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Credit Ratings Agencies

McGraw Hill Spikes Book That Slammed Credit Ratings Agency It Owns

Zachary Roth | February 11, 2009, 3:04PM

Did McGraw Hill pull out of a book deal with a top financial blogger because it looked like the book would be critical of Standard & Poor's, the credit ratings agency owned by McGraw?

Portfolio reports that the publisher has dropped Barry Ritholtz's Bailout Nation. And Ritholtz -- a TPM friend and investment expert who runs an institutional research firm -- claims it's because he ripped S&P.

The major credit ratings agencies, S&P perhaps foremost among them, have been widely criticized (by TPMmuckraker, no less) for helping to enable the financial crisis, by sticking grade A ratings on toxic mortgage assets -- a move which pleased the investment banks, who are the ratings agencies' customers.

Ritholtz wrote in his original manuscript that the ratings agencies "conducted a form of 'payola.' "

He continued:

These three rating agencies were the key enablers in the housing crisis and the subprime debacle. They were the pimps to the fixed-income fund managers' johns. The investment banks whored out junk paper, and the ratings agencies were extremely well compensated for their role in helping to create the entire subprime fiasco. But for their imprimatur of triple-A respectability on garbage paper, it could not have danced its way onto the laps of so many drooling buyers.

When McGraw Hill complained, the writer agreed to take out that passage. But, according to Ritholtz, the publisher still wasn't happy, saying it couldn't verify his assertions -- a rationale Ritholtz, speaking to Portfolio, rejects as a manufactured excuse. The book's general take remained critical of the ratings agencies.

In a post on the blog The Big Picture, Ritholtz offers more details about the sequence of events, and claims that the contract he signed with McGraw gave him final edit rights.

He also adds that over the summer, a McGraw Hill publisher told him that the section on the ratings agencies would have to be handled "delicately and diplomatically."

In any case, the deal ultimately fell apart -- and the notion that it was because McGraw Hill couldn't stomach Ritholtz's frank criticism of S&P is tough to shake.

Portfolio adds the publisher's side:

McGraw Hill spokesman Steven Weiss this afternoon said the publisher dropped the book because of a conflict with Ritholtz over editing, not because of his criticism of S&P. "The material needed extensive corroboration across a range of topics. We could not agree on unified approach with the author for resolving the issues," Weiss said. He denied that the publisher dropped the book because of what Ritholtz had written about S&P. "It is simply not true," Weiss said. "We have a range of editorial entities that often report critically about the company and we support and encourage their independent voices."

Ritholtz told Portfolio that other publishers are interested in Bailout Nation. So we may even get to see the full unedited version of the book.

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Topics: Bailout, Credit Ratings Agencies, Financial Crisis, Wall Street

Bailout

New Rules For Credit Ratings Agencies

Zachary Roth | December 3, 2008, 2:01PM

We told you last month about the under-reported role of the credit ratings agencies in helping to cause the financial crisis. The problem, in a nutshell, is that the major ratings agencies -- Moody's, Standard & Poor's, and Fitch -- are paid by the insurers (often investment banks) who are issuing the bonds. That gives the agencies a clear incentive to produce favorable ratings, or risk seeing the banks hire a different ratings agency that's willing to offer a better rating.

So it's worth noting that the Securities and Exchange Commission today adopted new rules designed to protect against that conflict of interest.

The Associated Press has the rundown on the new rules:

Among other things, the conflict-of-interest rules ban the rating agencies from advising investment banks on how to package securities to secure favorable ratings. Gifts over $25 from clients also will be prohibited.

Rating agencies will be banned from making ratings in cases where the agency made recommendations to the company issuing securities or the investment bank underwriting them concerning the corporate structure, assets or activities of the issuing company.

In addition, rating agencies will be required to disclose statistics on all their upgrades and downgrades for each asset type. They also will have to disclose how much verification they performed on the quality of complex securities, such as those underpinned by mortgages, student loans or auto loans, in determining ratings for them.

Investors will receive detailed information on the ratings process for complex securities, thereby exposing potential conflicts of interest for the agencies, SEC officials said.

The SEC commissioners also voted to propose and open to public comment other rules that would require rating agencies to disclose in interactive electronic format the ratings history information for all of their assessments that companies issuing the securities pay them to do.

But the AP adds that the rules don't go far enough for some critics of the agencies, who want "new requirements to govern how the rating agencies are paid and to provide for the suspension of their licenses if they engage in unfair practices."

The Senate investigations committee has launched a probe of the ratings agencies. And we're going to be doing our own digging, so you'll hear more on this...

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Topics: Bailout, Credit Ratings Agencies

Credit Ratings Agencies

Senate To Probe Ratings Agencies

Zachary Roth | November 20, 2008, 10:36AM

Yesterday we told you about the key role of the credit ratings agencies in helping to trigger the current financial crisis.

