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June 2, 2010 Wednesday 2:05 PM EST
SECTION: NEWS & COMMENTARY; Economy and Politics
LENGTH: 1201 words
HEADLINE: BYLINE: Ronald D. Orol, MarketWatch mailto:email@example.com.
Ronald D. Orol is a MarketWatch reporter, based in Washington.
WASHINGTON (MarketWatch) — The chairman of a panel examining the financial crisis said Wednesday that he backs a controversial provision included in a Senate-approved bank-reform bill to create a government clearinghouse, through which credit raters would be assigned to handle structured-finance products.
“Our model where the issuer [corporation or government] pays for ratings, is it a broken model?” Phil Angelides, chairman of the Financial Crisis Inquiry Commission, asked top Moody’s Corp. executives and Berkshire Hathaway Inc. (BRKA) (BRKB) Chief Executive Warren Buffett at a hearing on the future of credit-rating agencies. “You have a duopoly with enormous pricing power. Should we outlaw the issuer-pay model and rather than having an issuer selecting a rating agency, should be selected by the SEC?”
The panel’s inquiries come at the same time as the European Commission announced plans for the supervision of credit-rating agencies under a new pan-European body.
Citing his years as California’s state treasurer, Angelides repeatedly pressed panelists about the provision, which would have the Securities and Exchange Commission set up a Credit Rating Agency Board that would assign a rater for a structured-finance security. With the measure, an investment bank seeking a rating on a structured-mortgage product would need to submit it to the credit board, which would decide which rating agency would do the rating.
The goal would be to break up the cycle of credit-rating agencies providing inflated ratings to get repeat business.
Angelides’ comments also came as rating agencies have come under stinging criticism for their role in the financial crisis — in part because many of the leading firms gave their highest ratings, such as the coveted AAA, to mortgage securities packaged from subprime loans. Such loans were extended to borrowers deemed to be at high risk of default.
Key agencies under scrutiny include Standard & Poor’s (MHP) and Fitch Ratings (FIM) , as well as Moody’s.
A recent investigation found that 91% of AAA-rated, residential mortgage-backed securities issued in 2007 and 96% of similar securities issued in 2006 have now been downgraded below investment grade to so-called junk status
Buffett acknowledged that he “hated” the existing system, which he said isn’t perfect, adding that he needs to further consider the controversial provision before backing or opposing it.
“I don’t know the answer to that,” Buffett said. “The wisdom of somebody picking out raters, is that going to be perfect? I don’t know.”
He added that the market will continue to demand ratings from top-tier rating agencies, such as Moody’s or Standard & Poor’s.
“When rating agencies come to Berkshire, they have me by the throat,” the investor commented. “I have no leverage whatsoever. If there were 10 agencies and I took the cheapest one, people would say ‘You took the cheapest, but they didn’t do the work,’ so it’s not an easy answer.”
However, Buffett (a major shareholder of Moody’s stock) said that he believed the rating-agency business model is threatened in some way, and that legislative efforts to change their model as well as public criticism is threatening their once “bulletproof” stock prices.
Buffett also said he couldn’t conceive of a predominant alternative model where investors pay for the ratings. “It is difficult to think of an alternative where the user pays. I’m not going to pay.”
Raymond McDaniel, Moody’s chairman and chief executive, admitted that there are potential conflicts in the existing model, but contended that they can be remedied through transparency — not through a government intermediary. “It’s important for us to recognize that any business model in which the fee payer has an interest in the outcome is a model that has potential conflicts of interest, and those conflicts must be managed transparently and properly.”
McDaniel also acknowledged that the agency’s performance was disappointing. “We are deeply disappointed with performance of ratings of securities in the housing sector,” he said. “The regret is genuine and deep with respect to the housing sector.”
Question of leadership
Angelides raised questions about whether there should have been a change in leadership at Moody’s after the rating agency’s failures were evident.
“Under your leadership there were in the end very significant failures at Moody’s. If American capital was about risk and reward, shouldn’t there have been a change in leadership at Moody’s?” he asked McDaniel.
McDaniel responded: “If we reach a point where our shareholders or board or I don’t believe I am the best person to lead the company in the future, I will not be at this job.”
Buffett argued that financial institutions that failed and required taxpayer assistance should remove their executives. “For societal reasons, the CEO should go away broke and his spouse should go away broke. Incentives are an important aspect of behavior,” he said.
A former credit-rating executive on Wednesday blamed his superiors along with bankers for the inadequacy of reviews of complex mortgage securities.
“In the old days, we had month and half to rate a deal,” said Eric Kolchinsky, speaking before a congressionally appointed inquiry commission meeting in New York. “At this point, the bankers took advantage of the fact that we wouldn’t walk away from a deal, and they sent us documents whenever they wanted to,” he elaborated.
Kolchinsky had been Moody’s managing director in charge of rating subprime-mortgage securities.
Angelides said that rating agencies’ business models made it impossible for their analysts to say no. “It seems to me the resources were not applied to understanding these products. It seemed to me profit was always predominant over ratings. It was very hard to say ‘We’re not going to rate these flawed products anymore.'”
Kolchinsky and other former ratings executives told the panel that they were under pressure from their superiors to increase market share.
As a result, according to Kolchinsky, bankers seeking reviews for their mortgage securities understood that rating analysts couldn’t push back, and gave them virtually no time to conduct adequate reviews of securities.
“That was the problem,” he elaborated. “I said I needed three or four weeks to research the deal, but because bankers knew we could not walk away from a deal, they sent the documents three or four days before closing or even after closing.”
Kolchinsky also said superiors didn’t give him sufficient resources for the job. “My own attempts to stay on top of the increasingly troubled market were chided by my manager. She told me that I spent too much time reading research,” he told the inquiry panel.
An 18-month investigation by a congressional panel — which reviewed hundreds of emails and conducted interviews with officials at rating agencies — revealed a world of overwhelmed analysts who didn’t have enough information at hand about securities they were rating, and were under pressure from clients to issue good ratings for complex securities at the heart of the financial crisis.
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