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50–399 2010

S. HRG. 110–982 

TURMOIL IN U.S. CREDIT MARKETS: THE ROLE 

OF CREDIT RATING AGENCIES 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

ON 

ISSUES INVOLVING THE RATING OF STRUCTURED FINANCE INSTRUMENTS BY THE NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATIONS (NRSROS), AS WELL AS RECENT INITIATIVES THAT THE 

NRSROS HAVE ADOPTED AND RECOMMENDATIONS FOR LEGISLATIVE, 

REGULATORY AND VOLUNTARY CHANGES TO IMPROVE THE CREDIT 

RATING PROCESS 

TUESDAY, APRIL 22, 2008 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 


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(II) 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

ROBERT P. CASEY, Pennsylvania 

JON TESTER, Montana 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

SHAWN MAHER, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

DEAN V. SHAHINIAN, Counsel 

ROGER M. HOLLINGSWORTH, Professional Staff Member 

DIDEM NISANCI, Professional Staff Member 

DAVID STOOPLER, Professional Staff Member 

JAYME ROTH, Professional Staff Member 

BRIAN FILIPOWICH, Legislative Assistant 

MEGAN BARTLEY, Legislative Assistant 

JASON ROSENBERG, Legislative Assistant 

MARK OSTERLE, Republican Counsel 

ANDREW OLMEM, Republican Counsel 

TEWANA WILKERSON, Republican Professional Staff Member 

COURTNEY GEDULDIG, Republican Legislative Assistant 

DAWN RATLIFF, Chief Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 


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C O N T E N T S 

TUESDAY, APRIL 22, 2008 

Page 

Opening statement of Chairman Dodd .................................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 3 

Senator Menendez ............................................................................................ 4 

Senator Reed ..................................................................................................... 6 

Senator Allard ................................................................................................... 6 

Senator Schumer .............................................................................................. 7 

Senator Tester .................................................................................................. 8 

WITNESSES 

Christopher Cox, Chairman, Securities and Exchange Commission ................... 10 

Prepared statement .......................................................................................... 61 

Response to written questions of: 

Chairman Dodd ......................................................................................... 141 

Senator Shelby ........................................................................................... 142 

Senator Menendez ..................................................................................... 146 

Senator Bunning ....................................................................................... 149 

John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia University 

Law School ............................................................................................................ 34 

Prepared statement .......................................................................................... 69 

Response to written questions of: 

Senator Shelby ........................................................................................... 150 

Vickie A. Tillman, Executive Vice President for Credit Market Services, 

Standard & Poor’s ................................................................................................ 37 

Prepared statement .......................................................................................... 89 

Response to written questions of: 

Chairman Dodd ......................................................................................... 152 

Senator Shelby ........................................................................................... 155 

Senator Menendez ..................................................................................... 161 

Claire Robinson, Senior Managing Director, Moody’s Investors Service ............ 39 

Prepared statement .......................................................................................... 106 

Response to written questions of: 

Chairman Dodd ......................................................................................... 186 

Senator Shelby ........................................................................................... 196 

Senator Menendez ..................................................................................... 210 

Stephen W. Joynt, President and Chief Executive Officer, Fitch Ratings .......... 41 

Prepared statement .......................................................................................... 119 

Response to written questions of: 

Chairman Dodd ......................................................................................... 216 

Senator Shelby ........................................................................................... 220 

Senator Menendez ..................................................................................... 225 

Arturo Cifuentes, Ph.D., Managing Director, R.W. Pressprich & Co. ................. 43 

Prepared statement .......................................................................................... 125 

Response to written questions of: 

Senator Shelby ........................................................................................... 240 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Aaron Lucchetti, The Wall Street Journal, ‘‘As housing boomed, Moody’s 

opened up,’’ article dated April 11, 2008 ............................................................ 242 


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(1) 

TURMOIL IN U.S. CREDIT MARKETS: THE 

ROLE OF CREDIT RATING AGENCIES 

TUESDAY, APRIL 22, 2008 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 10:12 a.m., in room SD–538, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. The Committee will come to order, and my 

apologies to my colleagues and others for being a few minutes late 

this morning. I was taking the shuttle down, which is always a bit 

of roll of the dice. So I apologize for being a few minutes late, but 

I want to thank all in attendance for being here this morning. Let 

me share some opening thoughts. I will turn to Senator Shelby and 

then to other Members of the Committee who would like to make, 

if they so desire, some opening comments on the subject matter of 

today’s hearing. 

Today we are going to talk about the role played by the credit 

rating agencies in the subprime mortgage crisis. I asked the staff 

a short time ago, just to go back over this, this is our 13th hearing 

this year on this subject matter or related matters to it. We had 

35 hearings last year. So it is almost 48, close to 50 hearings since 

beginning February 7th of last year. Some of those hearings were 

conducted by my colleagues here. I want to thank Jack Reed particularly for doing some of this last year—in fact, on this very subject matter. And Senator Shelby, of course, has been deeply involved in these issues, and we owe him a debt of gratitude for what 

he has done. But the Committee has spent an inordinate amount 

of time over the last year on this subject matter. Including even 

when we had hearings on student loan issues the other day, it was 

really related in many ways to the subprime problem. So almost 

every other matter we are looking at bears some relevancy to the 

subject matter here today. We could have a hearing on credit rating agencies, but obviously in the context of the subprime mortgage 

crisis, it has real relevancy. 

Senator Reed, as I mentioned a minute ago, chaired a hearing of 

the full Committee on this subject matter, and Senator Shelby, of 

course, has been deeply involved in the subject matter of credit rating agency reform. In fact, during his tenure or stewardship as 

Chairman of this Committee, he not only held hearings on the topic 

of the credit rating agencies, but, in addition, the Committee 


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passed legislation. That legislation, the Credit Rating Agency Reform Act of 2006, was signed into law on September 29, 2006. It 

makes important reforms in the area of capital market reforms, 

which in my view were prescient. 

Credit rating agencies played a very important role in our economy and continue to do so. They provide opinions to investors 

about the ability of debt issuers to make timely payments on debt 

instruments. That may sound like a simple modest function, but it 

is an indispensable one. Decisions about how to invest enormous 

sums of money are based, at least in part, on credit ratings. As one 

commentator has said, ‘‘Credit rating agencies can, with the stroke 

of a pen, effectively add or subtract millions from a company’s bottom line, rattle a city budget, shock the stock and bond markets, 

and reroute international investment.’’ 

We have seen over the past few months just how influential a 

role credit rating agencies play in our markets, and particularly in 

the structured finance markets, and not in a positive sense. Credit 

rating agencies have played a central role in the subprime mortgage crisis and, by extension, on the volatility and illiquidity plaguing our capital markets. 

During the past several months, these agencies, which are technically referred to as nationally recognized statistical rating organizations, have downgraded their ratings of thousands of tranches of 

residential mortgage-backed securities. Bloomberg recently reported that the three largest of these organizations began cutting 

in July and have since either downgraded or put on review a total 

of 38,000 subprime bonds. Moody’s and S&P combined have downgraded more than 9,500 of these securities dating from 2005. These 

downgrades meant that, with the stroke of a pen, again, assets 

once seen as safe and profitable were suddenly something quite the 

opposite. 

Many investors who by Federal or State law must invest in securities within investment grade ratings were suddenly forced to sell. 

Others suddenly found the value of their securities reduced to a 

fraction of their previous value. The net result is that investors 

have lost tens of billions of dollars. 

The impact of these downgrades has spread beyond the downgraded bonds themselves. Imagine, if you will, using this analogy, 

going to a grocery store to buy food for your family. You are told 

that almost all of the food in the store is safe and healthy, but that 

a small fraction—a small fraction—of the items contained a very 

toxic substance that could cause serious illness or death. It is 

doubtful that you or anyone else is going to be doing much shopping in that store without some assurance that it is free from the 

taint of any toxic substance. 

In the same manner, the downgrading of some subprime mortgage securities have sown doubt and fear in investors about a 

much larger universe of securities. It has cut investors’ appetite for 

subprime mortgage securities generally and for a host of other 

asset-backed securities. As a result, our credit markets are experiencing unprecedented levels of volatility and illiquidity. 

These recent rating downgrades have raised serious questions 

about the role, function, and performance of credit rating agencies. 

For instance, do the credit rating agencies give ratings that are 


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overly optimistic in order to obtain more business? Do they sufficiently analyze the data they are given by clients before issuing 

ratings? Do they properly manage real or perceived conflicts of interest with clients who pay for rating and/or consulting services? 

And, last, when Congress acted 2 years ago, it gave the SEC the 

authority ‘‘to prohibit or require the management and disclosure of 

any conflicts of interest.’’ Has the SEC used this authority effectively? Can or should it do more? 

These are some of the important questions that our witnesses 

will address this morning. The investing public, of course, deserves 

to know that every step is being taken to protect one of their most 

basic rights, and that is the right to sound, reliable, credible information. They deserve to know that our regulatory agencies will 

apply and enforce the law with vigor on their behalf. And they 

want to see the credit rating agencies demonstrate that they have 

learned from their mistakes and have reformed their practices so 

that this very sorry chapter in their history will never be repeated. 

I want to welcome Chairman Cox of the SEC to the Committee 

once again. We know he is currently working to implement by rulemaking the new act, and we look forward obviously to hearing his 

testimony this morning. Let me also welcome our other distinguished witnesses who will be here this morning. We appreciate 

their willingness to appear before us. 

Let me now turn to Senator Shelby and then to other Members 

of the Committee for any comments they may have about this very, 

very important subject matter. 

OPENING STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. Welcome, Chairman 

Cox. 

Since our last hearing on this subject, the situation in our financial markets has underscored the role played by the rating agencies. The past few months have also demonstrated that the rating 

agencies were not meeting their responsibilities. We have witnessed this series of ratings downgrades particularly in structured 

finance. It seems that rating agencies grossly underestimated the 

risks associated with these securities. Unfortunately, these products were widely distributed and held by a broad array of investors 

and institutions. The severity of these downgrades sent banks, pension, and money market funds scrambling for capital. Plunging investor confidence ultimately led credit markets to tank worldwide. 

The markets for commercial paper, municipal securities, and auction rate securities have all experienced disruptions in part because 

financial institutions no longer trust the credit ratings of issuers, 

bond insurers, and other counterparties. Rather than conduct their 

own due diligence, too many investors appear to have relied solely 

on credit ratings to assess credit risk. And while credit ratings play 

and should continue to play an important part in evaluating risk 

in our economy, over reliance on the ratings of just a few firms appears to have diminished the amount of independent risk assessment undertaken by market participants. 

Because rating agencies underestimated the risk of subprimebased securities, these securities were allowed to spread throughout our financial system without their real risk being detected until 


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it was too late. In our modern economy, we need not only better 

ratings but also more market participants assessing risk to prevent 

this from happening again. 

Before the current crisis began, this Committee worked and enacted the Credit Rating Agency Reform Act of 2006. This act 

sought to improve the quality of ratings and to foster accountability, transparency, and competition in the industry. The Securities and Exchange Commission was given broad authority to enforce this act. Last year, the SEC issued initial rules governing registration of NRSROs and prohibiting certain conflicts of interest. 

These rules have opened up the process for new firms to become 

NRSROs, fostering more competition in the industry. The SEC is 

now preparing to propose additional rules to implement the act. 

Today, we look forward to hearing Chairman Cox discuss the 

types of rules the SEC is considering adopting and what additional 

reforms he believes are needed. I believe the SEC has a chance to 

help restore confidence in our markets and establish a more competitive and accountable credit rating industry. For example, rules 

that improve the transparency of the ratings process will make it 

easier for investors to assess and compare ratings. 

I am also interested in the preliminary finding of the SEC’s ongoing examination of the rating agencies, and we would like to learn 

more about the relationship between the agencies and investment 

banks. A rating, after all, is only as good as the information on 

which it is based. 

If there was insufficient due diligence and risk assessment in the 

process of creating and underwriting structured financial products, 

the ratings will be flawed from their inception. We found that they 

were. 

Mr. Chairman, given the critical role underwriters played in this 

crisis, I hope that our examination—I believe our examination is 

incomplete without the participation of the firms that created these 

products, and I hope that we will address those two in the future. 

The sophisticated underwriters that structured and sold these securities reaped huge fees for their efforts, regardless of how the securities performed for investors. I hope their absence from this discussion is not permanent, Mr. Chairman. 

Chairman DODD. Well, thank you very much, Senator Shelby. 

Just on that point of the investment banks, we had a hearing last 

year—in fact, Senator Reed looked into that. 

Senator SHELBY. We did. 

Chairman DODD. And I am certainly willing to hold an additional 

one. As I mentioned, we have had a lot of hearings on the subject 

matter, but certainly that is a very legitimate question that you 

raise, Senator Shelby, and we will do that. 

Senator Reed. 

Senator REED. Mr. Chairman, I will yield to Senator Menendez. 

He has—— 

Chairman DODD. Fine. Absolutely. 

OPENING STATEMENT OF SENATOR ROBERT MENENDEZ 

Senator MENENDEZ. Thank you. Let me thank both Senator Reed 

and Senator Schumer for their courtesy. I have to chair a Foreign 

Relations Subcommittee hearing at 10:30, and I hope to get back 


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for our second panel, Mr. Chairman. So I appreciate them both for 

their courtesy. This is something I have been following along with 

the Committee and am very interested in. 

Over the last year, we have grappled with a foreclosure crisis 

that has swept across our country, devastating families and neighborhoods and a credit crunch that has spread throughout our markets with ripple effects throughout our economy. Within the turmoil, there are many pieces for us to focus on as we seek to help 

homeowners, stem any further spillover into other markets, and 

work to stabilize our economy. But the worse mistake I think we 

could make is not to learn from what happened and to let the 

cracks in the system slip by unfixed. Our credit rating system 

threatens to possibly be something that slipped by, and I am glad 

through your leadership and the Ranking Member’s that we are 

not letting that happen. 

Last year, we held what I thought was a very important hearing 

to examine one of the most severe and overlooked cracks in the 

mortgage and the securitization chain. While the credit rating 

agencies were not a direct cause of the subprime crisis, they certainly were a key link in the securitization chain and had a hand 

in perpetuating a mortgage process in which no one asked the right 

questions. That chain failed in large part because the very ratings 

that the market was supposed to rely on were flawed. And often 

I think they played the conflicting roles of referee and coach. 

Recently, we witnessed what happens when the whole system 

fails. Extenuating circumstances or not, our regulatory system did 

not know what hit it when Bear Stearns collapsed. In addition to 

the questions I and many of my colleagues have had about how our 

regulators missed the warning signs, I have serious questions 

about the role that the ratings played or could have played in helping raise flags earlier. The fact is credit ratings play an essential 

role for our markets. Issuers depend upon them to seek investments. Investors depend upon them to know the creditworthiness 

of the investments they are making. The system as a whole depends upon them to track risk. But the question is: Who is rating 

the rating agencies? And that answer has been clear: No one. 

So I want to applaud the SEC for taking seriously the need to 

reform this process. I have raised some questions with the Chairman when he came to visit—I appreciate his visit—of whether 

some of the SEC plans go far enough, and I hope we can find solutions that will increase disclosure and root out the practices that 

keep the ratings from being what they should be: fair, simple, and 

accurate. 

Finally, I hope, Mr. Chairman, we look at the bigger picture for 

a moment. This discussion about how to reform the rating system 

is largely cleaning up the mess. We are still mopping up the aisles 

and trying to figure out what broke and why. But beyond this, as 

I spoke to Chairman Cox when he visited me—and, again, I appreciate that visit—the larger challenge at hand is getting ahead of 

the curve. The problem is not just that the ratings were flawed or 

that there are conflicts in the system. It is that what is going on 

in the market and on the street is light years ahead often of what 

is going on in our regulatory system. How can our regulators watch 

for the warning signs and respond if they do not even know what 


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the signals are? I feel like they are in the same struggle as parents 

who cannot keep up with their teenage kids texting back and forth 

on their cell phones. 

The fact is much of our market operations are taking place in a 

language all its own, and we need our regulators to be fluent in 

that language as well. And I am looking forward to the Chairman’s 

proposals in this particular regard and the Commission’s proposals, 

and I am hoping that we will have a system that puts us ahead 

of the curve. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Senator Corker. 

[No response.] 

Chairman DODD. Senator Reed. 

OPENING STATEMENT OF SENATOR JACK REED 

Senator REED. Well, Mr. Chairman, thank you very much, and 

I will make some comments. 

First, welcome, Chairman Cox. We have been down this road before. In the wake of Enron, we saw flaws in the credit rating system. We have tried to address those faults. I want to commend 

Senator Shelby for his efforts as Chair last year and at least giving 

the SEC some authority and some traction in this regard. But I 

think what we have seen in the last 12 months has been another 

indication that we have to take more directed action. 

Twelve months ago, when at your request I chaired a hearing, the subprime crisis was seen as a $19 billion worldwide phenomenon that was already self-correcting. That is not the case, and 

so I think we have to do much more. We have to ensure that the 

Commission has the authority to adequately supervise, regulate, or 

direct the credit rating agencies. We have to ensure, I think, that 

the new rules that they are promulgating really do the job. As I 

said, we have been down this road before, and we are still going 

down it. I think we want to reach an appropriate conclusion. 

