Hearing of the Senate Banking, Housing and Urban Affairs Committee - Turmoil in U.S. Credit Markets: The Role of the Credit Rating Agencies

Interview

Hearing of the Senate Banking, Housing and Urban Affairs Committee - Turmoil in U.S. Credit Markets: The Role of the Credit Rating Agencies

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SEN. CHARLES SCHUMER (D-NY): Well, thank you, Mr. Chairman.

I very much appreciate the opportunity to have this hearing and very much appreciate your being here.

And I think it's appropriate, because at least to me, credit agencies were the weak link in the subprime crisis. They, along with mortgage brokers, are probably more at the center of this than just about anybody else.

And incidentally -- at least until we passed our legislation, and much of the action occurred before that -- neither the mortgage brokers nor the credit rating agencies had any real regulation at all. And so it's difficult to ask the SEC -- they now have regulation and we've met and talked about it. They have the ability to look at things like conflict of interest, but they didn't back then.

Second -- so, to me, the credit rating agencies are at the heart of this problem, and we need to do a thorough examination of what's happening. That's why I appreciate you, Mr. Chairman and the ranking member being so interested in this issue -- which he was when he was chairman, as well, as well as Senator Reed.

Second, I really regret that the heads of -- I want to commend Fitch's for sending their CEO, but where are the heads of Moody's and Standard and Poor's? The bottom line, this is really serious stuff. The whole world is focused on this. And for the CEOs not to come is very disappointing. They should be here.

And particularly they should be here because I met with the CEO of Moody's awhile ago and I asked him, did Moody's do anything wrong, and he said, no. I'd like to know if he still believes that. He said, no, they did nothing wrong. I was incredulous. And so, again, I think the credit rating agencies really have an obligation to send their leaders and to find out what happened, and what's going on here. And I want to register my disappointment.

Third, to me, the nub of this problem is conflict of interest. Obviously, when you're paying for a rating there's an inherent conflict of interest. And that has to change. And there was a story in the Wall Street Journal, which I'd just ask unanimous consent to put into the record --

SEN. DODD: It will be in --

SEN. SCHUMER: -- of April 11th, that just documented one instance of a conflict where analysts were changed because people didn't like the rating agency. Here's -- here's a quote from the article, "On occasion, Moody's agreed to switch analysts on deals after bankers complained." And another quote, "There was rather a palpable erosion of institutional support for rating analysis that threatened market share;" "Moody's decided they'd increase market share in this area, and their standards declined at the same time."

Conflict is inherent sometimes. And, look, sometimes there are legitimate reasons to complain -- you didn't take this into account. There has to be a dialogue between the agency and the issuer. But, disclosure is key.

And I asked you, Mr. Chairman, when we met, would you make sure that this is all disclosed -- when an analysis was changed after complaint, or if a rater was switched -- that should be known. Again, you can't say that the issuer can never complain -- maybe they missed something, but at least disclosure would be a prophylactic. And the new legislation that we supported -- and Chairman Shelby shepherded through this Congress, allows for that disclosure, and we eagerly await the regulations that you will have.

One final point I'd make here. For somebody to say nothing is wrong, here's the nub of it: How did no-doc loans -- loans with no documentation, that were parts of these packages, get Triple-A ratings? Now, when you ask the credit rating agencies, how did no-doc loans deserve Triple-A ratings, they said, well -- not them, but the people now analyzing, say, well, they thought housing would go up no matter what. And so, therefore, it didn't matter if the guy couldn't repay. So, you didn't have to look at the loan.

Well, maybe they should have paid one of us. We could have told them housing prices would go up forever; we didn't need to do any analysis either -- or somebody, or the guy on the street. So, something is really wrong here. Something is really wrong. I know some of it has been self-corrected already, but there has to be more to be done, and this hearing is a very constructive step along that path, and I thank you for holding it, Mr. Chairman.

SEN. DODD: Thank you very much, Senator.

We invited the CEO --

SEN. SCHUMER: (Off mike.)

SEN. DODD: -- today is their shareholder meeting there, and so he -- we could maybe schedule this another time. I didn't know it about the time. And he's -- let us know he would have been here but for that presiding over the shareholder meeting. And Moody's, anyway, I want to give them a -- at least include that in the record.

SEN. SCHUMER: Well, I'd like an opportunity for them maybe to come back at some point, if we have time, either --

SEN. DODD: No, no. Very good --

SEN. SCHUMER: -- at the committee or subcommittee level.

SEN. DODD: -- a very good point.

Senator Tester.

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SEN. SCHUMER: Thank you, Mr. Chairman.

And thank you. I'm sorry that I couldn't be here for the testimony. But I have a few questions based -- some are based on our discussions that we had, which I want to again reiterate: I appreciate your coming to my office and briefing me on these ahead of time.

Now, we all know now that the SEC has stronger oversight authority over the agencies since the legislation that Senator Shelby, Senator Dodd and others of us endorsed is now the law. And so you've had examiners at the firms. And my focus is on the conflict of interest issue.

I know your investigations are ongoing. But can you just give us a sense of what you've found regarding the agencies compliance with their stated procedures intended to control conflicts?

In other words, the article here that I referred to earlier -- which I found a very good job -- seems to indicate that before you were given authority, that there were conflicts and nobody paid much attention to them within the credit rating agencies themselves. Is it getting better? Do they have their own controls? Does some little buzzer go off when a supervisor wants to change the person on the job, because he's not giving or she's not giving as a good a rating?

