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THE MADNESS
Unfortunately, of the three competitive factors, rating quality is proving
the least powerful given the long tail in measuring performance. . . . The
real problem is not that the market does underweights [sic] ratings
quality but rather that, in some sectors, it actually penalizes quality by
awarding rating mandates based on the lowest credit enhancement
needed for the highest rating. Unchecked, competition on this basis can
place the entire financial system at risk. It turns out that ratings quality
has surprisingly few friends: issuers want high ratings; investors don’t
want rating downgrades; and bankers game the rating agencies for a few
extra basis points on execution.
Moody’s employees told the FCIC that one tactic used by the investment bankers
to apply subtle pressure was to submit a deal for a rating within a very tight time
frame. Kolchinsky, who oversaw ratings on CDOs, recalled the case of a particular
CDO: “What the trouble on this deal was, and this is crucial about the market share,
was that the banker gave us hardly any notice and any documents and any time to an-
alyze this deal. . . . Because bankers knew that we could not say no to a deal, could not
walk away from the deal because of a market share, they took advantage of that.”
For this CDO deal, the bankers allowed only three or four days for review and final
judgment. Kolchinsky emailed Yoshizawa that the transactions had “egregiously
pushed our time limits (and analysts).” Before the frothy days of the peak of the
housing boom, an agency took six weeks or even two months to rate a CDO. By
, Kolchinsky described a very different environment in the CDO group:
“Bankers were pushing more aggressively, so that it became from a quiet little group
to more of a machine.” In , Moody’s gave triple-A ratings to an average of
more than mortgage securities each and every working day.
Such pressure can be seen in an April email to Yoshizawa from a managing
director in synthetic CDO trading at Credit Suisse, who explained, “I’m going to have
a major political problem if we can’t make this [deal rating] short and sweet because,
even though I always explain to investors that closing is subject to Moody’s timelines,
they often choose not to hear it.”
The external pressure was summed up in Kimball’s October memorandum:
“Analysts and [managing directors] are continually ‘pitched’ by bankers, issuers, in-
vestors—all with reasonable arguments—whose views can color credit judgment,
sometimes improving it, other times degrading it (we ‘drink the kool-aid’). Coupled
with strong internal emphasis on market share & margin focus, this does constitute a
‘risk’ to ratings quality.”
The SEC investigated the rating agencies’ ratings of mortgage-backed securities
and CDOs in , reporting its findings to Moody’s in July . The SEC criticized
Moody’s for, among other things, failing to verify the accuracy of mortgage informa-
tion, leaving that work to due diligence firms and other parties; failing to retain doc-
umentation about how most deals were rated; allowing ratings quality to be
compromised by the complexity of CDO deals; not hiring sufficient staff to rate