We have to, I think, ensure that we have the appropriate balance 

between market discipline and good rules and regulations. That is 

something, I think, that is out of balance at this moment. 

I will conclude with the comments of Lew Ranieri, who created 

the mortgage-backed security years ago, when he said, ‘‘The mortgage-backed security sector was unfettered in its enthusiasm and 

unchecked by today’s regulatory framework. We have a quasi-gatekeeper in the rating services, and in the end the SEC is the regulator of the capital market. It is the one who can touch this stuff 

and make a difference.’’ And I think we have to touch this stuff and 

make a difference now since we have not in the past. 

Chairman DODD. Thank you very much, Senator. And, again, for 

the purpose of the record, all statements, complete statements of 

Members and witnesses, will be included in the record as well. 

Senator Allard. 

STATEMENT OF SENATOR WAYNE ALLARD 

Senator ALLARD. Mr. Chairman, thank you for holding this hearing, and also Ranking Member Shelby. I would just make a few 

brief comments. 


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The nationally recognized statistical rating organizations play an 

important role in financial markets. Confidence in these ratings 

have been shaken following a number of downgrades of residential 

mortgage-backed securities. And so this lack of confidence is of concern to me. I have said this to a lot of people, I believe. And I just 

would remind us of a quote from former Federal Reserve Chairman 

Alan Greenspan when he said that people believe that they—meaning the credit rating agencies—‘‘knew what they were doing, and 

they don’t. What kept them in place was a belief on the part of 

those who invested in that that they were properly priced.’’ 

Now everyone knows that they weren’t, and they know that they 

can’t really be properly priced. And I am anxious to hear what 

Chairman Cox might have to say about that particular statement. 

As always, I would like to welcome my friend and former colleague from the House. It is always good to see you, Mr. Chairman. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator. 

Senator Schumer. 

STATEMENT OF SENATOR CHARLES E. SCHUMER 

Senator SCHUMER. Well, thank you, Mr. Chairman. I very much 

appreciate the opportunity to have this hearing and very much appreciate your being here. And I think it is appropriate because, at 

least to me, credit rating agencies were the weak link in the 

subprime crisis. They, along with mortgage brokers, are probably 

more at the center of this than just about anybody else. And, incidentally, at least until we passed our legislation—and much of the 

action occurred before that—neither the mortgage brokers nor the 

credit rating agencies had any real regulation at all. And so it is 

difficult to ask the SEC—they now have regulation, and we have 

met and talked about—have the ability to look at things like conflict of interest, but they did not back then. So, to me, the credit 

rating agencies are at the heart of this problem, and we need to 

do a thorough examination of what is happening. That is why I appreciate you, Mr. Chairman, and the Ranking Member being so interested in this issue, which he was when he was Chairman as 

well, as well as Senator Reed. 

Second, I really regret that the heads of—I want to commend 

Fitch’s for sending their CEO, but where are the heads of Moody’s 

and Standard & Poor’s? The bottom line, this is really serious stuff. 

The whole world is focused on this. And for the CEOs not to come 

is very disappointing. They should be here. And particularly they 

should be here because I met with the President of Moody’s a while 

ago, and I asked him, Did Moody’s do anything wrong? And he said 

no. I would like to know if he still believes that. He said no, they 

did nothing wrong. I was incredulous. 

And so, again, I think the credit rating agencies really have an 

obligation to send their leaders and to find out what happened and 

what is going on here. And I want to register my disappointment. 

Third, to me, the nub of this problem is conflict of interest. Obviously, when you are paying for a rating, there is an inherent conflict of interest, and that has to change. And there was a story in 

The Wall Street Journal—which I would just ask unanimous consent to put into the record. 


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Chairman DODD. It will be included. 

Senator SCHUMER. It is an article from April 11th that just documented one instance of a conflict where analysts were changed because people did not like the rating agency. Here is a quote from 

the article: ‘‘On occasion, Moody’s agreed to switch analysts on 

deals after bankers complained.’’ And another quote: ‘‘There was, 

rather, a palpable erosion of institutional support for rating analysis that threatened market share.’’ Moody’s decided they would increase market share in this area, and their standards declined at 

the same time. 

Conflict is inherent sometimes, and, look, sometimes there are legitimate reasons to complain: you did not take this into account; 

there has to be a dialog between the agency and the issuer. But 

disclosure is key, and I asked you, Mr. Chairman, when we met, 

would you make sure that this is all disclosed when an analysis 

was changed after a complaint or if a rater was switched? That 

should be known. Again, you cannot say that the issuer can never 

complain. Maybe they missed something. But at least disclosure 

would be a prophylactic. And the new legislation that we supported 

and Chairman Shelby shepherded through this Congress allows for 

that disclosure, and we eagerly await the regulations that you will 

have. 

One final point I would make here. For somebody to say nothing 

is wrong, here is the nub of it: How did no-doc loans, loans with 

no documentation that were parts of these packages, get AAA ratings? Now, when you ask the credit rating agencies how did no-doc 

loans deserve AAA ratings, they said, well—not them but the people analyzing them. They say, well, they thought housing would go 

up no matter what. And so, therefore, it did not matter if the guy 

could not repay, so you did not have to look at the loan. 

Well, maybe they should have paid one of us. We could have told 

them housing prices would go up forever. We did not need to do 

any analysis either, or somebody, or the guy on the street. 

So something is really wrong here. Something is really wrong. I 

know some of it has been self-corrected already, but there has to 

be more to be done, and this hearing is a very constructive step 

along that path. And I thank you for holding it, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator. 

We invited the CEO. Today is their shareholder meeting, and so 

he—though we could maybe schedule it another time. I did not 

know that at the time, and he let us know he would have been here 

but for presiding over the shareholder meeting. Moody’s, anyway, 

I want to include that in the record. 

Senator SCHUMER. Well, I would like an opportunity for them 

maybe to come back at some point if we have time, either at the 

Committee or the Subcommittee level. 

Chairman DODD. Very good point. 

Senator Tester. 

OPENING STATEMENT OF SENATOR JON TESTER 

Senator TESTER. Thank you, Chairman Dodd and Ranking Member Shelby, for calling today’s hearing on credit rating agencies as 

another in a series of hearings looking into the turmoil in the credVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00012 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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it markets. I want to welcome Chairman Cox and the members of 

the second panel. 

My stay here today is going to be limited because I have to chair 

on the floor, but this is a topic that is both timely and critical as 

issues that surround the credit rating agencies and their role in the 

current credit market crisis keep arising. In Montana, we are confronted with uncertainties in the student loan market, as the auction rate bond market is no longer viable, due in no small part, 

some say, to mistrust in the credit rating agencies. 

As important as it is to delve into the oversight of the credit rating agencies, I really want to spend my opening statement today 

addressing the distinguished witness Chairman Cox on the possibility that market manipulation led to the fall of Bear Stearns 

leading up to its merger with JPMorgan Chase. 

Mr. Chairman, you testified before this panel on April 3rd, along 

with Chairman Bernanke and other distinguished panelists, to discuss recent actions of Federal financial regulators as it related to 

the Government’s role in the Bear Stearns saga. At the time, I inquired if there is any evidence suggesting that speculators had bet 

heavily that Bear Stearns’ share price would fall, known on Wall 

Street as ‘‘short selling.’’ You responded, and I quote, ‘‘I am a little 

bit constrained because the SEC is in the law enforcement business.’’ You then continued to say that the SEC pursues insider 

trading aggressively and that your agency was mulling several law 

enforcement matters that have not been filed in any U.S. court. 

A week after, on April 10th, I sent a letter to you and to Attorney 

General Mukasey asking you to immediately and thoroughly investigate whether illegal insider trading led to last month’s downfall 

of Bear Stearns. To date, I have not heard back from your office, 

nor have I heard back from the Department of Justice. I understand your response is currently being drafted and will likely echo 

the sentiments that you told me on April 3rd, that you were in the 

law enforcement business and cannot confirm nor deny, but you 

will investigate if any wrongdoing has taken place. 

While I respect that, and I admire the SEC for playing an integral role in the investigations of securities law violations, I want 

you to know that this is not an ordinary situation, and the events 

that followed what some view as market manipulation were unprecedented—a $29 billion loan from the Government to facilitate 

a merger of two of the world’s largest banks. 

I am not sitting here to criticize the Federal Reserve Bank of 

New York for their actions if risking nearly $30 billion of taxpayer 

dollars with a limited amount of due diligence was necessary, but 

I do want to know if it could have been avoided, if speculators conducted insider trading to make a buck, a whole lot of bucks, which 

led to taxpayers being forced to stand behind the loan that is big 

even by Washington, D.C., standards, much less the standards of 

my home State of Montana. 

As I stated earlier, I will have to leave very shortly to go preside 

on the floor, but we will continue to have a dialogue. You will continue to hear from me in the coming months on the need for a thorough investigation. Hopefully that is going on as we speak, and 

hopefully it will get to the bottom of the situation. I have asked 

other financial regulators, investors, and knowledgeable individuals 


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their thoughts, and to a person, they believe fear and speculation 

alone did not eat up Bear’s significant liquidity position. But I 

want to hear it officially from you. 

So thank you, Chairman Cox. Thank you, Chairman Dodd. 

Chairman DODD. Thank you very much, Senator. 

Senator Bayh has joined us. Senator, do you have any opening 

comments you want to make? 

Senator BAYH. Thank you, Mr. Chairman. No. I am looking forward to hearing from Chairman Cox, and I did want to note my— 

this takes me back a few years, Mr. Chairman. My corporate law 

professor in law school, John Coffee, is here, and I just wanted to 

give him my best regards. 

Chairman DODD. Now we are going to really have an interesting 

hearing. 

Senator BAYH. And for both our sakes, I hope he will not disclose 

what my grade in the course was. 

Chairman DODD. I tell you, we expect very tough questioning 

from you, though, Senator, of the witness. 

Chairman Cox, welcome to the Committee once again. You have 

been before the Committee on numerous occasions over the last 

year, and we appreciate your being back here today. 

Mr. COX. Thank you. Senator Tester I notice is just leaving, 

but—— 

[Laughter.] 

Mr. COX. Just on your way out, I think you recognize that both 

the Department of Justice and the SEC do not confirm investigations into people for privacy reasons before they have been publicly 

identified with wrongdoing. But I also stated at that hearing that 

the problem with Bear Stearns was too big to miss and people 

should take comfort that the SEC was doing its job in this area. 

So I hope to signal by that within the silent forum that we all must 

operate in the law enforcement agency business that that is the 

case. And beyond that, I look forward to speaking with you in private to give you the maximum amount of comfort in that respect. 

Senator TESTER. You took the words right out of my mouth, 

Chairman Cox. I would like to set up a meeting with you, and we 

can visit about the issue in private. That would be great. Thank 

you. 

Mr. COX. Thank you. 

Chairman DODD. Thanks very much. Mr. Chairman, we look forward to your statement. 

STATEMENT OF CHRISTOPHER COX, CHAIRMAN, SECURITIES 

AND EXCHANGE COMMISSION 

Mr. COX. Thank you, Chairman Dodd, Senator Shelby, Members 

of the Committee, for inviting me today to discuss the work of the 

SEC concerning credit rating agencies. 

When Congress passed the Credit Rating Agency Reform Act and 

President Bush signed it into law in late 2006, its purpose was to 

improve ratings quality by fostering accountability, transparency, 

and competition in the credit rating industry. Prior to the Rating 

Agency Act, credit rating agencies were essentially unregulated by 

the Federal Government, and the SEC had no authority to make 

rules governing their business or to subject them to examinations 


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as nationally recognized statistical rating organizations. With the 

passage of the act, the Commission became their regulator, and 

since that time, we have devoted considerable new resources to this 

responsibility. 

Since the end of September 2007, seven credit rating agencies, 

including those that were most active in rating subprime-related 

products, have been subject to the Commission’s new oversight authority, and subject as well to our newly adopted rules. In the 61⁄2

months since the SEC’s authority over CRAs went into effect, the 

Commission has aggressively used its authority to examine the 

adequacy of their public disclosures, their recordkeeping, and their 

procedures to prevent the disclosure of material non-public information. 

The review process has included hundreds of thousands of pages 

of the rating agencies’ internal records and e-mail. In addition, the 

staff are reviewing the ratings agencies’ public disclosures relating 

to the ratings process for those securities, and Commission staff 

have analyzed the ratings history of thousands of structured finance products. These extensive examinations have involved approximately 40 SEC professional staff. 

Much has been accomplished already on these examinations, but 

there is still much more work to be done. The Commission expects 

that the report describing the staff’s observations from the examinations will be issued by early summer. At this stage, with more 

examination work to be completed and the staff’s across-the-board 

inferences yet to be drawn, it is premature to describe the results. 

I can say that it appears the volume of the structured finance deals 

that were brought to the credit rating agencies increased substantially from 2004 to 2006, and at the same time, the structured 

products that the rating agencies were being asked to evaluate 

were becoming increasingly complex, with many employing derivatives such as credit default swaps to replicate the performance of 

mortgage-backed securities. 

Meanwhile, the loan assets underlying these securities shifted 

from primarily plain vanilla 30-year mortgages to a range of more 

difficult-to-assess products, including ARMs and second-lien loans. 

We are currently evaluating whether and how the credit rating 

agencies adapted their ratings approaches in this rapidly changing 

environment. We expect the results of these staff examinations will 

provide significant and useful new information that will help not 

only the SEC but also issuers and users of credit ratings to address 

the problems that we have seen. 

Because the Commission’s authority over credit rating agencies 

took effect just over 6 months ago, the SEC is already far along in 

preparing for a second round of rulemaking. This second round of 

rulemaking will be based on information provided by the staff’s ongoing examinations of these firms as well as the many empirical 

analyses provided by regulators and industry groups, academics, 

and multinational organizations, including many in which the SEC 

itself has participated. I expect the Commission will issue rule proposals for public comment in the near future. Of course, the internal development process for these rules within the Commission is 

still very much ongoing. So while I am happy to provide you today 

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ation, I do so with the caveat that what ultimately is included in 

these new proposed rules has yet to be decided. 

That said, the rules that we are likely to consider will fall into 

three broad categories: rules designed to foster accountability, rules 

to enhance transparency, and rules to promote competition in the 

credit rating agency industry. These, of course, are the three goals 

of the Rating Agency Act itself. 

To strengthen accountability, the new rules may include requirements for enhanced disclosures about ratings’ performance. This 

would enable market participants to better compare one NRSRO 

with another. To ensure NRSRO accountability for the management of their conflicts of interest, the new rules could include specific prohibitions on certain practices. They could also establish requirements to address potential conflicts of interest that could impair the process for rating-structured products. 

Among the conflicts of interest that could be addressed are the 

provision of consulting services by credit rating agencies to the 

issuers of the securities that they rate and the rating of structured 

securities that the credit rating agency itself helped to design. The 

proposed rules may also include requirements that the firms furnish the Commission with annual reports describing their internal 

reviews of how well they adhere to their own procedures for determining ratings, managing conflicts of interest, and complying with 

the securities laws. 

In the second category of enhancing transparency, the Commission may consider rules to require the disclosure of information underlying the ratings of subprime-related products, including, for example, the particular assets backing MBS, CDOs, and other types 

of structured products. This would allow market participants to 

better analyze the assets underlying the structured securities and 

reach their own conclusions about creditworthiness. 

Making this data available to the market could particularly benefit subscriber-based NRSROs who could use it to perform independent assessments of the validity of their competitor’s ratings. 

Other improvements that the new rules could make in the area of 

transparency could come from enhanced disclosure about how 

NRSROs determine their ratings for structured products. This new 

disclosure could include, for example, the kind of analysis that is 

done on the degree to which the mortgages behind asset-backed securities conform with underwriting standards. Additional disclosure could be required as well for the firms’ procedures for monitoring their current credit ratings. The Commission may also consider rules to help investors to readily distinguish the ratings for 

different types of securities such as structured products, corporate 

securities, and municipal securities. 

In the third area of potential rulemaking, promoting competition, 

the new rules could include provisions to enhance disclosure about 

ratings’ performance so that it affords other credit rating agencies, 

including newly recognized NRSROs, an opportunity to identify 

flaws in their competitive approach or to demonstrate to investors 

that their ratings performed better. The Commission is also reconsidering its extensive reliance on credit ratings in our own rules. 

Limiting the use of credit ratings for regulatory compliance purposes could encourage investors in the marketplace as a whole to 


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use ratings for their informational value rather than merely to satisfy a regulatory requirement. This could induce greater competition among rating agencies to produce the highest-quality, most reliable ratings. 

Yet another way the new rules might seek to enhance competition could be to ensure that all NRSROs have access to the same 

information underlying a credit rating. In that way, regardless of 

whether the NRSRO follows the issuer-pays approach or the subscriber-based approach, there would be no competitive advantage 

or disadvantage based on access to information on the assets underlying a structured credit product. And at the same time, 

NRSROs that were not paid by the issuers to rate securities could 

develop their own track record for rating these products. 

