As our economy is trying to recover from losses related to the financial crisis, credit-rating agencies (CRAs), once a relatively anonymous group, are finally on the spotlight. This spotlight has led to numerous litigations against CRAs, as well as debates for both congressional and regulatory oversight.
The wave of litigation based on claims that the mortgage lenders, investment banks, and companies purchasing subprime securities failed to disclose material information about their portfolio of subprime securities. Also, claims include that that CRAs gave inflated triple-A ratings too many of the subprime securities that did not accurately represent the risks associated with such securities.
One of such lawsuits filed against Fitch, Moody’s, and S&P claims that the rating agencies failed to conduct due diligence and assigned the highest ratings to impaired instruments since they received substantial fees from the issuers. In fact, Fitch, Moody’s, and S&P saw their revenues double, from $3 billion in 2002 to $6 billion in 2007, as the real estate bubble expanded. The suit alleges that the company applied lax standards or no standards in its ratings of mortgage-backed securities.
Attorneys general in several states also have begun looking into the CRAs’ role in the foreclosure crisis. In New York, all three major agencies reached an agreement with the attorney general in June 2008. Under the agreement, the agencies will charge fees for various analytical tasks, not just rating and they must disclose information about all securitizations submitted for their review. CRAs also have to review individual mortgage lenders and the lenders’ mortgage origination processes. The agencies required to develop criteria for the due diligence information that is collected by investment banks on the mortgages underlying mortgage-backed securities. Finally, on an annual basis, they must address any potential conflict of interests that would compromise the independence of their ratings.
The CRAs have a number of legal defenses, such as their unique treatment under the U.S. constitutional and regulatory system. Also, that it’s the normal industry practice to make a rating of the securities based on incomplete information under short deadline constrains. Moreover, greed and speculation may be the real culprits in what is now a deep worldwide recession. These and other defenses surely are to be tested in the time ahead.
The CRA also now face increasing scrutiny from lawmakers and regulators. Some congressmen accused the CEOs of Fitch, Moody’s, and S&P of failing to warn the public of the problems they knew were coming. The earlier examination by the SEC found that the agencies struggled to handle the huge demand in the number and complexity of subprime residential mortgage-backed securities and collateralized debt obligations since 2002. On the table is a proposal to require disclosure of ratings history information for 100 percent of issuer-paid ratings and amendments that would require the information used for the rating made available to other rating agencies.
