Senate chairman calls for tighter rein on credit rating agencies

By Daniel Wagner
Associated Press / April 24, 2010

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WASHINGTON — Lawmakers rewriting financial regulations took aim yesterday at credit rating agencies, whose analysts often gave safe ratings to risky investments that fueled the financial crisis.

Senator Carl Levin, a Democrat from Michigan, said the Senate’s regulatory overhaul should go further to curb the industry’s inherent conflicts of interest: The agencies are paid by the banks whose investments they rate. Banks generally want higher ratings to make the securities they offer more attractive to investors.

At a hearing Levin chaired yesterday, former executives acknowledged that competition within the industry often led the agencies’ analysts to rate high-risk securities as safe.

Levin suggested the co-dependent relationship between the agencies and the banks is a dangerous flaw in the financial system. He offered an analogy: “It’s like one of the parties in court paying the judge’s salary.’’

Levin was chairing a hearing of the Permanent Subcommittee on Investigations, which has been examining the causes of the financial crisis.

The Senate next week is expected to take up a version of the financial regulatory legislation that would require only a study of the industry’s conflicts of interest. A House-passed bill would go further. It would instruct the Securities and Exchange Commission to produce a policy that would either bar the conflicts or require the agencies to disclose their relationships with banks.

Levin wants the Senate bill to move closer to the House approach.

In a report Thursday, Levin’s panel said the agencies kept ratings too high in the run-up to the crisis even though they knew mortgage fraud and subprime loans were leading more homeowners to default.

The agencies finally began responding in 2006 by downgrading some securities, the report said. The downgrades accelerated in 2007. The mass downgrades by the agencies were the single greatest trigger of the financial crisis, Levin said.

Former executives of Moody’s and Standard & Poor’s testified that pressure from competitors and management pushed their analysts to award safe ratings to risky investments.

Frank Raiter, a former managing director for Standard & Poor’s, said management placed increasing pressure on analysts to earn fees by attracting business from banks. He said some analysts had tried to persuade management to lower ratings on some securities as the housing market became distressed. But he said those analysts were told “revenues would go down.’’

Raiter said analysts felt they faced a choice: Keep giving inflated ratings or quit their jobs.

Both the House and Senate bills would force credit raters to register with the SEC. Both would allow investors to sue the agencies for assigning recklessly assigning high ratings. And both would require the agencies to share more information about how they determine ratings and how accurate they have proved over time. In the Senate version, agencies with poor track records could lose their SEC registrations.