To the extent both the issuer-pays and the subscriber-based models were to flourish in a competitive marketplace, each could act as 

a healthy competitive check on the other. Of course, because this 

planned proposed rulemaking is ongoing, there could and undoubtedly will be other subjects covered in the draft rules that the staff 

will present to the Commission for its consideration. 

In closing, Mr. Chairman, I want to emphasize that the Commission is very much open to ideas from the Congress on this proposed 

rulemaking, and we especially welcome ideas from this Committee 

since you are the authors of the Credit Rating Agency Act and it 

is your intent in writing the law that the Commission is now working to fulfill. 

I appreciate this opportunity to provide the Committee with this 

update on the SEC’s new regulatory responsibilities for credit rating agencies, and I look forward to answering your questions. 

Chairman DODD. Well, thank you very much, Mr. Chairman, and 

I want to ask the clerk to put up about 7 minutes per Member here 

so that we can give everyone a good chance to raise some issues 

with you. 

First, I was pleased to hear your plans to require greater clarity 

of methodologies and to make issuer data available to all NRSROs 

and to propose needed reforms. Let me ask you a couple of sort of 

underlying questions, and then there is a series of specific ideas 

that have been raised, including some of our witnesses who submitted their testimony and will be before us a little later this 

morning. 

I guess one question we would have for you, all of us would up 

here, putting aside the various ideas, do you need any additional 

statutory authority, do you think, for the SEC to act? And if so, 

would you share with this Committee what limitations you have in 

that regard and what recommendations you would make if, in fact, 

there is a gap in terms of what you think you need to do and the 

authority that you have been given either by the legislation we 

adopted or previous legislation? 

Mr. COX. Mr. Chairman, thank you for the question and for the 

opportunity. In connection with this latest proposed round of rulemaking, we have come upon a number of topics where we had to 

ask ourselves, Do we have the authority aggressively to do this? 

And thus far, the answers that we have been able to give are all 

yes. We do have the authority, not only in the Rating Agencies Act, 

but also under the Exchange Act and the other Commission auVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00017 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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thorities in combination. And so thus far, what we have in mind 

is amply supported by the new legislation that you have just written. 

Chairman DODD. The second question would be budget. I expressed in my views and estimates letter to the Budget Committee 

of February 25th of this year, I raised concerns as to whether or 

not the President’s fiscal year 2009 budget request of $913 million 

for the SEC would be adequate to examine and regulate the 

NRSROs as well as to deal with enforcement, the subprime crisis, 

consolidated supervision, and other issues. 

Do you feel, Mr. Chairman, that the amount that you are going 

to be given here is enough, will provide enough resources to effectively oversee the securities markets? And if not, would you share 

with the Committee what you believe you are going to need? 

Mr. COX. Mr. Chairman, as you know, the budget that the President has put before you is the largest budget that the SEC would 

ever have received. It is approaching $1 billion. I think it would be 

appropriate for this Committee as authorizers to consider both the 

CSE program and the CRA program from the standpoint of their 

place within the agency. I think overall the nearly $1 billion that 

Congress has provided us in the latest budget is ample for the 

overall achievement of our goals, and I have been able as CEO of 

the agency to allocate resources, for example, to credit rating agencies and to our CSE program. 

At the same time, because both of these programs are relatively 

new, the CRA program itself very new and it has never been the 

subject of extensive consideration, therefore, on the Appropriations 

Committee, and because the CSE program is a voluntary program 

based on old authority and not itself authorized in law, I just think 

it would be very useful if there were a dedicated funding stream 

for these two significant new responsibilities for the agency because 

they have changed overall the responsibilities of the SEC. 

Chairman DODD. Well, we will take that into consideration. Of 

course, we have some Members of the Appropriations Committee 

here, including Senator Shelby, so we can examine that issue further. 

Let me raise a couple of specific suggestions that will be raised 

in testimony from some of our witnesses coming along that I 

thought were interesting. Again, I agree with your intent to enable 

market participants to better compare the rating agencies. And 

Professor Coffee has proposed an idea along these lines that I think 

has some merit, and I would be interested in your own reaction to 

it, and that is, a neutral website that displays the past ratings for 

each security rated by multiple NRSROs so investors could compare the accuracy of the different rating agencies. 

I wonder what your views would be on a proposal such as that, 

and could the SEC maintain such a website? Is there anything that 

would prohibit you from doing that? 

Mr. COX. Well, the idea of enhancing the transparency of the ratings themselves and their performance is at the heart of what we 

have been talking about, of course. Making the information as easily available to the public in the most easily comparable form also 

is a natural objective. And so Professor Coffee’s proposals in that 

respect are very much consonant with at least what I am thinking 


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and I believe what the Commission staff and perhaps the other 

Commissioners are thinking. 

As you know, the statute, I think wisely, says that the Federal 

Government should not dictate the ratings themselves, should not 

tell rating agencies in this competitive market precisely how they 

should do it, but there is ample support in the statute for disclosure around these things. So provided that the scorecard was disclosure and not indirect regulation—— 

Chairman DODD. No, I think that is what we are talking about. 

Professor Coffee can contradict me when he testifies, but I think 

the idea was just to allow—so you would have some way of looking 

at the accuracy of this and making judgments. 

Mr. COX. The final point that I would make is that were the disclosure mandated to be tagged with XPRL data tags in interactive 

data form, then almost anyone could put together their own comparative scorecard, and I think that a lot of financial intermediaries on the Web would do this probably for free for consumers 

and investors in addition to whatever the SEC might do on its own 

website. 

Chairman DODD. Yes. Of course, the SEC, that Good Housekeeping Seal of Approval is a very valued determinant. 

Mr. COX. Yes, of course, and if the SEC requires more detailed 

disclosure beyond what already is provided on the NRSRO, then, 

of course, all of that data would be official SEC-filed data. 

Chairman DODD. An additional suggestion from Professor Coffee 

would have the SEC temporarily suspend an NRSRO, the status of 

a rating agency that consistently errs in rating a particular type 

of security over a period of time. What are your thoughts on that? 

Mr. COX. The authority that you have just given to the SEC includes not only censure but revocation of the registration of an 

NRSRO. 

Chairman DODD. So you have that authority? 

Mr. COX. Yes, we do. 

Chairman DODD. There has been—— 

Mr. COX. Now, I should add, not if that authority were to be used 

to sanction someone for getting the rating wrong, but for violating 

any of the rules or provisions of the statute, that sanction would 

be appropriate. And as I mentioned before, you did not want us, 

the SEC, to actually regulate the substance of the ratings. But we 

would not revoke a registration for that reason. 

Chairman DODD. There has been a suggestion as well that a rating agency separate its rating business from its rating analysis 

function. We have heard similar arguments in the past in other related areas of financial services. What is your reaction to that suggestion? 

Mr. COX. Conflicts of interest of that sort are very much at the 

heart of what we are looking at in the proposed new rulemaking, 

and I agree both with the mandate in the act very strongly and 

with the inferences that have been drawn from it that conflicts of 

interest are directly related to some of the problems that we see 

in the market. 

Chairman DODD. Let me come back to the previous question. I 

heard your answer to it. It is one thing to break rules and certainly 

suspend. I understand that, you have that authority. What I was 


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driving at more is the error in judgment of consistently—I am not 

talking about, obviously—and this would have to be, you know, 

over a period of time you get just error after error in judgments 

and drawing conclusions about various instruments here. It seems 

to me there that—well, anyway, you don’t believe that that is an 

appropriate role for the SEC where you have a consistent error in 

judgment on these ratings, that that would be a justification for 

suspending that rating agency’s function? 

Mr. COX. Well, what the law contemplates—and I think what our 

rules will flesh out when they become final later this year—is a 

world in which everyone knows what the rating agencies are doing 

and why and how. We know what their internal procedures are. 

We know how they deal with conflicts of interest. We know what 

the prohibited practices are. If then in a competitive world their 

ratings fare less well even though they are performed exactly according to spec than someone else’s, that fact alone would not be 

grounds under the statute for revocation of their registration. 

If, on the other hand, the reason that their ratings were consistently wrong is that they had not followed the procedures that they 

described, not disclosed fully what they were doing—they had, for 

example, changed their ratings model under pressure to get business or what have you, or committed any other kind of error, or 

worse, in judgment, then I think their registration under the statute could be revoked by the SEC, and we would have the authority 

to do so. 

Chairman DODD. My time has expired, but I suspect my colleagues may want to pursue this line of questioning with you a little further. 

Senator Shelby. 

Senator SHELBY. Thank you, Senator Dodd, and thank you for 

bringing that up. I want to continue along that line for a minute. 

If some firm or NRSRO is consistently wrong on their ratings, 

you know, they rate them, then they are downgraded—and we 

have seen this over and over and over consistently—wouldn’t that 

call in, just common sense, the confidence of that firm, or whoever 

it was? And why wouldn’t you jerk their license or whatever they 

have to do business if they are consistently wrong, they are ignorant, they are incompetent, or they do not care, or they are sloppy, 

they are not diligent? I think that is what we were getting at, 

among other things. 

Mr. COX. Well, I think it stands to reason that there would be 

a connection in most cases—this is obviously a hypothetical discussion—between that kind of horrible track record and failure to follow all of the good hygiene that is mandated in law and regulation. 

This has heretofore been an unregulated industry. Once the regulations are in place and once people have an opportunity to either be 

in compliance or not with them, you will be able to draw a correlation, I imagine, between compliance with the law and regulation 

and failure in the marketplace. 

Senator SHELBY. But incompetence in the marketplace like this, 

especially rating securities that are so important, I think calls for 

rigorous enforcement of the rules and whatever they are. But you 

take doctors, if they are incompetent, they jerk their license, you 


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know, lawyers after a while, but why not something like this that 

goes to the very heart of our financial system? 

Mr. COX. Well, I think you may be asking me for advice on new 

legislation, because what I am trying to do is interpret—— 

Senator SHELBY. I think Senator Dodd asked did you need anything else. 

Mr. COX. Yes, interpret—— 

Senator SHELBY. You might and you might not. I do not know. 

Mr. COX. Well, I will say that if you want the SEC to revoke the 

charter of a credit rating agency simply for being wrong, even 

though it has followed all of its own rules and procedures, fully disclosed them, and fully disclosed the basis for all of its ratings, then 

we would need new law to do that because—— 

Senator SHELBY. Mr. Chairman, we are not asking for being 

wrong once. I believe Chairman Dodd used the words ‘‘consistently 

wrong,’’ which would bring about incompetence, the lack of diligence, and so forth. A lot of these rating agencies have been consistently wrong on the subprime, and I think they have contributed 

greatly to the financial debacle that we have today. Do you not 

agree with that? 

Mr. COX. Actually, over a long period of time in a number of circumstances, I have observed the pattern of ratings of very high levels, preceding almost by days in many cases horrible consequences 

thereafter. There is no question that the legislation that you provided us and the new authorities that we are going to exercise are 

much needed for that reason. 

I think, however, that the judgment that you made in passing 

the law is a good one, that there is a role for competition here; that 

if the Federal Government were to be the open arbiter of whether 

ratings approaches were good or bad, that would probably result in 

poorer ratings performance over time because people would not be 

able to update their models without regulatory approval. They 

would always stand to be second-guessed and so on. I think a system such as the one that you have designed in which everyone has 

to be aboveboard about the approach that they are taking and they 

are subjecting to competitive pressures, they are accountable, they 

are transparent, is probably most likely to get us the results that 

we want to achieve. 

Chairman DODD. Richard, would you let me—— 

Senator SHELBY. Go ahead. 

Chairman DODD. Just on this point, Mr. Chairman, under the act 

that was signed in 2006, let me just read the language here and 

see if this gives you any pause in terms of your response. It is entitled, under Section 3, ‘‘Grounds for Decision. The Commission shall 

grant registration under this subsection,’’ and then there are two 

or three—or two subparagraphs. Subparagraph (2), ‘‘unless the 

Commission finds, in which case the Commission shall deny such 

registration, that, one, the applicant does not have adequate financial and managerial resources to consistently produce credit ratings 

with integrity.’’ Now, that would be at the initial granting of a 

charter. So we are talking about something a little different here, 

and that is to withdraw a charter or to suspend a charter. 

So if you make a decision to grant one based on the ability to 

produce results with integrity, it would seem to raise the question 


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that at least the Commission would have the authority to suspend 

that charter if, in fact, that integrity were compromised. 

Mr. COX. I think that is exactly right. In fact, that is authority 

that we intend to use aggressively. That provision, of course, goes 

to resources. So I think we are talking hypothetically here. 

What we have done, rather unnaturally, in this hypothetical discussion is we have isolated just the ratings performance, and we 

have imagined that it has nothing to do with lousy management 

or violations of rules or procedures or other things, which undoubtedly in the real world it would. But this provision that you have 

just cited concerning failing to maintain adequate financial and 

managerial resources goes to quantity, and if the place spent tens 

of millions of dollars on their analysis, they probably would get 

past this. 

In any case, the provision that is the bar to our regulating the 

substance of credit rating agencies and the procedures by—or, pardon me, the substance of credit ratings or the procedures by which 

they are adopted is prefaced with the legislative language, notwithstanding any other provision of law. So it trumps everything else 

in the statute, and it says that what we cannot do is regulate the 

substance of credit ratings, and we cannot by regulation prescribe 

the methodologies by which they are obtained. 

Senator SHELBY. Chairman Cox, what are we trying to do with 

the rating agencies? Maybe you have a different take than I have. 

I hope we are trying to restore confidence in the rating system, 

their methodology, how they do what they do, because there is no 

trust out there in the market today. I don’t know many people that 

trust the rating system. They see that as a big contributor of where 

we are today and what we are trying to do, working with the SEC, 

and I was trying to do when I offered that legislation, what Chairman Dodd is trying to do now, is to give the SEC the tools that 

you need not to do business as usual. Doing business as usual with 

a rating agency, that is gone. So many conflicts of interest, as I see 

it, always so many cozy relationships, so much money made if the 

ratings went this way and that way. 

How do we change that? That is what we are after, is transparency and so forth, because I think the rating agencies can play 

and have played a tremendous positive role in our financial markets. But today, my gosh, you know, would I buy bonds that 

Moody’s or S&P rated AAA without looking at them and having 

somebody else look at them closely? No. I would be foolish to do 

it, wouldn’t I be? 

Mr. COX. I think that is exactly right, Senator. And as you know, 

as the author of the legislation, the overarching purpose is to improve ratings quality. The devices of transparency and accountability and competition are the means to achieving that result. 

And, of course, improving the quality of ratings is the prerequisite 

to improving confidence in that whole rating system. 

Senator SHELBY. Well, you are the Chairman of the SEC. There 

have been some recommendations to Secretary Paulson to change 

the role of the SEC, to make the Fed, you know, the great arbiter 

of everything, which I think would be kind of dangerous and foolish 

myself. But if the SEC is not going to do the job, somebody else 

will have to do the job. I hope that you and your leadership and 


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your other Commissioners will do the job that needs to be done. We 

are at a crisis here, a crisis of trust, a crisis of confidence, looking 

at rating agencies with so many obvious conflicts of interest. I 

think it is horrible. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator Shelby. 

Senator Reed. 

Senator REED. Well, thank you, Mr. Chairman. 

Borrowing an analogy from another field, do you think that any 

of these rating agencies were guilty of malpractice, not meeting the 

standard that you would expect as the Chairman of the Securities 

and Exchange Commission in the execution of their responsibilities 

to rate some of these securities? 

Mr. COX. That is one of the questions that we are asking and in 

part coming to answers on in our ongoing examination of the three 

largest firms. As you know, we have some 40 people on that project 

right now, and we expect to report fully to you by early summer. 

Senator REED. Your typical remedy, again, using this rough analogy, for malpractice is some type of action against the individual 

institutions and restitution or something, or at least to correct the 

behavior. And I am trying to sort of connect the dots here between 

at least the possibility of not operating appropriately and any type 

of sanction. They claim—and the claim has been, I think, affirmed—that they are protected under the First Amendment in 

terms of any type of legal liability. 

How do we get them to behave differently if, in fact, there is a 

serious question of misperformance? 

Mr. COX. Well, I think that from the fourth quarter of 2007 forward, we are in a different world, because now we have a regulated 

industry with legal standards of conduct, as we were just discussing. They can be censured. They can be hit with targeted sanctions. They can get the death penalty. There are all sorts of regulatory norms that they will now have to comply with. 

In addition, we will have a marketplace that is now much more 

competitive, not so oligopolistic. We already have additional credit 

rating agencies that have been able to enter the business as 

NRSROs as a result of the new legislation. And the disclosure and 

transparency that the new regime should provide will force—I 

think it is the legislative intent, and we expect it as well—some 

quality as a result. 

Senator REED. You said, Mr. Chairman, that you have got 40 individuals working on this analysis. When you implement the regulations, will you have the dedicated staff of roughly that size with 

the expertise to continue to evaluate the performance under the 

new regulations? 

Mr. COX. It is not necessary to have the current examination 

staff on a permanent basis as part of the CRA program. But we do 

have budgeted approximately in the range of 10 to 20 people over 

the long haul for this purpose. 

