Former Moody's execs: We bear some blame

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Former Moody's execs: We bear some blame
By David Ellis, staff writerJune 2, 2010: 11:16 AM ET


NEW YORK (CNNMoney.com) -- Two former Moody's executives admitted Wednesday that the credit rating agency should bear some blame for the financial crisis, alleging that competition to win mortgage deals forced workers to put profits over its reputation.

"The focus on market share inevitably lead to an inability to say "no" to transactions," said Eric Kolchinsky, a former managing director within Moody's derivatives division, in prepared remarks before a hearing of the Financial Crisis Inquiries Commission in New York.


"While there was never any explicit directive to lower credit standards, every missed deal had to be explained and defended," he added.

Testimony provided by Kolchinsky and Mark Froeba, a former senior vice president within the same division, revealed a variety of seemingly questionable business practices that went on within the firm.

Buffett to testify on derivatives
In some instances, certain analysts were blocked from participating on new deals at a banker's request out of fear that they might not assign the new security the coveted 'AAA' rating.

Higher-ups in the company also allegedly employed a variety of techniques to grease the wheels in the mortgage rating process, including understaffing the residential mortgage rating group so analysts could not look at any single deal too closely.

Between 2000 and 2007, Moody's rated $4.7 trillion in securities backed by consumer home loans and approximately $736 billion in complex mortgage investments known as collateralized debt obligations, or CDOs.

More than three-quarters of those bonds, based on dollar amount, received a 'AAA' rating, according to a preliminary staff report published by the commission.

Froeba condemned the culture that had developed at the firm during the mortgage boom.


0:00 /3:30Ratings agencies' role in the crisis
"When I left Moody's, an analyst's worst fear was that he would do something that would allow him to be singled out for jeopardizing Moody's market share, for impairing Moody's revenue or for damaging Moody's relationships with its clients and lose his job as a result," said Froeba, who is scheduled to appear before the commission later in the day.

Kolchinsky and Froeba are among seven current and former Moody's (MCO) executives, including company chairman and CEO Raymond McDaniel, that will appear before the FCIC.

In a copy of his prepared remarks, McDaniel attempted to deflect some of the criticism that has circled his firm, including its inability to foresee troubles in the housing market during the boom and its "issuer-pay" business model that some believe led to cozy relationships between banks and the rating agencies.

"I am proud of our history and the work of our people," said McDaniel, who is due to appear before the committee later in the morning.

All eyes however will be focused on Warren Buffett, the chairman of Berkshire Hathaway (BRKA, Fortune 500), and one of Moody's largest investors.

Buffett had originally declined the commission's offer to participate in the hearing, before he was later subpoenaed. Buffett did not provide prepared remarks for the hearing.

Wednesday's hearing is the latest in a series examining the root causes of the financial crisis.

The 10-member commission, chaired by former California treasurer Phil Angelides, has convened four hearings so far this year. It has examined the role of Wall Street firms, subprime lenders, as well as government agencies including the Federal Reserve and the Securities and Exchange Commission.

The committee is expected to deliver a report with its findings on Dec. 15 of this year.

Critics have suggested that rating agencies including Moody's, as well as its main rivals, Fitch and Standard & Poor's, a division of McGraw-Hill (MHP, Fortune 500), played a key role in the economic meltdown.

Not only did the ratings agencies assign top marks to securities issued by banks that would eventually turn toxic, they have also been accused of moving too slowly to warn of the risks of bonds and other securities tied to subprime mortgages.

The FCIC's examination of Moody's practices turns up the heat on the firm and the entire rating agency industry. Lawmakers are currently considering a number of proposals which threaten to shake up the industry.

One amendment currently on the table, proposed by Sen. Al Franken, D-Minn., would create a board to divvy up the work of rating so-called structured securities.

The company also recently revealed it is potentially facing enforcement action from the SEC after Moody's allegedly made "false and misleading" statements about its procedures when it applied to become a preferred rating agency in June 2007.