Subcommittee On Capital Markets Hearing – The Role Of Credit Rating Agencies In The Structured Finance Market

Oct 2, 2007 | By

(27 September 2007)  Congressman Paul Kanjorski, Chairman, provided the opening remarks concerning the need to supervise credit rating agencies, such as Moodys, Fitch and Standard & Poor’s.  Specifically, the Subcommittee is examining ratings as they relate to mortgage-backed securities, which are pooled and packaged into collateral debt obligations.  While the role of the credit rating agencies is to rate the likelihood of defaults, many investors believe that the ratings are an indication of strength.  As a result of this misinformed belief, the rating agencies have created a subprime mortgage problem, with false high ratings attributed to the mortgage pools.

The Credit Based Agency Reform Act (“Act”) is now a year old, and Chairman Kanjorski indicated it may be time to review the Act.  Among other options, the Subcommittee is exploring policy options, requiring more disclosures by the rating agencies, instituting rotation of the agencies in assigning pools to be rated, altering the compensation method to the rating agencies, and mandating more public disclosures.

Mr. Sherman, Subcommittee Member, noted that another problem with the ratings of mortgage-backed instruments is the fact that the ratings are based upon past performances and do not look forward to future potentialities, such as the downturn in the housing market.

The Subcommittee then turned to the testimony of the panel of witnesses, consisting of consultants and members of two of the rating agencies.  The panel previously submitted written testimony to the Subcommittee, and each panel member was limited to a five-minute summary of his or her written testimony.

Mr. Mathis, a panelist, maintained that the failure to supervise the rating agencies brought about the collapse of the subprime market.  He made four (4) specific points in this regard:  (1) the subprime market is just the first of the failures; (2) the rating system is suffering from flaws of execution and lack of accountability; (3) Congress must review the rating agencies; and (4) to fix the inadequacies, a line must be drawn between those securities eligible for a rating designation and those securities which are too new to be rated.  Overall, Mr. Mathis emphasized the need for regulatory oversight of the rating organizations.

Admitted testimony, in support of the rating agencies, stated a need to educate the public as to what the ratings stand for, that is, that they are only an indication of the likelihood of default.  The agencies themselves have already changed the models they are using to rate mortgage-backed securities, and have in place mechanisms to review and reevaluate previously rated pools.  Additionally, the agencies separate the analysts from compensation issues to minimize potential conflicts of interest.

Mr. Mason, another panelist, labeled the agencies as pseudo-regulatory, since the government has mandated a rating of B+ or above for public pension investments.  As such, there must be more accountability by the rating agencies and review of the models used in the rating process.  Additionally, Mr. Mason advocated for more re-rating of the pools of mortgages following the initial rating.

Much discussion centered upon the concept of re-rating the pools and whether this would be meaningful.  Given that the original ratings are based on projections and models, these models were not created to take into account the actual performance history of the rated securities.

Chairman Kanjorski concluded the hearing by noting that the profit motive must be removed from the rating process.  Additionally, he noted that the rating agencies do not assume any of the risk involved with the securities.  Finally, he reiterated the need for more disclosures.

 

The above information is intended to be a general summary of the discussions that took place during hearing.  It is neither intended to provide specific analysis nor should it be relied upon in making individual business decisions, specific in nature.

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