
Friday, June 6, 2008
NEW YORK, June 5 -- Wall Street's three major credit-rating agencies reached an agreement Thursday with the New York state attorney general's office to change the way they evaluate mortgage securities that have roiled financial markets for the past year.
The deal with Moody's Investors Service, Standard & Poor's and Fitch Ratings aims to restore confidence among investors -- who saw top-rated securities lose much of their worth in a matter of months -- by revising how the agencies are paid for issuing ratings. The agreement also requires credit-rating agencies to direct investment banks to provide them with more data on the pools of mortgages that make up the bonds.
The agencies have been under fire for the role they played in the subprime mortgage crisis by awarding top ratings to securities that soured. Regulators and investors have alleged that the agencies have a conflict of interest because they are paid by the investment banks issuing the securities, thus encouraging the credit agencies to give high ratings to win business.
The agreement seeks to end this practice by having the issuers pay the credit-rating agencies at four points during the rating process, not just at the end when the rating is given.
Credit-rating agencies will also be required to disclose information about all securities submitted for review, allowing investors to determine whether issuers sought, but subsequently decided not to use, ratings from a specific agency. This will allow investors to see whether investment banks shopped around for the agency that would give their securities the best rating, said Andrew M. Cuomo, New York's attorney general.
In addition, the agencies are to establish criteria for reviewing individual mortgage lenders and their mortgage-underwriting processes. The evaluation of the lenders will be posted online.
"The mortgage crisis currently facing this nation was caused in part by misrepresentations and misunderstanding of the true value of mortgage securities," Cuomo said in a statement. "By increasing the independence of the rating agencies, ensuring they get adequate information to make their ratings, and increasing industry-wide transparency, these reforms will address one of the central causes of that collapse."
The changes are to be put in place over the next six months. The agreement ends a months-long investigation by Cuomo's office into the credit-rating industry. Under the agreement, the rating agencies will cooperate with the attorney general's ongoing investigations into various players in the mortgage industry, including large Wall Street investment banks that packaged and sold mortgage securities to investors around the world. The agencies will not be required to pay a fine under the agreement.
The agencies are still subject to lawsuits and other investigations, including one by the Securities and Exchange Commission. The SEC is scheduled to meet next week to propose its own set of changes.
Critics panned the changes announced Thursday as little more than window dressing, saying that merely tweaking the pay structure does not remove the fundamental conflict of interest.
These critics also faulted a move Thursday by Standard & Poor's to strip the troubled bond insurance units of MBIA and Ambac Financial Group of their coveted AAA ratings, saying it came much too late. Moody's said a day earlier that it was considering downgrading the bond insurers. Fitch Ratings downgraded both MBIA and Ambac to AA earlier this year.
The AAA rating is critical for bond insurers, who are paid to guarantee bonds by local governments and other institutions. The insurance essentially transfers MBIA and Ambac's top ratings to the bonds they insure. A downgrade in the financial strength of the bond insurers would mean that much of the billions of dollars in securities they guarantee would also be downgraded. That could also raise the cost of borrowing for a variety of public projects, such as schools, roads and parks.