And today, the Wall Street Journal reports that a probe by the Senate's Permanent Subcommittee on Investigations will focus in part on that very subject.

As we explained, the leading ratings agencies -- Moody's, Standard and Poor's, and Fitch -- are paid by the banks whose securities they rate, creating a clear incentive for them to inflate their ratings.

The Senate investigation is expected to go more deeply into the problem than did hearings held last month by Rep. Henry Waxman's House Oversight Committee.

Norm Coleman, the subcommittee's ranking Republican, who will lead the portion of the investigation focusing on the ratings agencies, told the Journal: "We're going to look at the root causes of this, looking at whether the inherent conflict clouded the judgment of the agencies. Somebody missed something here. Was it because of the complexity or was it in the zeal to make money?"

The SEC, as well as New York Attorney General Andrew Cuomo, are already looking into the agencies. An SEC report released in July found "serious shortcomings" in their practices.

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Topics: Credit Ratings Agencies

Bailout

"It Could Be Structured By Cows And We Would Rate It": How The Ratings Agencies Helped Cause The Financial Crisis.

Zachary Roth | November 19, 2008, 5:43PM

This morning, reports the Wall Street Journal, credit ratings agency Standard & Poor's sharply downgraded its rating for bond insurer Ambac Financial, anticipating that the company's debt obligations would continue to absorb losses.

Why should we care?

Because this seemingly mundane piece of financial news offers a window into one of the crucial -- and often under-covered -- causes of the financial crisis currently shaking Washington and the country: the role of the credit ratings agencies. And inside that wider crisis, as we'll be making clear in the coming weeks, there's perhaps as much muck, both personal and institutional, as anything the Bush administration has given us over the last eight years.

First, a very quick and dirty rundown of the issue:

The banks and insurers felled by the collapse of the housing market relied on the three major credit ratings agencies -- S&P, Moody's, and Fitch -- to rate the mortgage-backed securities that they offered to investors. But here's the problem: the ratings agencies are paid for their work by the very banks and insurers for whom they're producing ratings. If the banks don't like the rating they receive from one ratings agency, they can simply go to another agency that's willing to produce a more favorable score -- what's known as "ratings shopping."

As a result, the agencies have an obvious incentive to knowingly inflate their ratings -- and sometimes even to rate junk securities that shouldn't even get a rating at all. And since many of these securities turned out to be all but worthless pools of home-loan mortgages, that's exactly what the ratings agencies often did.

Internal agency documents released last month as part of an investigation by Rep. Henry Waxman's House Oversight and Government Reform Committee show that at least some ratings analysts were aware that their ratings were more about increasing their company's bottom line than accurately gauging the value of the securities at issue.

Here's one IM exchange from April 2007, between two S&P analysts, reported last month by the Wall Street Journal --:

Rahul Dilip Shah: btw -- that deal is ridiculous.
Shannon Mooney: I know right ... model def does not capture half of the risk
Shah: we should not be rating it.
Mooney: it could be structured by cows and we would rate it.

And in a 2007 presentation to directors, Moody's CEO Raymond McDaniel wrote:

Analysts and MDs [managing directors] are continually 'pitched' by bankers, issuers, investors -- all with reasonable arguments -- whose views can color credit judgment, sometimes improving it, other times degrading it (we 'drink the kool-aid'). Coupled with strong internal emphasis on market share & margin focus, this does constitute a 'risk' to ratings quality.

At a hearing he held on the issue, Waxman himself quoted another S&P analyst asserting:

Rating agencies continue to create an ever-bigger monster, the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters.

The ratings agencies are now being forced by events to at last downgrade some of these securities -- hence today's news about S&P's belated move to downgrade Ambac, which sent the company's stock plummeting.

Indeed, this same dynamic preceded the collapse of insurance giant AIG in September. Until the 15th of that month, S&P had rated its unsecured debt at AA minus, far above what it merited given the value of the underlying mortgages -- leading investors to see AIG as a secure bet. When, on that day, S&P suddenly and severely cut their rating to bring it into line with reality, the company was required to post $14 billion to comply with the terms of the credit default swap agreements they had entered into. That was $14 billion AIG didn't have, and all of a sudden, U.S. taxpayers were on the hook.

It doesn't have to be this way. Sean Egan is a founder of Egan-Jones, an independent ratings agency that's paid not by insurers, but by investors. In testimony before Waxman's committee, and again in an interview with TPMmuckraker, Egan emphasized that -- despite the apparent personal corruption of individual analysts and senior management at the agencies -- the only way to fix the problem is for the federal government to take steps to re-align the system of incentives that prevails on the agencies. If they're rewarded for giving investors an accurate picture of the value of securities, they'll be likely to do so. If not, they'll keep pumping up their ratings to please the banks. And soon enough, a new house of cards will rise and fall.