Top members of the House Financial Services Committee have sent a letter to SEC Chairman Christopher Cox asking him to launch an investigation into Moody's Investors Service after reports disclosed it made a massive error in rating certain debt obligations and failed to correct the mistake for more than a year. The lawmakers raised concerns after the Financial Times reported that Moody's had incorrectly assigned triple-A ratings on a certain credit derivative known as a constant proportion debt obligation. While Moody's discovered the error in February 2007, right after issuing the securities, it failed to change the rating for more than a year, according to the report.
"The credit rating industry's reputation has suffered -- deservedly, many believe -- because of its failure to accurately assess mortgage market risk. The credit crisis will continue as long as investors, particularly those seeking to purchase structured products, lack the confidence in the rating agencies' ability to accurately assess credit risk," wrote House Financial Services Chairman Barney Frank and ranking member Spencer Bachus in a letter, which was signed by Capital Markets Subcommittee Chairman Paul Kanjorski, D-Pa., and ranking member Deborah Pryce, R-Ohio. "Moody's alleged conduct in this matter raises questions not only about its competence, but more importantly its integrity. The Commission must quickly examine this matter and sanction any rating agency for any wrongful conduct it has committed."
The four asked Cox whether Moody's violated a 2006 law that forced firms to detail their ratings procedures and their organizational structures, disclose conflicts of interest and institute ethics codes. Lawmakers were spurred to enact the 2006 law after major firms such as Moody's and Standard & Poor's were slow to spot the accounting scandals at Enron in 2001 and WorldCom in 2002, waiting months before downgrading both companies even as their stock prices plummeted. They have come under criticism after they rated thousands of mortgage-backed securities as investment grade, which were later downgraded as those loans turned out to be faulty because they were predatory or made without any documentation required by the borrower.
The SEC is conducting a review of the industry's role in the subprime mortgage crisis, while Congress is again ramping up its oversight of the industry. Some lawmakers, such as Sen. Charles Schumer, D-N.Y., have suggested that they want to examine the industry's fee structure. Most firms take fees from the companies they rate, raising the prospect of a conflict of interest because analysts could be under pressure to provide a good rating on a product when millions of dollars are at stake. Frank said today his panel would take a look at the industry, but would likely dig deeper into the issue next year. "Clearly something has got to be done by the ratings agencies. At this point we're more clear about what the problem is rather than the solution. What do you get with changing the pricing model? I don't know yet," Frank said.
This article appears in the May 24, 2008 edition of National Journal Daily PM Update.