Senator REED. It just seems to me that in everything we read 

about these products, they are inherently complicated, complex. In 

fact, many people will not buy them. Jamie Diamond has been 

quoted several times saying, ‘‘They are too complicated. I do not 

understand them. I will not buy them.’’ And yet you will have 


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about 20 people who are going to overlook the credit rating agencies. Do you think that is adequate resources to ensure that they 

are—unless it is simply procedural, they check the blocks, you 

know, we did this, we did this, we did this, but with no substantive 

regulation? 

Mr. COX. For purposes of managing the registration and inspection regime—and, remember, we can use the resources as we are 

using now our Office of Compliance, Inspections, and Examinations 

for this purpose in the future as well. But for the ongoing purposes 

of managing the registration and compliance regime, I think that 

that is about the right number. 

On the other hand, the reason that I am inviting the views of 

this Committee on the size and scope of this program is so that we 

can be sure that within the context of the overall SEC, we have, 

in fact, right-sized this function. It is a brand-new function. We 

want to get it right. 

Senator REED. In that regard, how thoroughly will you anticipate 

the staff looking down through—and maybe this is not exactly correct, but a simple security model of a mortgage-backed security, 

where there are actually mortgages and a pool of mortgages, you 

sell securities. Then there is the CDOs, which basically gets more 

complicated, CDOs, squares, et cetera. Do you anticipate that your 

staff would be looking all the way through independently to the collateral of these securities, or at least on a spot-checking basis? 

Mr. COX. Most certainly on a sampling basis, and probably across 

the board just in terms of the different genres of products that are 

being rated. 

Senator REED. You raised in your opening statement the possibility of less reliance under the SEC rules on ratings. Can you amplify that? 

Mr. COX. One of the concerns that has been expressed in several 

of the multinational fora, including the Financial Stability Forum 

and IOSCO, is that that there was insufficient attention paid to 

what these rating were and what they were not and that there was 

in some cases nearly mindless reliance on the fact that it said AAA. 

In order to make sure that the ratings are understood for what 

they are and what they are not, we are going to have a lot of new 

disclosure. At the same time, we want to make sure that there is 

not a check-the-box mentality, and if the rule says you can do X 

if you have a AAA rating, that might induce that kind of behavior. 

So we will not be able to purge, by any means, our rules of references to ratings, but there may be some fine-tuning that we can 

do in order to make sure that we do not create that moral hazard. 

Senator REED. Well, it would seem to me that, theoretically, as 

you diminish purposely the role of the ratings, not that, you know, 

Good Housekeeping Seal of Approval, put the onus, I think, either 

directly by rules for publicly registered companies to independently 

evaluate the ratings that they are either buying or they are arranging to obtain, that might be appropriate for some larger institutions, but for small investors, for municipalities, for people who are 

looking—do not have the infrastructure, how effective would that 

be? 

Mr. COX. Well, I think if the only consequence of a change were 

to increase the investor burden, then we would not have accomVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00024 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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plished the objective. We have got to be very, very sensitive to that. 

The opportunity, I think, that we have is to state very clearly in 

our rules what is the point that we are trying to establish, what 

is the objective test that we are asking people to meet. And if a rating—— 

Senator REED. What is that test? 

Mr. COX. It depends entirely on the circumstances. The ratings 

themselves are mentioned in rules and in statute, I should add, in 

many different contexts. But if we can simply clearly state, and in 

plain English, what it is that the law and the rules are trying to 

accomplish by referencing these ratings, we can add a little more 

context to it so it is not just a mindless act of I got the rating even 

if the use of a rating for that purpose would not be appropriate. 

Senator REED. Thank you. 

Chairman DODD. Thank you very much. 

Senator Corker. 

Senator CORKER. Yes, Mr. Chairman, thank you. 

I thank you for your testimony, Mr. Chairman, also, and we have 

had you up here many times, and we appreciate very much the position that you are in. 

I have to tell you, the rating agencies do not spend a lot of time 

on accounting issues, and we have heard of the fact that they are 

not audits, which obviously they are not. But it seems to me that 

it would be almost impossible in many cases for a rating agency to 

give a rating without at least looking at some of the basic accounting principles that are being dealt with. 

I spent all day yesterday with the leaders of financial institutions 

in New York, and this whole fair-value accounting system, which 

needs some kind of updating, there is a huge, huge issue there. But 

for them not to at least get into some of the things that are occurring there as a rating agency and how judgments are being made 

as to assets being written down and that type of thing seems to me 

a very important—and there are many others—a very important 

thing for a rating agency to be able to do to actually issue a rating. 

Otherwise, I do not know how it would occur, and I would love for 

you to comment on that if you would. 

Mr. COX. Well, there is no question that particularly in terms of 

market pricing, those kinds of accounting judgments associated 

with fair value and related issues have had big impacts. The rating 

agencies have described on occasion their purpose and their object 

as being slightly different than predicting market prices. They are 

in the business, they tell us, of predicting the creditworthiness of 

the ultimate instrument on maturity and so on, and that, therefore, 

gainsays a lot of the wave motion that might occur, even if the 

wave motion capsizes the boat in the short run. And so these 

issues, at least in the current market turmoil, have really 

conflated—I do not think it is any longer possible to neatly parse 

what is the ultimate creditworthiness of the instrument from what 

is going on in the marketplace. 

If an instrument, for example, is totally illiquid, then it is reduced to something like worthless for an indefinite period of time, 

and it is very difficult for adults to say that, nonetheless, it is a 

very valuable security and we want to own it because ultimately 

it is going to pay off. 


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Senator CORKER. So then what should be the role? I mean, 

should rating agencies not indulge more, if you will, on the accounting side? I mean, is that not a valuable piece of information 

for them, if you will, as to—because there are people, obviously, 

that do rely on these ratings; you know, that is what they have 

been put in place for in the first place. Is that not something that 

rating agencies should be somewhat involved in as they make these 

ratings? 

Mr. COX. Yes, I think one of the sources of confusion for investors 

has been this big gulf between what they see happening in the 

marketplace and what they say with the ratings. And before the 

round of significant downgrades, there was this big gap. Ultimately, many of the downgrades had the effect of conforming the 

ratings with the judgment of the marketplace. And so I think that 

there is no question what is going on now inside the rating agencies is informed by this much different world. 

Senator CORKER. Talk to us a little bit about the notion that has 

been floated—and we have heard a lot from constituencies about 

this—of separating out ratings for structured finance itself and the 

impact that that might have, if you will, on those particular instruments. If you would, expand a little bit on those discussions. 

Mr. COX. Well, the suggestion has been made—and it is under 

careful consideration by the SEC and may be included in our proposed rules—that there be different symbologies for different kinds 

of products, whether they be structured products, corporate or municipal, for example. There is no question that a AAA rating on a 

structured product is very different than on a corporate, and yet 

the same labels being applied to all of these things might have 

caused confusion in that respect in the marketplace. 

So I think this is a very valuable subject for us to explore in connection with our proposed rulemaking, and I can confidently predict, even though I do not know what the ultimate proposed rules 

look like, that we will expose that whole idea for public comment. 

Senator CORKER. And that would obviously have a tremendously 

dampening effect on the structured finance market if that occurred, 

at least in the short term. Is that not correct? 

Mr. COX. I do not think that would be the idea at all. The idea 

would rather be to let people know exactly what it is, what a rating 

means. 

Senator CORKER. And is there a notion of maybe actually stamping structured finance as sort of a scarlet letter-type approach, if 

you will, to this type of financing? 

Mr. COX. Well, there have been calls from State governments and 

State finance officers for different symbology for municipals as 

well. They believe that having—at least some people believe that 

having different symbology would actually advantage them because 

they believe their default rates are provably lower. And so I do not 

think it is inherent in the nature of having unique symbology that 

you are advantaged or disadvantaged in the marketplace. It is just 

simply a way for people to understand what it is they are talking 

about. 

Senator CORKER. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator. 

Senator Bayh. 


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Senator BAYH. Thank you, Mr. Chairman, and you, Mr. Chairman. 

It seems to me that the issue we are focused on here, Mr. Chairman, is that one of the principal factors that has led to the market 

failures we have experienced—and I gather Senator Schumer 

touched upon this before I arrived—at the originating end you had 

brokers who had incentives to just kind of get these mortgages out 

the door and not adequately assess the underlying risks involved, 

the likelihood of the mortgages being repaid, you know, that sort 

of thing. Here we had the rating agencies giving their blessings to 

the repackaging and selling of these loans, again, possibly with incentives to do that without really digging in and accurately assessing the risks involved. And markets can’t function very well without access to accurate information, and so here we are today to try 

and ensure that we do have accurate information going forward. 

Mr. Chairman, it seems to me that this is in some ways analogous, as I think you mentioned in your testimony, to some of the 

accounting issues that we dealt with before. I mean, for example, 

can you imagine any reason why a rating agency should be allowed 

to pass judgment on products that it has itself helped to structure? 

Isn’t there just an unavoidable conflict in such an arrangement? 

And didn’t we decide that in some respects in the accounting 

arena? 

Mr. COX. Well, there is an unavoidable conflict in that arrangement, and there are, in fact, other unavoidable conflicts that are 

built into either the issuer-pays or the subscriber-based models. 

And so what we are preparing to do in our proposed rulemaking 

is in some cases just flat out to prohibit them if we can see our way 

clear to doing that without disrupting markets and the ability of 

firms to function. And on the other hand, if you cannot bar a practice altogether without upending the whole thing, then to come up 

with approaches to manage those conflicts very clearly, for example, to make sure that at a minimum people who are in the business of negotiating fees do not have anything to do with the ratings 

process. 

Senator BAYH. If we are going to be living going forward in a 

more robustly competitive world with new entrants coming into the 

rating marketplace, as you were describing, why would a prohibition not work since there are all the new entrants coming in and 

it would presumably be easier to just prohibit this without it disrupting the marketplace? 

Mr. COX. Well, the only reason I left it open to either interpretation is I did not say what specific practice it was that we are talking about prohibiting. 

Senator BAYH. Same thing for consulting—— 

Mr. COX. Without question, the easier way, even from, I would 

think, the firm’s standpoint because they know what the rules are, 

would be just to flat out prohibit these virulent practices. 

Senator BAYH. Same thing for consulting services by rating agencies? 

Mr. COX. Yes. I think that is undoubtedly a conflict of interest, 

and properly structured, speaking for myself, I do not see why that 

could not be prohibited. But I should add once again, because while 

I am appearing here as an individual and as Chairman, that I am 


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part of a five-member Commission, that there are a lot of issues 

here, and I do not know what we might propose in our rules. 

Senator BAYH. In the previous enactment of the new law governing this area and the new robust nature of the competition you 

have described that is beginning to take root in this area, is it your 

opinion, did real competition exist among these ratings agencies before this problem we have encountered here? Was there real competition or not? 

Mr. COX. Barely. If—— 

Senator BAYH. Somebody used the word ‘‘oligopoly,’’ I think. 

Mr. COX. I think that was I earlier in this proceeding, and that 

is my view. This industry needs more competition, and the legislation that you have passed will help it to mature into a much more 

competitive industry. That in turn, I believe, will improve the quality of the ratings. 

Senator BAYH. Do you see a problem between—again, competition and markets function very well. It is somewhat dependent 

upon the incentives that exist in the marketplace. Is there the potential for a disconnect, a continuing disconnect between shortterm incentives and long-term incentives leading rational decisionmakers to perhaps make decisions that are in their own best interests but not in the better interests of the overall functioning of the 

marketplace? I will give you an example here. 

Just as the loan originators, the mortgage brokers, were pushing 

a lot of this stuff out because they were compensated in many cases 

by volume rather than the ultimate accuracy of the loans they were 

making, do we have a problem here? I know at least one of the rating agencies was publicly held directly; another is held under another publicly held company. In any event, you might get people 

who were being compensated because of their short-term performance, and they get bonuses. If they have stock in a publicly held 

company, they can cash their options or sell their stock as it becomes unrestricted. So they are making real money in the short 

run, so there is a real incentive to do that, even if in the long run, 

if things go badly, there may be some risk to the reputation of the 

firm and ultimately the long-term value of the stock in the firm, 

but the pressure is on now, they are being compensated to perform 

now. What about that disconnect? And how does the marketplace 

take that into account? Were there such strong, you know, personal 

reasons to make a set of decisions today but then in the long run 

a rational decisionmaker might not make? What do we do about 

that ongoing problem with the way people are compensated in 

these businesses? And how does the competitive model—is there a 

risk to the competitive model when you have that kind of disconnect between the short-term incentives and perhaps long-term 

factors? 

Mr. COX. Well, that is very much a part of the short-termism 

that afflicts our markets overall. There has been on occasion a call 

to eliminate quarterly guidance for earnings for companies, for example, for related reasons. The compensation structure of a firm, 

and I would think now credit rating agencies, since they are now 

a regulated industry, have to be thought of in terms of the objects 

of the regulation and the objects of the ratings themselves in that 

particular industry’s case. 


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So as we look at conflicts of interest, compensation won’t be off 

limits. 

Senator BAYH. Oh, it won’t. Very good, because it seems to me, 

again, you could have, let’s say, with, you know, seven participants 

or nine or ten, whatever the number ends up being, if we have a 

system that rewards people for making certain kinds of decisions 

in the short run, irrespective of their accuracy in the longer term, 

we could get, you know, warped outcomes that affect the entire 

marketplace and, hence, you know, the economy and society at 

large that would not be in anybody’s best interest. So I am glad to 

hear that you will be addressing some of those issues as well. 

Mr. Chairman, thank you. I am surprised you can do the rest of 

your day job. You have been up here with us so many times. But 

we do appreciate it very much. 

Mr. COX. Well, if I may say so, Senator, in respect of this particular part of my job, writing regulations under this statute, it is 

of enormous value for me to have these conversations, these colloquies, because as I said, it is the intent behind this legislation, 

which is so fresh, that we are trying to flesh out with the regulations. And so I am entirely sincere when I say we want all the 

ideas we can get. This is the second round of rulemaking, and it 

is the most important one, because it is based on the very recent 

experience that we have had in the subprime debacle. 

Senator BAYH. Thank you. 

Chairman DODD. Thank you, Senator. Hence, the initial question: Do you need more statutory authority? What I do not want 

to discover here is have you complete this process and turn around 

and discover you needed additional authority to do something and 

we did not provide it for you when we had an opportunity to do 

so. And I heard your answer to the question, but I assume you will 

keep us posted if you encounter something different. 

Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. 

Where I see the greatest conflict of interest might be in the payment model that has been set up with the credit agencies; in other 

words, the one who is being evaluated ends up paying the credit 

agency for the outcome. Do you see a conflict there that concerns 

you? Or are you comfortable with that model? 

Mr. COX. Well, it is a necessary conflict of interest that somebody 

pay, because whoever pays is going to have some interest. And so 

in the issuer-pays model, you get one set of conflicts. In a subscriber-pays model, there are other kinds of conflicts that can arise; 

for example, the people who want to include certain things in their 

portfolio might want to have ratings that permit them to do so. 

And so there is really no way out, provided that someone is paying. 

What you are stuck with is recognizing and sharply identifying 

those conflicts and then managing them. 

Senator ALLARD. Even if the taxpayer pays, there is a conflict, 

I guess, in a way. Or is there not? 

Mr. COX. Well, there is a conflict with the Federal budget, I 

would imagine at some point. 

Senator ALLARD. Yes. 

Mr. COX. If we nationalize all these functions. 


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Senator ALLARD. You know, it is not that that model has not 

been used. I think in my own profession where we write a health 

certificate, when we write a health certificate, we are an agent of 

the Federal Government. We are paid by the—we act as an agent 

for the Federal Government, and we also act as an agent of the 

State that the animal is being shipped to. But the one who pays 

us is the one who is shipping the animal and is asking for—you 

know, and he will pay, and obviously we will pay a fee or whatever. 

But the consequences of not finding that you did something that 

was unethical or whatever can be pretty severe, and you could lose 

your license and not be able to practice in the profession. 

Do you think that you have the consequences there that are severe enough to prevent bad behavior? 

Mr. COX. There is no question, Senator. In addition to the sanctions that can be applied directly to the rating agencies under this 

new law, sanctions can be addressed to their associated persons. 

And so every single individual who works in an NRSRO can be the 

subject of SEC sanctions as well. 

Senator ALLARD. I want to take you into a hypothetical area because ‘‘consistency’’ has been a term that has been frequently used 

by my colleagues here on the panel, you know, consistent results. 

If we were to use—and we have consistency, I guess, in law. How 

in the world do you evaluate what consistency is? I mean, is it 20 

percent error? Is it 30, 40, or 50? Or is it some deviation from the 

normal from your competitors? Do you have any idea how we would 

determine consistency? 

Mr. COX. I think to begin with, it would depend upon the subject 

of the rating. It would depend upon the industry and its volatility 

and its history. So that coming up with a very simple rule of thumb 

that would apply across the board to everything in the capital markets I think would be impossible. 

The best approach to that kind of complexity is to have the maximum amount of disclosure of all the material information and 

then to permit comparison in the marketplace. 

