Page 179 - untitled


 F FINANCIAL CRISIS INQUIRY COMMISSION REPORTINANCIAL CRISIS INQUIRY COMMISSION REPORT

how CDOs were structured: assumptions of a lower correlation made possible larger
easy-to-sell triple-A tranches and smaller harder-to-sell BBB tranches. Thus, as is
discussed later, underwriters crafted the structure to earn more favorable ratings
from the agencies—for example, by increasing the size of the senior tranches. More-
over, because issuers could choose which rating agencies to do business with, and be-
cause the agencies depended on the issuers for their revenues, rating agencies felt
pressured to give favorable ratings so that they might remain competitive.
The pressure on rating agency employees was also intense as a result of the high
turnover—a revolving door that often left raters dealing with their old colleagues,
this time as clients. In her interview with FCIC staff, Yuri Yoshizawa, a Moody’s team
managing director for U.S. derivatives in , was presented with an organization
chart from July . She identified  out of  analysts—about  of the staff—
who had left Moody’s to work for investment or commercial banks. 
Brian Clarkson, who oversaw the structured finance group before becoming the
president of Moody’s Investors Service, explained to FCIC investigators that retaining
employees was always a challenge, for the simple reason that the banks paid more. As
a precaution, Moody’s employees were prohibited from rating deals by a bank or is-
suer while they were interviewing for a job with that particular institution, but the re-
sponsibility for notifying management of the interview rested on the employee. After
leaving Moody’s, former employees were barred from interacting with Moody’s on
the same series of deals they had rated while in its employ, but there were no bans
against working on other deals with Moody’s. 

SEC: “IT’S GOING TO BE AN AWFULLY BIG MESS”

The five major U.S. investment banks expanded their involvement in the mortgage
and mortgage securities industries in the early st century with little formal govern-
ment regulation beyond their broker-dealer subsidiaries. In , the European
Union told U.S. financial firms that to continue to do business in Europe, they would
need a “consolidated” supervisor by —that is, one regulator that had responsibil-
ity for the holding company. The U.S. commercial banks already met that criterion—
their consolidated supervisor was the Federal Reserve—and the Office of Thrift
Supervision’s oversight of AIG would later also satisfy the Europeans. The five invest-
ment banks, however, did not meet the standard: the SEC was supervising their secu-
rities arms, but no one supervisor kept track of these companies on a consolidated
basis. Thus all five faced an important decision: what agency would they prefer as
their regulator?
By , the combined assets at the five firms totaled . trillion, more than half
of the . trillion of assets held by the five largest U.S. bank holding companies. In the
next three years the investment banks’ assets would grow to . trillion. Goldman
Sachs was the largest, followed by Morgan Stanley and Merrill, then Lehman and Bear.
These large, diverse international firms had transformed their business models over
the years. For their revenues they relied increasingly on trading and OTC derivatives