Wednesday, October 21, 2009

Credit Rating Agencies and the Next Financial Crisis

Posted by Scarlett Lu

I recently chaired an Oversight and Government Reform Committee hearing to examine the role credit rating agencies contributed to the financial crisis. Credit rating agencies play a powerful role in our economy and they played a starring role in the collapse of the financial system last year.
The main mission of credit rating agencies is to tell investors the risk level of bonds and other debt securities. Pension plans, banks, insurance companies, and other investors depend on these ratings to help them decide where to invest their funds.
Unfortunately, for the past decade, the credit rating system has not worked well at all. Last year, my committee learned that ratings did not capture the true risk of many deals, because the rating agencies were more concerned with their own bottom lines. In turn, millions of people have had their pensions wiped out, seen their life savings evaporate or lost their homes due to foreclosure.
A year after the collapse of Lehman Brothers and the massive government bailout of AIG, Bank of America, and others, it looks like not much has changed. During the hearing we heard compelling testimony from two senior employees at Moody's who described a culture of tainted ratings and lax regulatory compliance at the agency which helped contribute to the financial collapse.
Eric Kolchinsky, a former Managing Director in charge of rating residential mortgage backed securities at Moody's, testified that conflicts of interest, inadequate methodologies and lack of independence for the Credit Policy and Compliance groups significantly contributed to the shoddy performance of Moody's ratings. According to Mr. Kolchinsky, Moody's has adopted "new" methods that actually maintain the status quo and continue to undermine the reliability of their ratings.Read more at:

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