Senator ALLARD. Let me ask a question about disclosure. If you 

have foreign securities, is disclosure a problem? You know, you 

might, for example, have a business that is partially owned by 

some foreign government. And so how do you get an adequate disclosure as to the background of how you are going to valuate that 

security? It kind of gets to the accounting issues, I think, that we 

were talking about earlier here on the Committee. How do you 

handle those kind of foreign securities? 

Mr. COX. Well, transparency varies dramatically from jurisdiction to jurisdiction, and in some cases, one is left with nothing 

more than a brand name to go on, because there is so little behind 

it when making an investment decision. 

On the other hand, in some other jurisdictions, there is a great 

deal of transparency, and the level of accounting detail and disclosure about management and ultimate parents and so on is what we 

would be accustomed to here in the United States, ordinarily so. 

So it just depends entirely on the jurisdiction in which—— 

Senator ALLARD. A brand name is pretty subjective, isn’t it? 


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Mr. COX. Yes, of course. And I think that people investing in 

those parts of the world tend to use diversification at some protection for the risk that they are taking. 

Senator ALLARD. I have always been under the impression that 

what happens in the marketplace as far as rate of return is somewhat influenced by the risk of the investment. Do you think that 

holds up still today? And do you see a correlation between—I suppose there is because what happens with the rate of return—I 

mean, when they do an anticipated rate of return, I suppose they 

take into account how the rating agency rated that particular security. 

Mr. COX. The correlation between risk and return is as ironclad 

as the certainty of death and taxes. 

Senator ALLARD. And you see it—and what you are seeing in— 

did you see an instance in these securities, particularly the home 

mortgage products, was there a higher rate of return with those 

more risky mortgages or not? 

Mr. COX. Well, I think that part of the alchemy that led to what 

we saw in the subprime turmoil was this sense that there was a 

cost-free way to improve the return. 

Senator ALLARD. A cost-free way to—— 

Mr. COX. Yes. It turned out not to be the case. 

Senator ALLARD. Yes. But there was an anticipation of greater 

return on their investment, would you say? 

Mr. COX. Yes, of course. 

Senator ALLARD. And so—— 

Mr. COX. And from the issuer standpoint, the opportunity to 

securitize permitted them to borrow at lower rates. 

Senator ALLARD. And that assumption of where that rate of return came from, do you think it was just the experience of the investor with the market? Of course, every individual would have different experiences in that regard. Or was it based pretty much on 

credit rating? Or both? 

Mr. COX. Well, I think the overall sense in the short run was 

that a better mousetrap had been built, that one of the working 

parts of that mousetrap was the credit rating, and even against the 

evidence, late in the game people clung to the hope and the belief 

that somehow it could be true. 

Senator ALLARD. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. You raise a couple of 

issues, and I think Senator Schumer may be on his way over as 

well to ask a couple of questions before we move to our second 

panel. 

If I may, we received a letter yesterday from a group of individuals, the Real Estate Roundtable, the Mortgage Bankers Association, Commercial Mortgage Securities Association, the National Association of Realtors. I presume that was all one letter. Was that 

one letter? 

They were opposed to proposals of the President’s Working 

Group to differentiate between credit ratings for structured finance 

products and other assets. What is your reaction to that? I will see 

you get a copy of the letter, too, but I would be curious what is 

your reaction. 

Mr. COX. Just a moment, if I may. 


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[Pause.] 

Chairman DODD. They make a case, by the way, in the letter, in 

fairness, they say that the changes would—and I quote them 

here—‘‘contribute to greater market volatility and investor confusion.’’ 

Mr. COX. Well, I have not seen the letter myself, but this is a 

subject that I think we are very interested in. I know that at 

IOSCO, regulators around the world are interested in this topic; 

within the Financial Stability Forum, it has been discussed; within 

the President’s Working Group it has been discussed; at the staff 

level at the Securities and Exchange Commission and at the Commissioner level, it has been discussed. 

So I would predict that whatever occurs in our proposed rules, 

we would ask the public questions about this and engender more 

of that kind of comment on both sides of the issue. 

Chairman DODD. I would be very interested in hearing if you do 

develop that or where maybe the Commission is heading with that. 

I would be interested. 

Senator Schumer. 

Senator SCHUMER. Thank you, Mr. Chairman. And thank you. I 

am sorry that I could not be here for the testimony, but I have a 

few questions based—some based on our discussions that we had, 

which I want to again reiterate I appreciate your coming to my office and briefing me on these ahead of time. 

Now, we all know now that the SEC has stronger oversight authority over the agencies since the legislation that Senator Shelby, 

Senator Dodd, and others of us endorsed is now the law. And so 

you have had examiners at the firms, and my focus is on the conflict of interest issue. 

I know your investigations are ongoing, but can you just give us 

a sense of what you found regarding the agencies’ compliance with 

their stated procedures intended to control conflict? In other words, 

the article here that I referred to earlier, which I found did a very 

good job, seems to indicate that before you were given authority, 

there were conflicts and nobody paid much attention to them within the credit rating agencies themselves. Is it getting better? Do 

they have their own controls? Does some little buzzer go off when 

a supervisor wants to change the person on the job because he is 

not giving or she is not giving as good a rating? 

Tell me—I am not asking for any specific investigation about a 

specific agency. I am asking in general how good are the agencies 

at uncovering these conflicts now that it is against the law to—you 

know, now that these conflicts are against the law. 

Mr. COX. Well, I feel very confident in saying that it is better. 

It is better for obvious reasons. There is so much focus on this right 

now and so much has gone wrong that many have reacted with 

alarm, and there is a lot of attention being paid to it. 

We have in the course of our examination thus far found examples of apparent failure to adequately manage conflicts of interest, 

and some instances have even occurred this year. 

Senator SCHUMER. So it would be better, but there are still 

lapses, even after all the focus on credit rating agencies. Is that a 

fair way to put it? 

Mr. COX. That is a fair way to put it. 


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Senator SCHUMER. And what are you doing when you find these 

lapses? 

Mr. COX. Well, of course, we are in there with live bodies in real 

time, and so anything that is brought to our attention is dealt with 

on the spot. But, in addition, we are going to make broad inferences based on our examination of the three largest firms and 

present those publicly, as well as to the firms in early summer. 

Senator SCHUMER. Good. So we will learn about some of these 

lapses. 

Mr. COX. Yes. 

Senator SCHUMER. And that should be somewhat prophylactic as 

well in terms of preventing them from doing it again. 

Is it that the agencies do not want to? Or is it just so embedded 

in their culture? You know, this article points out when new management came in at Moody’s, the whole world changed because 

they wanted to increase market share in something that ended up 

being risky, although it probably was not thought to be risky at the 

time. When you go to the higher-ups in the firms, do they want to 

change? Do they want to get rid of these conflicts of interest? Or 

do they say, hey, we will lose business, we better be careful and 

not do it so fast? 

Mr. COX. Well, it sounds as if you have, as I have, met with the 

leaders of these firms, and they certainly express a strong desire 

to deal with these problems and to take them seriously. I think the 

only proof, however, is going to be in the pudding. 

Senator SCHUMER. Right, and they are not there yet. OK. 

One other question related to this, and I thank you, Mr. Chairman. People have questioned the agencies’ reliance on information 

supplied by the issuer to determine their ratings. You know, I 

guess the average person, maybe even the average investor feels 

that the credit rating agencies do not just take the information that 

is given, but go investigate and see if it is for real, because obviously the issuer is going to put their best foot forward. 

Have you found—shouldn’t there be some disclosure on the 

amount, or the lack thereof, of the due diligence that is performed 

on a bond? 

Mr. COX. Yes. 

Senator SCHUMER. In other words, if they did not investigate it, 

if it has another no-doc loan in some other area, they should say 

that clearly: This is has no documentation, and we did not investigate it; or, It has documentation, and we did not investigate it; 

or—you know what I am saying. 

Mr. COX. Yes, that is an important subject for disclosure. It is 

one that I mentioned in my testimony that I think may well be covered in our proposed rules. 

Senator SCHUMER. Right. Now, let me ask you this: Do you 

think—this is, again, based on that article, which I guess you 

might think from my testimony I am obsessed with, which I am 

not. 

[Laughter.] 

Senator SCHUMER. But do you think that—it is just a good article. That is all. I did put it in the record in my opening statement, 

Mr. Ranking Member. 


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Do you think significant changes in market share should automatically trigger enhanced scrutiny by the SEC over the rating 

agency activity? If all of a sudden they rated 20 percent of these 

bonds and now they are getting 70 percent in a year, something is 

up. What do you think of that idea? 

Mr. COX. Well, because you provided it to me, I have had a 

chance to read that article, and—— 

Senator SCHUMER. Oh, there you go. 

Mr. COX. There is absolutely no question that that kind of red 

flag should be a guidepost for an examiner. 

Senator SCHUMER. Good. That is good to hear. And what about 

other red flags, such as significant deviation in ratings performance 

from historic averages or significant analyst turnover? In other 

words, you may not have the specific on this case, but you are seeing there are a lot of analysts that have been turned over lately. 

Should that also provide a similar red flag? 

Mr. COX. I think so. Obviously, the facts will inform in any particular examination where the examiners want to go, and I think 

over time, as the SEC develops more and more expertise in this, 

we will have, either formally or informally, a whole set of—— 

Senator SCHUMER. Right. And we can expect some of these in the 

proposed rules that you are going to put out this summer, I presume. 

Mr. COX. Yes, although what we are talking about right now is 

the kind of thing that examiners are going to look to. 

Senator SCHUMER. Right, or guidance to the examiners that 

might be made public. We are going to see concrete evidence of 

some of these things happening, and it will be sort of out there 

publicly that you are doing it. 

Mr. COX. I—— 

Senator SCHUMER. Not specifics. The general things. 

Mr. COX. I can undertake to do that, yes. 

Senator SCHUMER. Good. 

Mr. Chairman, thank you. 

Chairman DODD. Thank you very much, Senator. 

Let me ask one more question. Again, Professor Coffee is here 

and obviously is going to be testifying, but he, I thought, raised a 

very good issue in his testimony. It goes beyond the issue of the 

due diligence and all of the questions that Senator Schumer, Senator Shelby, Senator Reed, and Senator Corker raised, and that is 

the staleness of data. It is one thing to get it wrong initially, but 

then to have a conclusion hanging around for a long time, when information emerges that would certainly warrant at least someone 

stepping up to the plate and saying something—in fact, he calls it 

the ‘‘gravest problem’’ may be the staleness of the debt ratings. And 

I guess the agencies—are agencies timely in updating ratings and 

withdrawing obsolete ratings? What standards should they observe 

in that process? 

On page 8 of his testimony, the professor points out that major 

downgrades of CDO securities came more than a year after the 

Comptroller of the Currency first publicly called attention to the 

deteriorating conditions in the subprime market and many months 

after the agencies themselves first noted problems in the markets. 

I think it is a very good point, and we have talked a lot about the 


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front end of this. But the staleness of data I think is a very good 

observation. What is the reaction of the Commission to that? 

Mr. COX. Well, I think that overall, first, I should say that the 

contribution that Professor Coffee has made to this whole discussion has been exceptional, and I want to thank him, and I am glad 

you have him on your next panel. I am glad he is here today. And 

certainly at the agency, we have spent a good deal of time taking 

all of that in. 

Second, at least as a matter of pure disclosure, it seems completely feasible to deal with this issue, to require disclosure of how 

often the models are updated and how they do surveillance, how 

the rating agencies do surveillance of their past ratings. 

Chairman DODD. I appreciate that. 

Senator Shelby. 

Senator SHELBY. I want to pick up on something Senator Schumer brought up. Thank you, Senator Dodd. 

How do you measure these rating agencies in a sense? Transparency will help, but the SEC has to play a role here because this 

is such a debacle. They tell us at times—and I have talked to some 

of them—well, gosh, you know, we are just giving our opinion. Are 

they? Is it more than my opinion? They say, well, under the First 

Amendment of the Constitution, we are just giving our opinion, 

free speech. But they are selling this information, and then it is relied on all through our financial system. So there is something 

amiss here, Mr. Chairman. You know, as Chairman of the SEC, I 

know you are going to look at all this, but Senator Dodd brought 

up that the Comptroller of the Currency has to start asking some 

questions about some of the subprime things. Where were the rating agencies early on in this? I am afraid what they were doing is 

continuing to rate a lot of these subprime securities at investment 

grade, some even AAA and so forth. And, Mr. Chairman, I will ask 

you as you get into this: When did they start downgrading their 

ratings? Was it after the whole thing was in a free fall? 

I do not know, but I just know something is amiss here in all 

of this. We went through the Enron deal, but, gosh, this is so much 

bigger, you know, in many ways than that. And I know that the 

rating agencies play an integral role here. The SEC has to play a 

big role of oversight here. Make no mistake about it. 

Mr. COX. Well, I think the fundamental answer to your question 

of how you measure their performance is the quality of their ratings. And, you know, up until very recently, there has not been a 

lot of competitive pressure on that quality, and so whatever—— 

Senator SHELBY. Is that because everybody bought into it, you 

know, the euphoria? 

Mr. COX. It is for a variety of reasons, but not least of which is 

that there are very few of them, and yet ratings were by regulation 

and by law in many cases required. And so they had a Government-required function. There was no place else to shop, and so 

that is not a good competitive climate to begin with. 

The measurement of the quality of ratings is inherently subjective. It is going to be quantitative, to be sure. It is going to be analytical. But there are so many things that go into it, it is going to 

inherently be subjective. It is the kind of thing that markets are 

good at. 


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Our disclosure system at the SEC when it comes to price discovery for all sorts of things, like corporate equities, helps people 

arrive at a very specific number, the price for a security, whether 

people think that that price is the future discounted cash-flow, the 

quality of management, new product introductions, or what have 

you. Reducing complexity to a measurement like that is what markets are very good at, and the SEC is very good at disgorging information to the public and making sure there is full disclosure so 

that the public can make those judgments. I think that is what we 

are about to do now with credit rating agencies. 

Senator SHELBY. Mr. Chairman, if the rating agencies are the 

linchpin of our financial markets, our securities market—and a lot 

of people believe they are—our linchpin is broken right now as far 

as confidence, trust in the financial markets. And I believe it is 

going to be—a lot of what you do, and your other Commissioners, 

and what we try to help you do is going to help restore some of 

that. But the old way of doing business with the rating agencies, 

that has got to go. I believe it has to, and it should have already 

gone. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, and I am going to leave 

the record open, Mr. Chairman, for additional questions that may 

come from members here. We have a second panel I want to get. 

Senator Reed and I were chatting and, you know, raised the 

issue—which I will not raise with you right now because—unless 

Jack wanted to bring it up, but the whole notion of whether or 

not—I have had some people say to me, Why even bother having 

rating agencies in this day and age? There is a case to be made 

for people who are in this world who wonder whether or not we are 

just spinning our wheels in a sense by doing this. I think there is 

an argument for it. And, second, why not even consider the possibility of sort of a nonprofit sort of a credit rating agency, have a 

colleges approach that sit and determine whether or not something 

is a good institution or not, to take all the conflict out altogether? 

Now, that is a bigger question than what we have asked you to 

do here, but do you have any quick comments on that at all? I 

mean, that is an idea that has been raised by some. We may never 

be able to address—as you point out, both from the subscriber as 

well as the issuer, the conflicts are going to be there, no matter 

which side of this you flip it. And so are we reaching a point that 

maybe we ought to be talking about a different system altogether? 

To go to the question Senator Shelby has raised here, if this is the 

linchpin in all of this. What are your thoughts on that? 

Mr. COX. I think it is entirely possible to have private sector entities that are commercial in nature that are, nonetheless, independent from the securities that they rate and who do a good job 

of it. 

There is a conflict of interest in virtually every commercial relationship in the sense that, you know, if you go to the dentist and 

it is the dentist’s interest to charge as much money as possible and 

you do not really know that much about dentistry, well, the dentist 

could tell you that you need all your teeth replaced. 

Chairman DODD. I can sue that guy for medical malpractice. I 

cannot sue this guy. 


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Mr. COX. Well, I think that that is what is changing. The result 

of the legislation that you passed and the regulatory authority that 

you have given us, the ability that we now have to define practices, 

define what is necessary to manage, mitigate, or end entirely those 

kinds of conflicts of interest makes this all very different. 

The authorities that we have under the securities laws will now 

apply in like way to participants in this market; not only the firms 

themselves but their associated persons will now be subject to 

sanction by the SEC. And so the difference between being completely unregulated, which was the case 61⁄2 months ago, and now 

being a regulated industry is enormous. And I think there is a good 

deal of reason to expect that it will do a lot of good. 

Senator SCHUMER. Mr. Chairman? 

Chairman DODD. Yes. 

Senator SCHUMER. Just one question, if I might. I mean, there 

is an intermediate step. Senator Dodd’s ideas are, as usual, intriguing. But do you think there is less conflict in the investor when the 

investor pays the agency as opposed to the issuer paying the agency? I mean, it is conflict from the other side. It puts the premium 

on not AAA but maybe failing grade, you know; or it moves it in 

one direction rather than the other, is a better way to put it. But 

does one make more sense than the other? Should that be something that is seriously explored as well? 