Tell me -- I'm not asking for any specific investigation about a specific agency. I'm asking in general: How good are the agencies at uncovering these conflicts, now that it's against the law to do -- you know, now that these conflicts are against the law?

MR. COX: Well, I feel very confident in saying that it's better. It's better for obvious reasons. There is so much focus on this right now and so much has gone wrong, that many have reacted with alarm and there's a lot of attention being paid to it.

We have, in the course of our examination thus far, found examples of apparent failure to adequately manage conflicts of interest and some -- (inaudible) -- instances have even occurred this year.

SEN. SCHUMER: So it would be better, but there are still lapses -- even after all the focus on credit rating agencies. Is that a fair way to put it?

MR. COX: That's a fair way to put it.

SEN. SCHUMER: And what are you doing when you find these lapses?

MR. COX: Well, of course, we're in there with live bodies in real time, and so anything that's brought to our attention is dealt with on the spot. But in addition, we're going to make inferences based on our examination of the three largest firms and present those publicly, as well as to the firms, in early summer.

SEN. SCHUMER: Good. So we will learn about some of these lapses.

MR. COX: Yes.

SEN. SCHUMER: And that should be somewhat prophylactic as well.

MR. COX: That's correct.

SEN. SCHUMER: In terms of preventing them from doing it again.

Is it that the agencies don't want to, or is it just so embedded in their culture? You know, this article points out when new management came in at Moody's, the whole world changed, because they wanted to increase market share in something that ended up being risky, although probably wasn't thought to be risky at the time.

When you go to the higher-ups in the firms, do they want to change? Do they want to get rid of these conflicts of interest? Or do they say, hey, we'll lose business. We better be careful and not do it so fast?

MR. COX: What I -- Senator, if you have -- as I have -- met with the leaders of these firms, and they certainly express a strong desire to deal with these problems and take them seriously. I think the only proof, however, is going to be in the pudding.

SEN. SCHUMER: Right. And they're not there yet.

Okay. One other question related to this -- and I thank you, Mr. Chairman.

People have questioned the agency's reliance on information supplied by the issuer to determine their ratings. You know, I guess the average person -- maybe even the average investor -- feels that the credit rating agencies don't just take the information that's given, but go investigate and see if it's for real, because obviously, the issuer's going to put their best foot forward. Have you found -- shouldn't there be some disclosure or -- on the amount or the lack thereof of the due diligence that is performed on a bond?

MR. COX: Yes.

SEN. SCHUMER: In other words, if they didn't investigate it -- if it has another no-doc loan in some other area -- they should say that clearly: This has no documentation and we didn't investigate it; or it has documentation and we didn't investigate it; or we -- you know what I'm saying.

MR. COX: Yes. That's an important subject for disclosure. It's one that I mentioned in my testimony that I think may well be covered in our proposed rules.

SEN. SCHUMER: Right.

Now, let ask you this: Do you think -- this is again, based on that article, which I guess you might think from my testimony I'm obsessed with, which I'm not -- but do you think that -- (laughs) -- it's just a good article, that's all.

Do you -- (laughter). I did put it in the record in my opening statement, Mr. Ranking Member! (Laughs.) Good.

Do you think significant changes in market share should automatically trigger enhanced scrutiny by the SEC over the rating agency activity? If all the sudden they rated 20 percent of these bonds, and now they're getting 70 percent in a year, something's up. What do you think of that idea?

MR. COX: Well, because you provided it to me, I've had a chance to read that article. And --

SEN. SCHUMER: Oh, there you go! (Laughter.)

MR. COX: There is absolutely no question that that kind of red flag should be a guidepost for an examiner.

SEN. SCHUMER: Good. That's good to hear.

And what about other red flags, such as significant deviation in ratings performance from historic averages or significant analyst turnover? In other words, you may not have the specifics on this case, but you're seeing there's a lot of analysts that have been turned over lately. Should that also provide a similar red flag?

MR. COX: I think so. Obviously, the facts will inform in any particular examination where the examiners want to go. And I think over time, as the SEC develops more and more expertise in this, we will have either formally or informally a whole set of --

SEN. SCHUMER: And we can expect some of these in the proposed rules that you're going to put out this summer, I presume?

MR. COX: Yes. Although, what we're talking about right now is the kind of thing that examiners are going to look to.

SEN. SCHUMER: Right. Well, guidance to the examiners that might be made public. We're going to see concrete evidence of some of these things happening. And it'll be sort of out there publicly that you're doing it.

MR. COX: I --

SEN. SCHUMER: Not specifics. The general things I asked for.

MR. COX: I can undertake to do that, yes.

SEN. SCHUMER: Okay.

Mr. Chairman, thank you.

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SEN. SCHUMER: Mr. Chairman?

SEN. DODD: Yes.

SEN. SCHUMER: Just one question, if I might. I mean, there's an intermediate step. Senator Dodd's ideas are, as usual, intriguing. But do you think there's less conflict in the investor when the investor pays the agency as opposed to the issuer paying the agency? I mean, it's a conflict from the other side. It puts the premium on not AAA but maybe failing grade, you know, or it moves it one direction rather than the other is a better way to put it. But does one make more sense than the other? Should that be something that's seriously explored as well?

MR. COX: Well, I think they'd both make more sense in combination because each is a check against the other. And what your legislation has opened the door for now is relatively easy entry into the market for subscriber-based ratings.

SEN. SCHUMER: And there are a few.

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