While current Moody’s executives and even shareholder Warren Buffett defended the ratings agency as merely a provider of information who was as in the dark as everyone else, it was Mark Froeba, a former senior vice president of Moody’s, who offered up the most interesting insight into how the ratings agency played its part in the meltdown.
Froeba left the firm in 2007 but in his testimony to the Commission he outlined a culture within the agency that he believed led to inaccurate ratings on securities to benefit the banks and keep Moody’s market share higher.
“The Moody’s of [pre-2000] had the stature and maybe even the power to stop something like the sub-prime bubble had it arisen then. Unfortunately, by the time the bubble arrived, Moody’s had deliberately abandoned its stature and surrendered this power,” he said.
This was illustrated by former Moody’s managing director Eric Kolchinsky, who also left in 2007. His testimony said: “The focus on market share inevitably lead to an inability to say “no” to transactions. It was well understood that if one rating agency said no, then the banker could easily take their business to another.
“Market share issues had totally corrupted the way Moody’s analysts and managers conducted rating analysis.”
“For senior management, concern about credit quality took a back seat to market share. During my tenure at the head of US asset backed securities, I was able to say no to just one particularly questionable deal. That did not stop the transaction – the banker enlisted another rating agency and received the two AAA ratings he was looking for.”
Froeba told the Commission how Moody’s became hell-bent on taking market share from its rivals by initiating a “campaign of intimidation” against employees who would rate an asset against the wishes of the provider.
Froeba said the firm would threaten “poor performance evaluations, no promotions, no raises, effective pay cuts, smaller bonuses and restricted stock options” if analysts made investment bankers unhappy.
He said: “By bullying Moody’s analysts into docility and by encouraging bankers into bold defiance, Moody’s ratings were made to be no better than its competitors’ worst ratings.”
He told of analysts who were replaced and fired after banks “aggressive complaints” against less than satisfactory ratings only for the replacement to find that the initial assessment was precise while the bank’s model “was wrong, or at least very imprecise.”
“You began to hear of analysts, even whole groups of analysts, at Moody’s who had lost their jobs because they were doing their jobs, identifying risks and describing them accurately,” Froeba said.
Kolchinsky told the Committee he was once criticised by a manager for “spending too much time reading research.”
Froeba’s testimony also details an occasion where Moody’s Europe changed its scoring system so as to offer better ratings on European pooled securitisations and gain market share. Froeba said this allowed some securities to gain scores one or two notches above their real risk rating.
Froeba said: “Market share issues had totally corrupted the way Moody’s analysts and managers conducted rating analysis…malfeasance may be buried under so many layers and layers of complexity that only a small number of experts would ever notice and understand it.”
Moody’s chief operating officer Raymond W. McDaniel said the performance of many of Moody’s mortgage security ratings were “deeply disappointing”. He said the firm was “raising the bar” on its rating actions and was welcome to more transparency in the sector.
But McDaniel stressed that his firm were just as surprised as anyone when securities were found to be significantly more risky than Moody’s had assessed.
“The rating agencies faced the age old and pedestrian conflict between long-term product quality and short term profits. They chose the latter.”
Kolchinsky said: “The rating agencies could generate billions in revenue by rating instruments which few people understood. The lack of guidance from the private and public users of ratings ensured that there was little concern that anyone would question the methods used to rate the products. The rating agencies faced the age old and pedestrian conflict between long-term product quality and short term profits. They chose the latter.”