Risk Mis-Assessment Agencies

No real surprises here. One of the reasons financial markets faltered is that ratings agencies fell down on the job, in large part due to the presence of incentives that worked against issuing low ratings:

Study Finds Flawed Practices at Ratings Firms, by Michael M. Grynbaum, Commentary, NY Times: The analyst at the credit ratings agency was blunt: “Let’s hope we are all wealthy and retired by the time this house of cards falters.”

That candid assessment, sent by e-mail to a colleague in December 2006, referred to the market for certain investments linked to subprime mortgages — investments that were assigned top AAA ratings from major agencies, only to later plummet in value.

That e-mail message and dozens like it were disclosed Tuesday in a blistering 37-page report issued by the Securities and Exchange Commission, which confirmed what many on Wall Street had long suspected: the major ratings firms, including Fitch, Moody’s and Standard & Poor’s, flouted conflict of interest guidelines and considered their own profits when rating securities, among other suspect practices.

The report represented a definitive dent in the aura of objectivity that has been cultivated for decades by ratings firms… The assumption was that the firms’ analysts — ostensibly disinterested types who assess the financial health of everything from states and cities to complex mortgages — offered a bias-free view of potential investments.

Instead, the S.E.C. found that the agencies had become overwhelmed by an increase in the volume and sophistication of the securities… Analysts … began to cut corners. …

The report also turned up evidence that ratings firms had run afoul of basic guidelines intended to avoid conflicts of interest. It is common practice for investment banks and other financial outfits to pay agencies to rate assets they will later sell. Agency regulations often require analysts … to remain unaware of any business interests involved with the products whose safety they are gauging.

The S.E.C. found that this was not always the case. … For example, in an e-mail message from November 2004, an analyst wrote that he was unsure of providing a particular rating because it could hurt revenue. …

The agencies also considered changing their ratings criteria to better compete with their rivals. …

The S.E.C. also found that the agencies did not sufficiently disclose or document changes to their ratings criteria. …

It was unclear whether the findings would lead to criminal charges against the agencies. … The findings from Tuesday’s report would have to be referred to the enforcement arm of the S.E.C. before any charges can be filed, a spokesman said.

Some states have already opened investigations into the agencies’ conduct. Last week, Moody’s acknowledged that some employees had gone astray of internal conduct codes. …


Originally published at Economist’s View and reproduced here with the author’s permission.Related RGE Content:1) Redrawing Wall Street Regulation: Fed May Extend Primary Dealer Credit Facility Into 2009, Seals Formal Oversight Agreement with SEC

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