Posted On: November 6, 2008

Moody’s, Standard & Poor's, and Fitch’s Assignment of High Credit Ratings to Mortgage-Backed Securities Contributed to the Financial Meltdown

At a hearing presided over by the House Oversight and Government Reform Committee in Washington DC, the executives of Moody’s, Standard & Poor's, and Fitch Ratings, the three top credit rating agencies in the country, were grilled about how their assignment of high ratings to mortgage-backed securities, while drastically underestimating their risks, contributed to the current financial crisis.

While the heads of the country’s three leading credit agencies—Standard and Poor’s Deven Sherman, Fitch Ratings’s Stephen W. Joynt, and Moody’s Raymond W. McDaniel—have called the mortgage-backed securities collapse “unprecedented” and “unanticipated and said that any errors the agencies' made were unintentional, internal documents reveal that the credit rating agencies knew that the ratings they were giving the securities were overvalued. It wasn’t until this past year, when homeowners began defaulting on subprime mortgages, that the credit ratings agencies began downgrading thousands of the securities.

Lawmakers are trying to determine whether the firms’ business model contributed to the conflicts of interests. Issuers pay the credit ratings agencies for evaluating securities. While the credit ratings agencies were giving mortgage-backed securities high ratings, the heads of the three leading credit agencies were earning $80 million in compensation.

At the hearing, former Moody’s credit policy managing director Jerome S. Fons testified that the agencies’ business model prevents analysts from placing investor interests before the firms’ interests. In one confidential document obtained by investigators, Moody’s CEO McDaniels is quoted as saying that bankers, investors and creditors regularly “pitched” the credit ratings agency. According to Frank L. Raiter, the former head of residential mortgage-backed securities ratings at Standard and Poor's, "Profits were running the show."

Investors depend on the credit rating agencies for independent evaluations. According to Congressman Waxman, the ratings agencies “broke this bond of trust,” while federal regulators failed to heed the red flags and protect investors.

Related Web Resources:

Credit Rating Agency Heads Grilled by Lawmakers, New York Times, October 22, 2008

Oversight Committee Hearing on Credit Rating Agencies and the Financial Crisis, Polfeeds.com, October 22, 2008

Committee on Oversight and Government Reform

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