Credit rating agencies have defended their risk-rating methodologies in hearings before both houses of the US Congress and insist that claims they exacerbated the subprime crisis are groundless.
Testifying before the Senate Banking and House Financial Services Committees, representatives from Moody’s and Standard & Poor’s rejected claims that the agencies are at fault for giving high credit ratings to structured products with large exposure to subprime loans.
“Moody’s observed the trend of weakening conditions in the subprime market and adjusted our rating standards to address the increased risk. Along with most other market participants, however, we did not anticipate the magnitude and speed of the deterioration in mortgage quality or the rapid transition to restrictive lending,” says Michael Kanef, group managing director of asset finance at Moody’s.
The rating agencies insist that, rather than representing a miscalculation on their part, the high ratings given to securitised vehicles could not have anticipated the number of foreclosures seen in the last 12 months as they are the result of a confluence of unforeseen market events that could not have been predicted through traditional reliance on historical data.
“To date, the majority of subprime mortgages that originated between 2002 and 2005 have performed at or better than subprime loans performed in prior periods. Many subprime mortgages underlying the securitisations issued in 2006, however, are experiencing higher levels of serious delinquencies than the mortgages that backed securitisations issued between 2002 and 2005,” Kanef added.
Vicki Tillman, executive vice-president of credit rating services at Standard & Poor’s, went further, claiming the historical data that forms the bedrock of credit rating might prove to be obsolete in the age of structured products.
“S&P began downgrading some of its ratings in this area towards the end of last year and had warned of deterioration in the subprime sector long before that. Nonetheless, we are fully aware that, for all our reliance on our analysis of historically rooted data that sometimes went as far back as the Great Depression, some of that data has proved no longer to be as useful or reliable as it has historically been,” Tillman says.
Despite the agencies’ assurances, regulators are investigating further to ascertain whether any culpability for the crisis lies with the rating agencies – with particular attention to whether the fact issuers pay the agencies to rate them amounts to a conflict of interest.
“We have as yet formed no firm views on any of the reasons put forth by the credit rating agencies, but we are carefully looking into each of them. In particular, the Commission is examining whether these rating agencies were unduly influenced by issuers and underwriters of mortgage-backed securities to diverge from their stated methodologies and procedures for determining credit ratings in order to publish a higher rating,” says Securities and Exchange Commission chairman Christopher Cox.
Congressional appetite to tighten regulation of rating agencies might have been satiated for now by the passage of last year’s Credit Rating Agency Reform Act, which gave the SEC greater powers to regulate competition in a market dominated by just three agencies and investigate possible conflicts of interest. Nonetheless, congress is not ruling anything out.
“I want to assure everyone that I have not yet reached any conclusions. That said, we may ultimately decide that we need to revisit last year’s law and improve upon the quality controls adopted within it,” says representative Paul Kanjorski.