Mr. COX. Well, I think that both make more sense in combination, because each is a check against the other. And what your legislation has opened the door for now is relatively easy entry into 

the market for subscribed-based ratings. 

Senator SCHUMER. And there are few right now. 

Mr. COX. There are already two that we have registered. I expect 

there will be more in short order. 

Chairman DODD. Interesting. Mr. Chairman, very good We thank 

you immensely, and please stay tuned. And stay in touch with us, 

too, on this issue, on that question. If there is additional statutory 

authority that your agency thinks you may need in this area, this 

Committee would very much want to know that as soon as possible. 

Mr. COX. Thank you very much, Mr. Chairman. 

Chairman DODD. If our second panel would come up quickly, and 

I apologize. You have been waiting a long time. 

We hardly need to introduce Professor Coffee. He has been 

talked about so often here that he has already been sort of introduced. But Professor John Coffee, Columbia Law School, served on 

distinguished legal bodies, published significant research, and contributed to the work on Sarbanes-Oxley. 

We are pleased to welcome Dr. Arturo Cifuentes, the Managing 

Director on the Structured Finance Department of R.W. Pressprich, 

and former Managing Director of Global—the global head of 

collateralized debt obligation research at Wachovia Securities. 

I want to welcome the representatives of the three largest 

NRSROs: Vickie Tillman, Executive Vice President, Standard & 

Poor’s; Claire Robinson, Senior Managing Director of Moody’s Investor Service; and Stephen Joynt, President and Chief Executive 

Officer of Fitch Ratings. 

I want to underscore the point that Senator Schumer raised earlier, and I understand in Moody’s case there was a conflict today 


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because of shareholder meetings. And obviously his obligation is to 

be there for that. But for these other rating agencies, I would very 

much like to have heard from the heads of them. We have got people here from these agencies, but, candidly, it is a little more difficult to expect them to respond to these questions that we are all 

going to have for them. 

Senator SHELBY. May I say one thing, Mr. Chairman? 

Chairman DODD. Let me turn to Senator Shelby. 

Senator SHELBY. Mr. Chairman, I want to associate myself with 

your remarks. I want to commend the President and Chief Executive Officer of Fitch Ratings for coming to this hearing. But I am 

disappointed, as you are, and Senator Schumer was, and others, 

that the other CEOs of Standard & Poor and also Moody’s, regardless of conflict—this is a Senate hearing on something that I think 

is very, very important. And we are going to get them here, I hope, 

Mr. Chairman, because although they will have able people here 

testifying on their behalf, it is not like having them here themselves. 

Thank you. 

Chairman DODD. I appreciate that. 

I appreciate your patience. First of all, you have been—I hope 

this hearing has been instructive as you have been sitting there listening to all of this, and helpful to some degree. Certainly you have 

heard the expressions expressed by almost every member here 

about their concerns about all of this and the importance of this 

issue. So let me begin by asking for your comments, and, again, 

your testimony will be included in the record, beginning with you, 

Professor Coffee, and we will then turn to Ms. Tillman, Ms. Robinson, Mr. Joynt, and Mr. Cifuentes. 

STATEMENT OF JOHN C. COFFEE, JR., ADOLF A. BERLE 

PROFESSOR OF LAW, COLUMBIA UNIVERSITY LAW SCHOOL 

Mr. COFFEE. Thank you, Chairman Dodd, Ranking Member Shelby, and it is a pleasure to be back again in front of your Committee. In order to be brief, let me break my testimony down into 

three short segments. 

First, and very briefly, what have we long known about the rating agencies? And I suggest none of this is about to change. We 

have long known that they face limited competition, and if you 

want, they share an oligopoly. 

Two, we have long known that they face very little liability to investors, and, indeed, they have never been held liable to investors. 

That is different than every other financial gatekeeper, auditors, 

securities analysts, or anyone else. 

Next, they have a built-in conflict because they are a watchdog 

paid by the party they are to watch. Now, auditors are also, but 

auditors face real liability. 

And, fourth, they have a business model under which they can 

make money, even if no one trusts their ratings, because they are 

also selling regulatory licenses. Institutional investors cannot buy 

debt securities without their rating, and that protects them even 

if they are off the mark. 

OK. That is what we have always known. What have we learned 

recently? We have learned, first of all, that the rise of structured 


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finance was immensely profitable, but it did destabilize this industry by aggravating those longstanding conflict of interest problems. 

Why? There is no single corporate issue that has any leverage over 

a major ratings agency. But structured finance is controlled by basically five or six large investment banks. They package these deals 

on a monthly basis. They do have some real leverage with respect 

to their rating agencies, and thus, that means for the first time 

there are clients that have clout with respect to you. That was different than the past. 

Next we have learned that rating structured finance is very different than rating straight corporate debt. You rate straight corporate debt largely based on publicly available financial information, SEC reports, stock market and bond market prices—all of 

which tell you a lot. You rate a pile of mortgages—3,000 mortgages 

in this pile—it is opaque, it is non-transparent. It is much more difficult to do, and it is done basically on a quantitative model—a 

quantitative model that has never been in existence that long 

enough to have been fully checked out. That is point one. 

Point two of what we learned recently, loan originators and investment banks have learned how to game the model, how to play 

with it. This is partly because for a large advisory fee, the rating 

agency showed them how their model works. And once you are 

shown how it works, you learn how just tweaking it a little bit and 

selectively editing the data can get you a better rating. 

Now, I am not saying that rating agencies engage in fraud. What 

I am saying instead is that because the rating agencies are very 

vulnerable to selectively edited information, and also to misleading 

information, we have a system that is defenseless against loan 

originators and others who have strong incentives to try and game 

the system. 

Next point. Because the credit rating agencies do not perform 

any due diligence themselves—and some of the Senators were making this point earlier—because they do not do verification work 

themselves, they are almost uniquely vulnerable, maybe even defenseless, to selective editing and misinformation given to them by 

loan originators who have every incentive to game the system and 

try to get a higher rating. 

OK. The credit rating agencies also appear to have responded, in 

my judgment, in a fashion that I have to call tardy and slow to 

massive changes in the housing market. The Comptroller of the 

Currency and others—and they knew it themselves—saw major 

changes in which for the first time home purchasers were getting 

100 percent financing without any equity stake. They were able to 

get mortgage loans based on no documentation. All of these things 

means that you are vulnerable to significant problems, and there 

was a worldwide market demanding all of the CDO securities that 

you could sell if they had that letter rating. All of this meant there 

was vulnerability, but it was not until after the crisis broke that 

we saw the major fall, the major downgradings, which really as a 

major downgrading began in July of 2007. 

Now, against that backdrop, what do I suggest most needs to be 

done? Well, let me suggest that the single biggest problem is probably that no one verifies the data. In the world of structured finance where you are using a quantitative model, the oldest rule 


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about quantitative models is: Garbage in, garbage out. And you are 

going to get people selectively giving you somewhat incomplete information, and there is little you can do about it. Even for the future, we have to expect that loan originators will continue to provide biased or selectively edited information. It is in their own selfinterest. 

It is difficult to overstate this. This is almost as if the credit rating agency were in the position of an accounting firm that went to 

the corporate client and said, Give us your data, your revenues, 

your costs, your liabilities, and thank you very much; we won’t 

check this, we will just produce your net income figures, and we 

will tell the world what your earnings per share is. 

That is where I think you have to begin, and I suggest that SEC 

rules to be meaningful have to introduce some form of greater 

verification. Verification is being done. I recognize it cannot be easily done by the rating agencies because they do not have the inhouse staff to carefully verify thousands of thousands of securities. 

But issuers and underwriters today hire independent, due diligence firms that go out there and evaluate the quality of the collateral in the loan pool. That information, I suggest, should also be 

provided to the rating agency. And, indeed, the strongest rule that 

I would suggest to you is that NRSROs, Government-licensed rating agencies, should not be able to give an investment grade rating 

on structured finance products without having before them some 

report from an independent expert that sampled the loan collateral 

and reported that the loan collateral met the following parameters: 

there were not more than 10 percent of these mortgages that were 

without an equity investment, there were not more than 10 percent 

that had no documentation, or there were more, and we will disclose that. That I think is necessary so that we have a gatekeeper 

that really has both the auditing and sampling component as well 

as the analytical component. 

I would suggest to you today that the credit rating agencies have 

a lot of competence, a lot of skill of analysis, but very little on 

verifying and gathering data. 

Now, two other ideas that are in my testimony, I will be very 

brief about these. One, there is the problem of stale ratings. If you 

compared the debt rating agency to the securities analyst—and 

they are functionally similar—securities analysts update their ratings on a quarterly basis. I would suggest there is a lot of harm 

to the smaller institutional investor—and you have them in each 

of your districts. These are the school boards, the colleges, the 

charities, and the endowments who sit there and see that 2-yearold credit rating, that may no longer be accurate, that may no 

longer even be what the agency itself would give under its newer 

model. I would suggest something like an annual revision requirement. You go back, you review it, and you either renew it, change 

it, or withdraw your rating. But stale ratings are dangerous to less 

than sophisticated institutional investors. 

I would suggest something like an annual revision of your rating; 

and, second, when you change your model, make a material change 

in your model of methodology, you should go back and figure how 

that would change your past ratings, because today there are ratVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00040 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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ings that are sitting out there even though the model has changed 

and you would not give that same rating today. 

The last thing I would suggest to you besides dealing with this 

problem of staleness is the financial scoreboard. I think there are 

lots of less than sophisticated institutions that sit there and know 

one rating agency or two. They do not know there might be eight 

or nine or ten in another year from now. If you had the SEC giving 

us one financial scoreboard that showed the ratings of all of the 

NRSRO rating agencies, what would they learn? They would learn 

that, well, agency one and agency two gave an investment grades. 

Some of these newer subscriber-pay rating agencies are more critical and have given it junk or intermediate status. You would learn 

the diversity of opinion. And when you learn that diversity of opinion, you might decide to put your short-term money in Government 

securities or something else rather than AAA-rated CDOs. 

I think the SEC would be the right party to do this because you 

do need to standardize some of the terms. Things like default rates 

that should be on this website can be computed in different ways. 

I do not know which way is best, but I think the SEC could give 

us one standardized technique so they could tell us the default 

rates on these various classes of products for each of the major rating agencies that are NRSROs. 

I think I have gone over my time, so I will stop there and answer 

any questions that you have. 

Chairman DODD. No, that is very helpful and very insightful as 

well. Obviously, we want to hear the witnesses. 

I hate to interrupt here. Have you voted, Jack? 

Senator REED. No. 

Chairman DODD. All right. What we will do is we will go over 

and vote, and whoever gets back here first, just start right in. So 

if you would be patient for about 7 minutes, we will come right 

back to you. I apologize to you, but we have a vote on the floor of 

the Senate. But thank you very much for your testimony, Dr. Coffee. When we come back, we will hear from Ms. Tillman. 

The Committee will stand in recess. 

[Recess.] 

Senator REED [presiding]. If I can ask you to take your seats, 

Chairman Dodd asked the first returning member to reconvene and 

to begin to take the testimonies. And I believe we have concluded 

with Professor Coffee. 

Ms. Tillman, please. 

STATEMENT OF VICKIE A. TILLMAN, EXECUTIVE VICE PRESIDENT FOR CREDIT MARKET SERVICES, STANDARD & POOR’S 

Ms. TILLMAN. Thank you, Mr. Chairman, Mr. Ranking Member, 

Members of the Committee, and good morning. I am Vickie Tillman. I am Executive Vice President and head of the ratings business for Standard & Poor’s, and I appreciate the opportunity to 

speak before you today. 

Senator MENENDEZ. Ms. Tillman, could you put your microphone 

toward you. 

Ms. TILLMAN. Oh, sure. 

Senator MENENDEZ. Thank you. 

Ms. TILLMAN. You are very welcome. 


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At Standard & Poor’s, a core principle of our business and key 

driver of our long track record of analytical excellence is a constant 

commitment to improvement. Over the past several months, rating 

agencies have been the object of significant focus, including much 

critical attention. We have listened to, and reflected on, the numerous comments and concerns, and we have focused our efforts to enhance our ratings process, provide better and more information to 

investors, and promote confidence again in our ratings. The result 

has been a series of actions that we announced in February earlier 

this year. But before I go over those actions, I would like to note 

that ratings speak only to creditworthiness, and there have been 

a significant number of downgrades, and downgrades, again, are 

not defaults. They are movements because things do change in the 

environment. But there have been significant downgrades in the 

RMBs area and in other structured finance securities. But, to date, 

the volume of actual defaults on those securities has been less than 

one-fifth of 1 percent of all U.S. RMB assets Standard & Poor’s has 

rated between 2005 and the third quarter of 2007. And those numbers at one-fifth of 1 percent are those that have actually defaulted. 

I have attached to my testimony a detailed description of these 

actions that we released in February, and they include an update 

that we published earlier this month outlining the significant 

progress we have made to date in implementing them. 

In total, there were 27 different initiatives. I would like to highlight four broad categories. 

The first category of actions relates to our governance procedures 

and controls. Notably, initiatives in this category include: establishing an ‘‘Office of the Ombudsman’’ to address concerns related 

to, for instance, potential conflicts of interest; implementing ‘‘look 

back’’ reviews when analysts leave to work for an issuer; implementing periodic rotations for lead analysts. 

The second area is in analytics. The category of actions focuses 

on the substantive analysis we do in arriving at our ratings opinions. Notable initiatives in this category include: establishing an 

independent ‘‘Model Oversight Committee’’ to assess and validate 

the quality of the models used in our analysis; complementing traditional credit ratings analysis by highlighting non-default risk factors that can affect rated securities, such as volatility of ratings, 

correlation, and recovery. 

The third area is in terms of information. Notably, initiatives in 

this category include: presenting ‘‘what if’’ scenario analysis in our 

rating reports; implementing procedures to collect more information about the processes used by issuers and originators to assess 

the accuracy and integrity of their data and their fraud detection 

measures; increased dissemination of ratings-related data, including default statistics; developing an identifier to highlight when a 

rating is on a securitization or a new type of structure. 

And the final area is very important as well, and that is education. And these actions relate to our efforts to educate the market about ratings, their role, and their limitations. Notably, initiatives in this category include: launching a market outreach program to promote better understanding of complex securities that 

Standard & Poor’s may rate; working with other NRSROs to proVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00042 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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mote ratings quality through the introduction of best practices and 

issuer disclosure standards. 

We have been working aggressively to implement these actions. 

We welcome further suggestions as to how we can enhance market 

confidence and continue our tradition of quality of ratings that 

offer opinions on creditworthiness to the market. 

In addition to these initiatives, we have been engaged in discussions with legislators, regulators, market participant in the United 

States and around the world. For example, we have actively been 

involved with IOSCO as it considers possible revisions to the model 

of a code of conduct as it relates to securitization. Similarly, we 

have participated in an ongoing review of rating agencies by CESR 

and having engaged with the Financial Stability Forum members 

in a dialog about their suggestions. Here at home, we have been 

working with the SEC as it conducts its first exam of our ratings 

process under a recently established regulatory framework. That 

exam is still in progress. Its scope is extensive, and the SEC staff 

has been extremely active and thorough in their work. 

We look forward to the SEC’s completion of its work, and we are 

committed to addressing any recommendations that the Commission may have following its review process. 

We are also focused on the work being done by the President’s 

Working Group. We fully support the group’s efforts to bring transparency, stability, and confidence to the capital markets, and we 

look forward to working with them to help drive the effective functioning of the credit markets. 

In conclusion, I would like to thank you for the opportunity to 

participate in this hearing, and I would like to let you know that 

we are committed to improving on our analytical excellence and our 

desire to continue to work with the Committee as it explores developments affecting the capital markets, and I would be happy to answer any questions that you may have. Thank you. 

Chairman DODD [presiding]. Thank you. 

Ms. Robinson, welcome. 

STATEMENT OF CLAIRE ROBINSON, SENIOR MANAGING 

DIRECTOR, MOODY’S INVESTORS SERVICE 

Ms. ROBINSON. Good morning, Chairman Dodd and Members of 

the Committee. I am pleased to be here on behalf of my colleagues 

at Moody’s Investor Service to discuss our views of some of the recent developments in the credit markets and the initiatives underway to address them, both at Moody’s and across the industry. 

As you are well aware, the global credit markets have seen incredible turmoil over the past year. That turmoil has been driven 

by many causes, one of which is the deterioration in the U.S. housing sector resulting from an unprecedented confluence of factors. 

These include a sharp erosion in mortgage underwriting standards, 

misrepresentations in the mortgage application process, the steep 

decline in home prices, and a sharp contraction in credit available 

for refinancing. 

The rating agencies are one of many players with historically 

well-defined roles in the credit and structured finance markets. We 

believe that addressing the current challenges in the credit markets, including the general loss of confidence among many individVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00043 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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uals and institutions, will require action on the part of all market 

participants. We are eager to work with the Congress, regulators, 

and other market participants to that end. 

Over the past several months, Moody’s has been working constructively with various global authorities, policymakers, and others to identify and begin implementing initiatives that can enhance 

confidence in the global credit markets. We have been cooperating 

fully with the SEC in its review of these issues. That review has 

been extensive, and it is continuing. 

The President’s Working Group in the U.S. and the Financial 

Stability Forum internationally also have examined the current 

market turmoil and developed a series of recommendations for addressing it. 

We believe that implementing these measures globally can have 

a positive impact in helping to address some of the current issues 

in the credit markets. And we have already begun to adopt many 

of these recommendations. 

Moody’s has always been committed to continuously improving 

our ratings processes and analytic capabilities. We have recently 

undertaken several significant initiatives to enhance the quality of 

our analysis, address concerns in the marketplace, and further improve the usefulness of our credit ratings to investors. These measures include steps to: enhance our analytical methodologies, enhance our review of the due diligence process conducted by originators and underwriters, provide more clarity about the credit characteristics of structured finance ratings, promote objective measurement of ratings performance, continue effectively managing potential conflicts of interest, and enhance investors’ understanding of 

the attributes and limitations of our ratings. 

Let me elaborate on two of these initiatives. 

Moody’s has implemented several measures to further demonstrate the independence of our rating process. These include formalizing the separation of our ratings-related and non-rating businesses, enhancing our credit policy function, and codifying our existing policies about analysts’ communications with issuers. 

We are also implementing a lookback review to confirm the integrity of analysis performed by any analyst who goes to work for 

an issuer or issuer’s agent that he or she covered while at Moody’s. 

We have also undertaken a review of our rating system for structured securities. We have proposed five different potential alternatives to the current structured finance rating scale and asked 

market participants for their reactions to these proposals. Those alternatives could include moving to a completely new rating scale, 

adding a modifier to ratings on the existing scale to identify them 

as structured finance, or adding a suffix to the existing rating scale 

to indicate rating volatility risk. 

Finally, recent events show how rapidly and dramatically markets can change in today’s global economy. That is why we believe 

improvements to all market practices, including improvements to 

credit analysis, must be pursued vigorously to restore confidence in 

credit markets. We are firmly committed to the effectiveness, integrity, and transparency of our rating methodologies and practices. In 

this regard, we look forward to continuing our dialog with the auVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00044 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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thorities and market participants to help strengthen confidence in 

the financial markets. 

I am happy to respond to any questions. 

Chairman DODD. Thank you very, very much. We appreciate 

your being here. 

Mr. Joynt, we thank you very much. 

STATEMENT OF STEPHEN W. JOYNT, PRESIDENT AND CHIEF 

EXECUTIVE OFFICER, FITCH RATINGS 

Mr. JOYNT. Thank you, Mr. Chairman, for inviting me. My name 

is Steve Joynt. I have been President and CEO of Fitch Ratings. 

I have been with the company for 18 years, and I have been President for 12 years, so I have a good degree of experience in the industry. I am happy to answer your questions after some brief remarks. 

The past 10 months have seen continuing deterioration in first 

the U.S. and then in global fixed-income markets. Severe asset 

quality deterioration in the U.S. subprime market and related CDO 

securities initially caused large market price declines that required 

revaluations of these securities by financial institutions because ultimate credit losses are now expected to be far greater than anyone 

anticipated. 

Today’s market stresses, however, have become more broad 

based and emanate from a global reassessment of the degree of leverage and the appropriateness of short-term financing techniques 

inherent in today’s regulated and unregulated financial institutions. Deleveraging is dramatically reducing liquidity and contributing to price volatility. Many financial market participants today 

are seeking ways to enhance stability in the system. 

Fitch’s contribution to a better functioning market requires a reassessment of the changed risk environment, rating changes that 

reflect these changes in risk, ratings that are more stable and reliable, an improvement in our analysis and modeling techniques, 

and, finally, full transparency so investors and all market participants can understand and use our ratings to supplement their own 

risk analysis and their own decisionmaking. 

Like all of the major rating agencies, our structured finance ratings have not performed well and have been too volatile. We have 

downgraded large numbers of structured finance securities, particularly in the subprime mortgage and CDO areas, in many cases 

by multiple rating notches. While we still expect almost all AAA securities to pay off, we have downgraded many, and some previously 

highly rated securities are at risk of incurring losses in the future. 

While we were aware of, and accounted for, the many risks posed 

by subprime mortgages and the rapidly changing underwriting environment in the U.S. housing market, we did not foresee the magnitude or velocity of the decline in the U.S. housing market nor the 

dramatic shift in borrower behavior brought on by the changing 

practices in the market. We also did not foresee and are surprised 

by the far-reaching impact the subprime crisis has had on markets 

throughout the world. 

Understandably, the rating agencies have lost some confidence of 

the market for which I am disappointed. I think it will be a long 

and difficult road to win back confidence. We have, however, agVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00045 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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gressively started down that road, and we believe we are making 

progress, although slowly. 

To win back investor confidence, we simply must do a better job 

with our structured finance ratings and all our ratings. Our structured finance ratings must be more predictive and stable. Our research and analysis must be more forward thinking and insightful. 

We must tell investors about what might happen tomorrow instead 

of just what has happened yesterday. We, of course, remain committed to ensure that our work is of the highest integrity and objectivity. 

We have reevaluated our ratings across all structured finance 

areas and the financial services industry broadly as the credit turmoil has progressed. We are working hard to anticipate what might 

come next. Fitch has also been busy reassessing our structured finance criteria and models, changing them to reflect what we have 

observed in this turmoil. It has been our belief that we best serve 

the market by concentrating our efforts on improving our ratings, 

our criteria, and our models before doing anything else. 

As we conduct this work, we have decided to stop rating new 

issues in some structured finance markets that have experienced 

some of the greatest turmoil, such as CDOs. We will remain out 

of these markets until we can assure the market and ourselves 

that we have adequately updated our models and criteria to reflect 

what we have observed during this turmoil. 

The world’s financial infrastructure has become increasingly 

interconnected, and it seems as a result that credit ratings have 

become increasingly important to all market participants. Unfortunately, we have come to learn that ratings have been used in some 

cases as a proxy to measure liquidity and market risk, which ratings were never designed to address. Accordingly, we must do a 

better job at providing ratings and additional tools that allow investors to better assess risk in this increasingly complicated environment. 

We have been busy working with the other rating agencies as a 

group to increase transparency and the quality of ratings and to 

address the many varied concerns of regulators around the world. 

Here in the U.S., we have worked with the SEC extensively in 

their extensive examination of us. They began their formal examination last September. They have been conducting a thorough examination. We believe that will prove constructive to the SEC as 

it undertakes the important work Chairman Cox described, considering new rules for credit ratings and credit rating agencies. We 

support their efforts to improve transparency, integrity, and quality 

of ratings, and we believe their work will aid our efforts to win 

back investor confidence. 

We have been actively meeting with the staff of this Committee 

and the staff of the House Financial Services Committee, who have 

both taken a leadership role in understanding this market turmoil. 

And since last spring, we have been meeting with the Treasury Department, many bank regulators, State insurance commissioners, 

and many State and local officials, as well as the broad base of investors to share our perspective and gain insight from them. 

Thank you. I am happy to answer your questions. 

Chairman DODD. Thank you very much. 


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Mr. Cifuentes, thank you for being here. 

STATEMENT OF ARTURO CIFUENTES, Ph.D., MANAGING 

DIRECTOR, R.W. PRESSPRICH & CO. 

Mr. CIFUENTES. Good afternoon, Chairman Dodd, Senator Shelby, Members of the Committee. My name is Arturo Cifuentes. I am 

an investment banker based in New York. Thank you very much 

for the opportunity to be here. I am really honored to have my 

opinion considered in the matter at hand. 

I submitted yesterday a long sort of statement with my recommendations and my views. I am not going to read it here. I am 

just going to make a couple of points which I think are relevant. 

As I said in my testimony, just for the sake of clarity, my opinions 

here are my own opinions, for good or for bad. I do not intend to 

represent anybody but myself. 

One thing that we have here and I think is important to realize 

is that the press and in general there has been a view that the U.S. 

is having a credit crunch or a subprime crisis. Actually, I happen 

to believe that that is true, but actually the situation is far more 

serious than that. 

What we really have is the collapse of the alternative banking 

system, and by that I mean the system of finance that was created 

with securitization and credit derivatives, and that is very unfortunate because that was a big engine of growth behind the U.S. economy, and now there is a limit of trust. The market does not seem 

to be really convinced that the structured finance ratings are accurate, and that has impacted that market; for example, the assetbacked commercial paper is impacted. That is a very serious problem. So I think there is an issue of trust here. 

The other thing we need to keep in mind, this is a very global 

market; 50 percent of the participants in the fixed-income market 

are outside the U.S., and they trust the market because they trust 

the transparency of the market and they like the ratings. We are 

at the risk of losing that right now. 

Now, we are going to march into the right thing. I think it 

should—I mean, we have this view that the rating agencies are 

getting quite a few things wrong, but I think it is important to realize the nature of the problem. The rating agencies, unfortunately, 

initially rated the mortgages wrong. So there was a mistake there. 

For whatever reason, the rating of the mortgages was wrong. 

Then there was a second mistake, and I am going to use a term 

that sounds a little bit technical here, but, nevertheless, we have 

to mention it: CDOs of ABS. So I included a diagram here at the 

end of my testimony to clarify the issue of what is a CDO of ABS. 

But the point is there was a second mistake there. So, in addition 

to the wrong ratings on the mortgages, we had the wrong ratings 

on the CDOs of ABS. These were securitizations that included already the mortgages. 

And the further reality is also this happened at the same time, 

so they all got it wrong at the same time, which really magnified 

the problem. Now, I am not trying to suggest that the rating agencies acted in coordination to give the wrong ratings, but I think the 

system somehow encourages that kind of outcome. 


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I just want to make one issue that might sound a little bit theoretical, but I think we need to keep it in mind, and then I am going 

to make a couple of recommendations. 

If you remember, initially the ratings were created with the 

whole purpose of giving investors information regarding credit risk. 

That is it. Information for investors. And that was fine. Later, the 

regulators sort of took advantage of that and decided to use the 

rating as a proxy for other things, I mean, for example, capital requirements, where the bank needs enough resources, et cetera. 

Now, so we have two constituencies right now. We have the regulators using the ratings, and then we have here the investors. It 

is not obvious to me that both have the same goals in mind. It is 

not that they have contradictory goals, but a rating which is good 

for the regulator, presumably a rating that needs to be more stable, 

is not necessarily a rating useful for somebody who is an active 

participant trading securities in the secondary market. I mean, 

there is a little bit of—I do not want to say conflict of interest, but 

it is not clear that these two things are the same. So something to 

think about there. 

I want to also mention something that, unfortunately, in my 

opinion, has taken a great deal of attention in the press and everywhere, and I think it is the wrong issue, and it is not a good idea 

to spend a lot of time talking about that because it is not the main 

problem. There is a much more serious deal. 

We have talked about the conflict of interest because allegedly 

the investment banker pays the fee to the rating agency. I believe 

that is not the case. In reality, what happens, an investment banker raises money. You issue the securitization bonds, and at the 

same time, everybody gets paid—the rating agencies, the lawyers, 

the trustee, et cetera. So I do not believe there is a link there between the—I mean, paying attention to that potential conflict of interest, in my opinion there is no problem there. 

In addition to that, there has been the thought that the rating 

agencies have somehow been involved in designing this concept. 

Having been on all sides of this business, that is simply not the 

case. You have the regular give-and-take between what could have 

been an architect that wants to build a building and the city engineer telling him what he can and cannot do. So that is not really 

a serious problem. 

What I do believe is a serious problem—and if you remember one 

thing of my testimony, I think that is probably the key point here. 

We need to have a Chinese wall. We have gone through this road 

before. This is the same situation we had when we had the issue 

with the research in investment banking before. You remember at 

that time there was a gentleman or a lady writing research on the 

research side, and then there is the business side. So there is a 

very serious conflict of interest here. Evidently, if you have a rating 

analyst who is rating something and the person who is supervising 

the analyst is more concerned about credit risk, creates a very serious problem of interest. 

Now, this is more serious than investment banking or any other 

activity because if I do not like the research that the bank writes, 

I just do not read it, or I toss it and do not pay any attention to 

it. But the rating agencies have regulatory power. So the opinion 


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of the research analyst or the credit analyst is very, very relevant. 

So I think the idea of having a Chinese wall in which analysts will 

be protected, I think it is something that we should think about. 

The other point that I believe—I made a few points there, some 

correlated highly with what Professor Coffee said, so I am not 

going to expand on that. But one thing that puzzles market participants at this point, because they do not believe very much in ratings—and when I say ratings, I mean just for the sake of clarity, 

I am talking about structured finance ratings. I am not talking 

about corporate debt or emerging market or any security. Well, it 

seems like the rating agencies got it very wrong in the structured 

products, and so people wonder what else do they need to do in 

order to prevent from backing the security—yes, I mean, it seems 

like it could be unfortunate. We might be in a situation in which 

we have only three ratings agencies, and there is nobody on the horizon. That is why I am a little bit concerned about the 3-year requirement in terms of operating as a rating agency before you are 

approved. And I would pose that it is difficult to operate as a rating 

agency and making any money if you are not allowed to issue real 

ratings. I mean, you would need venture capital or somebody willing to finance you for 3 years. 

One final point that I would like to make, and, again, it might 

sound a little bit academic here, but we have been talking about 

ratings, and we have been talking about mortgages and subprime, 

et cetera, et cetera. Well, that is fine, but in my view, that is 50 

percent of the problem. The other 50 percent of the problem are the 

CDOs of ABS, which in my view were rated using wrong assumptions. 

If you look at what happened in 2007, CDOs of ABS I believe accounted for more than 90 percent of CDOs downgrade. As I show 

in my diagram here, this is the securitization, so using information 

that is probably contaminated or something like that. 

So, I mean, that is something to look into. That market obviously 

is completely paralyzed today, but just a casual inspection of the 

morals and assumption that were done for CDOs of ABS, it seems 

to me that maybe they were a little bit too relaxed. I mean, that 

is my impression based on some preliminary observations. 

The only thing—I think I am going to stop here. The only comment that I would like to make just in response to some of the 

things that have been said is that, well, maybe the reason we are 

seeing this massive amount of downgrades is because there is a 

unique situation, and the U.S. housing market maybe is having an 

extraordinarily bad time. Well, there is some truth in that, but I 

happen to believe that the argument is a little bit circular, because 

we would not be having this situation if somebody would have said 

initially, look, I am not going to allow you to put these mortgages 

in these CLOs because they are really bad. So I would make the 

case that perhaps the situation was exacerbated—in fact, it was 

not stopped because some of the ratings in these mortgages were 

not particularly accurate. 

So I think I am going to stop here. I thank Chairman Dodd and 

Senator Shelby, and I really appreciate being here, and I would be 

happy to answer whatever questions you may have. 


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Chairman DODD. Well, thank you very, very much, and I will ask 

the clerk to keep the clock on about 5 minutes here so we can get 

around. We have kept you a long time this morning, and we will 

probably have a lot of additional questions to raise with you. 

Let me, if I can, jump right in. Ms. Robinson, let me begin with 

you on the due diligence issue, if I could. It has been raised earlier. 

You have heard the conversation. I think Senator Corker was sort 

of talking about it to one degree. Senator Shelby raised it and others have as well. And I am looking at Moody’s Code of Professional 

Conduct, and let me quote it. It says, ‘‘Moody’s has no obligation 

to perform and does not perform due diligence with respect to the 

accuracy of information it receives or obtains in connection with 

the rating process. Moody does not independently verify any such 

information.’’ That is of June 2005. Now, it may have changed. 

Maybe that has changed since then. If it has, you will correct me. 

Obviously, when you have got a proliferation of liar loans, as we 

know about, the no-doc loans going forward here, how do you answer the question that obviously you probably have been asked before, that a rating agency should not be required to perform some 

due diligence when you are branding these bundles as being AAA, 

and yet not a heavy due diligence would have informed one that 

these products were anything but investment grade. I mean, these 

were products here that were very shaky, and how do you make 

that case that there is not a requirement here since so many people 

are relying—their long-term financial security, the security of a 

municipality, foundations, colleges, all these things depending upon 

that, and that there is no requirement for any due diligence and 

a Code of Conduct of ethical conduct when so much has been at 

risk here and so much lost for people, how do you address that? 

Ms. ROBINSON. Well, Mr. Chairman, the accuracy of the information that we receive is central in importance to our analysis. And 

we rely on the work of other parties to verify and establish the accuracy of that information. So, first of all, it is primarily the responsibility of the issuer and the loan originator to provide information to rating agencies and others that is accurate. 

Furthermore, the underwriters, the investment bankers who 

market the securities have an obligation to perform due diligence 

on the loans included in the securitization. And, finally, information presented in the offering documents associated with those securities is vetted by accounting firms. 

And so I agree that the accuracy of the information is very important, but there are others whose role it is to check and verify 

that information. 

Chairman DODD. But people are relying—I mean, people are saying this is—Moody’s puts its Good Housekeeping Seal of Approval 

on this. That is what people are counting on. I am counting on 

when you say this is AAA, Senator Dodd, this is a good product 

here, I am saying, you know, Moody’s told me so, Moody’s gave me 

that advice. And you are suggesting to me here that you do not 

bear any responsibility to me as someone who is counting on you 

here to do any kind of work at all to let me know that something 

is not—I understand that others have obligations, but what is the 

obligation of the rating agency if not to do some homework on this, 

so that when I count on you to give me that recommendation, that 


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there has been some work that has caused you to draw that conclusion, not some lesser conclusion about it? 

Ms. ROBINSON. Well, Mr. Chairman, our role as a rating agency 

is to provide our best opinion about the credit risk associated with 

the securities that we rate. And our opinion really goes to the creditworthiness of the securities. 

Chairman DODD. Well, let me—I do not want to—I have limited 

time here. Let me go to you, Mr. Joynt. We thank you for coming 

today. 

Mr. JOYNT. Sure. 

Chairman DODD. All my colleagues, we express our gratitude to 

you. 

Mr. JOYNT. Thank you. 

Chairman DODD. And I raised earlier Professor Coffee’s—which 

I thought was a very, very good point, the staleness of data. And 

I do not recall your exact statement in your opening remarks, but 

you talked about an obligation to sort of be current. At least that 

is how I read your statement. And yet here you have downgrades 

that did not occur—here you had—they came after the Comptroller 

of the Currency had drawn his conclusions. They come after, 

months after the agencies themselves know there are problems in 

the markets. You know, you say you were surprised by this. When 

we met here last year and asked the Federal Reserve staff, when 

did you have any idea this problem was becoming—I was stunned 

as the new Chairman of this Committee to learn it had been 31⁄2

years earlier that they began to identify a problem. Now, that is 

a separate issue. But the fact of the matter is how could you be 

stunned if you—it seems to me if you were doing your work in this 

area, one, how do you get stunned by it as a rating agency? And, 

second, what about the staleness of the information? Why can’t we 

do a better job here? When you are getting the Comptroller of the 

Currency and regulatory bodies acting and yet still the downgrades 

do not occur until months after that occurs, I mean, the credibility 

has been shot here. 

Mr. JOYNT. Yes. So I think the awareness of the problem from 

subprime loans in the first instance was most obvious, to us at 

least, in the beginning of last year and only started being reflected 

in the delinquency data that we were seeing in the securities that 

we were looking at in a way in which we could incorporate that 

new information into our modeling. 

Chairman DODD. Did you pay any attention when the Comptroller of the Currency—I mean—— 

Mr. JOYNT. Of course. Also, we need to recognize that we reflected, as did others, that the underlying loans were quite poor 

quality, and so when we are speaking about giving high ratings, 

behind those high ratings was a large amount of subordination. So 

there was a recognition that the loans were not—were subprime, 

were very weak. So it obviously was not enough recognition in 

hindsight, but it was not like we were unaware of these being weak 

loans. We were not aware, it is certainly true, and did not do the 

due diligence function of trying to recognize whether there was 

fraud involved in the origination of loans. That is certainly true. 

And I believe that has become one of the biggest accelerants for 

why there have been problems so across the board in the mortgage 


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markets itself, so extending to all, and even prime mortgages now. 

So that part we did not do. But we were aware of the weakness 

of the loans. We were aware that the securities in being put together were tranched so that senior classes were supported by junior classes. But I—— 

Chairman DODD. But did any of you think—were any of you facing liability that someone could sue you for not being forthcoming 

with information, that that might change the reaction of the agencies, the fact that you are sort of protected under the First Amendment—and I see my good friend Floyd Abrams here, who I respect 

immensely as a good First Amendment lawyer, and I have great respect for the First Amendment. But the whole idea you are insulated in a sense—anyone else gives me bad information like that, 

I can sue them. I can take them to court. 

Mr. JOYNT. Yes. So that is difficult for me to answer. I am not 

a lawyer. But I would say that our reputation is as important to 

us as the money that might come from a lawsuit, and that has 

been damaged. So by not being able to be accurate and forward 

thinking about our ratings, then you—you are holding us accountable, not you but everyone, accountable for that and reflecting on 

how good the credit ratings are. And so I think that is pretty significant. We treat that seriously. 

Chairman DODD. Senator Shelby. 

Senator SHELBY. All this is troubling to me, the role of the rating 

agencies, lack of due diligence and so forth. Professor Coffee, thank 

you again for coming here to bring some light to this subject, and 

I mean this sincerely. You were succinct about what you believe 

needs to be done. 

Were the rating agencies basically blinded by events? In other 

words, the subprime situation was going on. They were pumping 

them out, the assemblers of it, and they were rating them, and 

they were all making a lot of money. But this product was a new 

product, as I understand it, the packaging and slicing and so forth 

and rating of subprime loans as opposed to the old method of very 

few defaults and so forth. Were they blinded by greed? Were they 

blind to the situation? Were they blinded by the fact that they were 

telling themselves and others were telling them that, gosh, their 

opinion—they just gave their opinion, it did not mean anything, yet 

as I said earlier, it seems to be the linchpin of the financial industry. What is your comment there? 

Mr. COFFEE. I do not know—— 

Senator SHELBY. Turn your microphone on. 

Mr. COFFEE. I cannot tell you whether they knew these ratings 

were false. I do not happen to believe that. I happen to believe that 

in a bubble market and a time when everyone sees prices rising 

and the world getting better and great profit being received, you 

do not look too carefully at whether the data you are receiving is 

phony. And you are structurally in a position where you are relying 

upon the loan originator to tell you everything because you yourself 

do not have the in-house capacity to do that verification. 

As we go forward, I think the answer is to try to find ways to 

bring third-party verification into the credit rating process. 


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Senator SHELBY. Do you believe that credit rating agencies 

should have some responsibility for what they rate and how they 

rate it because so many people rely on it in the marketplace? 

Mr. COFFEE. Absolutely. They are the unique financial gatekeeper in that they do not have liability—and I am not pushing liability remedies as the answer. 

Senator SHELBY. We know. 

Mr. COFFEE. But they do not have anything like the risks and 

exposure of accountants or securities analysts. And they are functionally a securities analyst for debt markets. So I think we should 

look at the reforms that Congress and the New York Stock Exchange and the NASD have recently imposed on securities analysts 

to reduce conflicts of interest. That would involve Chinese walls 

around the rating agency, less consulting income, and other 

ways—— 

Senator SHELBY. Consulting income, conflicts? 

Mr. COFFEE. Well, you have heard Chairman Cox say he is 

thinking seriously about this, and I congratulate them, because I 

think that deserves a serious look. 

Senator SHELBY. Do you believe that the SEC—and you teach 

law and you are into all this very deeply. Do you believe the SEC 

can help remedy this situation? 

Mr. COFFEE. Well, they can certainly help remedy it. I think 

there are some ways in which they have to take maybe some bolder 

steps than I have yet heard—— 

Senator SHELBY. Absolutely. 

Mr. COFFEE [continuing]. About both verification, staleness, and 

some way that you can ultimately tell a rating agency that it no 

longer is an NRSRO without having to prove they were personally 

at fault. If you have to show that they were personally at fault, we 

are talking about 5 years of litigation because they will get challenged in court. 

I think the real outlier, the rating agency that has a 50-percent 

default rate when the next highest default rate is 20 percent, 

should not continue to be an NRSRO because too many people are 

relying upon them. 

Senator SHELBY. Ms. Robinson, Moody’s 12-month downgrade 

rate for global structured finance products reached a historic high 

of 7.4 percent in 2007. In a recent Wall Street Journal article dated 

April 11th of this year, Moody’s President, your President, Brian 

Clarkson, was cited as saying that the top thing that could get a 

Managing Director fired was inaccurate ratings. Is this report correct, that inaccurate ratings are the top thing that can get somebody fired? And if so, what steps has Moody’s taken to hold its executives accountable for its poor ratings? 

Ms. ROBINSON. Well, the accuracy of our ratings are a primary 

concern, and, you know, we are a learning institution, you know, 

we like to say, and we are constantly reevaluating our analysis and 

our methods to make sure that we incorporate all of the information that is available to us at the time. You know, our business 

really rests on our reputation and the confidence—— 

Senator SHELBY. And your reputation is in tatters right now, 

wouldn’t you think, in the financial world, all the rating agencies, 

or challenged deeply now? You wouldn’t agree to that? 


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Ms. ROBINSON. Oh, yes, we are challenged at the present time. 

Senator SHELBY. Ms. Robinson, in your written testimony, you 

also stated that Moody’s tracks debt for more than 11,000 corporate 

issuers, 26,000 public finance issuers, and 110,000 structured finance obligations—110,000. How often does Moody’s review and, if 

necessary, update each rating, or do you do that when you see pandemonium in the marketplace? 

Ms. ROBINSON. Well, to take an example of the RMBS market, 

we receive data monthly on all of the mortgage-backed securities 

that we rate. We have a separate surveillance team that is charged 

with reviewing those ratings, and we review that data every 

month. 

Senator SHELBY. Professor Coffee, what would you say that the 

SEC, and perhaps this Committee as the Committee of jurisdiction, 

needs to do to make sure as best we can that we can restore some 

confidence in the rating agencies and what they do? 

Mr. COFFEE. I think there—— 

Chairman DODD. The microphone again. 

Mr. COFFEE. I think there are a number of things. You already 

heard me talk about the need for getting some kind of 

verification—— 

Senator SHELBY. Absolutely. 

Mr. COFFEE [continuing]. A mandatory element before you give 

an investment grade rating on structured finance. You heard me 

talk about currency, and I would say there should be at least the 

requirement that you annually reaffirm, republish, reduce, or withdraw your rating, not just get information but state it again: I am 

reaffirming this because I believe this, or I am upgrading, downgrading, or withdrawing it. 

I also would say when you change your model, you have got to, 

within 90 days, say we are going to reduce ratings on every model 

that would produce different results had it been used back when 

these ratings were given. That is what I talked about earlier with 

the financial scorecard. 

Beyond that, I would tell you that you probably should disclose 

all fees. When you give a rating, there is today a problem of what 

I will call the hidden advisory fee. You get a fee as a consultant 

and as advisor, and you get a fee when you give the rating. This 

produces an incentive for what I will call ‘‘forum shopping.’’ You 

can find out from five agencies what their fee will be and get it 

from only the one or two that give you the highest rating. Forum 

shopping is a problem. One way to discourage forum shopping is 

to require rating agencies to disclose any fee they have received 

from an issuer or a structured finance offering, even if they did not 

give the rating, and that could show up on the SEC’s website, because they could show you that for this offering there were four 

ratings, two other agencies that got fees but did not rate. That 

would tell you there is something funny here that they got a fee 

and didn’t give a rating. So forum shopping is one of the problems. 

I have also suggested in prior testimony that there is an SEC 

rule called Regulation FD which effectively exempts the credit rating agencies and thereby permits selective disclosure. There are 

new agencies coming in that are subscriber-paid. I wish them well. 

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operation from any issuers or underwriters because they prefer 

dealing with the agencies that they pay because they can predict 

what will happen with the agencies—— 

Senator SHELBY. We have got to change the rules, have we not? 

Mr. COFFEE. You have got to change Regulation FD so that all 

rating agencies get access to the same data. 

Senator SHELBY. I hope the SEC is listening. 

Chairman DODD. They are listening. 

Senator SHELBY. Thank you, Mr. Chairman. 

Mr. COFFEE. Thank you. 

Chairman DODD. Senator Reed. 

Senator REED. Thank you very much, Mr. Chairman. 

Professor Coffee, one of the themes that is constant in Chairman 

Cox’s comments and the questions of my colleagues is accountability. Today, before this new regulation is proposed, other than 

shareholders, who are the rating agencies accountable to in a material sense? 

Mr. COFFEE. It is easier—— 

Chairman DODD. Again, you have got to—— 

Mr. COFFEE. It is easier to say ways in which they are not accountable. They do not have private liability. There is no regulatory 

agency like the NASD or PCAOB for accountants that has jurisdiction over them. It is only now that the SEC is proposing rules. 

Sure, they have a reputation, but in a world in which for the 

past there have only been three agencies, it is not a world where 

reputation counts as much. And reputation means less when you 

are also selling a regulatory license. So even if the market does not 

trust you, they will still pay you a fee to get that regulatory license. 

They are left in a position where they are only very weakly accountable and less accountable than the other major financial gatekeepers. 

Senator REED. Chairman Cox suggested that when these new 

rules are rolled out, there will be a new world, a world in which 

the presumptive immunity from even a suit for negligence would 

be overturned. Can you comment on that? What is your sense of 

this newer world that is emerging? 

Mr. COFFEE. I have a great respect for Chairman Cox, but the 

devil is always in the details. And I do not know what these new 

rules will say. I think that there are areas in which we need some 

strong rules, and while I thought he gave us a strong statement, 

much of it was a little opaque on exactly what the rules are going 

to look like. And I cannot evaluate rules until I see them. 

But I do not think absent some kind of either liability risk of possibility of suspension or forfeiture that we are going to have the 

same governmental oversight powers over the rating agencies that 

we have over the accounting profession or the securities analysts. 

Senator REED. A final question, because you have all been very 

patient, and I am not picking on Professor Coffee, nor anyone else. 

Thank you all, ladies and gentlemen, for your testimony. But it 

would seem—I mean, I think the system could be described as 

there is absolutely no incentive for an investment bank that is putting together an issuance and going to a credit agency to then come 

back and say you gave us a lousy rating, because what they are 


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trying to buy is the best rating, and when they get it, they have 

got what they paid for. 

So there is nothing in the system today for any one individual 

to come back and say you did not do the job. And that goes back, 

I think, to the same point about it is easier to list the lack of accountability than the points of accountability. 

Mr. COFFEE. And as a result, this market has collapsed. No 

longer are there any real estate mortgage-backed securitizations. 

There are also very few commercial mortgage securitizations. Thus, 

I think the industry does have a common interest with the regulators. This market is not going to come back, and there are not 

going to be fees for rating securitizations that do not happen, unless we can make the rating agency credible again. 

So I want to focus prospectively, and I think the industry as well 

as regulators have to find a way to create confidence, because without it there are not going to be fees. 

Senator REED. Thank you very much. 

Thank you, Mr. Chairman. 

Chairman DODD. Just to make that point—I think I made it the 

other day in a hearing here. In the commercial mortgage-backed 

security area, last year that industry did $230 billion worth of business in 2007. And this year, as of late April, they have done $5 billion worth of business, just by comparison, to give a sense of the 

magnitude of the problem. 

Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman. It is another great 

hearing, and I just want to emphasize something that Ms. Robinson said. And, by the way, I want you all to know I am loath to 

sort of pile on after the fact. You know, it is not really what I like 

to do. I will say in this case that it is hard not to, OK? But obviously you guys have lost reputation, credibility. I know recently I 

called about a specific thing. I remember the broker saying, ‘‘Oh, 

this is AAA rated,’’ and now I guess all of us in the world are realizing, What difference does it make if it is AAA rated? 

I would just go back and say to the Chairman that we make people use these folks, and I think that is something that we need to 

look at. We make people use these folks. And then if they do not 

use them, in essence, they cannot issue securities. So that whole 

situation is something we need to certainly look at. 

But, Mr. Coffee, I really enjoyed your testimony. I have never 

taken any law courses. Yours is one I actually wish I had taken. 

But what would the third party do that you mentioned earlier? You 

talked about a third party being involved in some verification. 

What exactly would they do? 

Mr. COFFEE. Well, what they do today, and they do this for the 

underwriters. The underwriters will hire a so-called due diligence 

firm—the best known is Clayton Holdings, Inc.—and they will send 

a team of investigators out to look at this mortgage pool. There 

may be in the old-fashioned real estate-backed securities, there 

may have been 5,000 mortgages in this pool. They will sample it, 

and they will do the kind of sampling that is similar to what an 

auditor might do to say they are reasonably confident that no more 

than 10 percent of these loans lack documentation, no more than 

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cent of these loans had a credit score below the minimum level that 

the bank or underwriter wants. 

So they will tell you how many of these loans are exception 

loans, outside the normal lending criteria. And if you hear there 

are 30, 40, or 50 percent, which was the statistics that were occurring in 2007 and 2006, you now have a warning signal that tells 

you this is really dangerous. 

I think if you give that information to the rating agencies, they 

will respond by downgrading or not giving an investment grade 

rating. The underwriters overlooked this in some cases because 

they thought their lawyers could write boilerplate that would protect them from any fraud liability. But I think the rating agency 

would be more sensitive to this if they got the information. 

Chairman DODD. Can I ask a simple question? 

Senator CORKER. Yes. 

Chairman DODD. Why wouldn’t you have the rating agency—why 

hire a consultant? Why not just do it? 

Mr. COFFEE. Because—you heard the numbers—there might be 

100,000 securitizations out there that they have to perform ratings 

on. The underwriters are already doing this and bearing the cost. 

If you give this information to the rating agency, whether it is the 

bank that gives it to them or whether it is the third-party firm, I 

think you have a way that will work, and it is more feasible, given 

the small in-house staff. 

Chairman DODD. Thank you, Bob. 

Senator CORKER. Of course, no, no. Of course, the fact is the underwriter is driven to get this product out, too. So there are actually conflicts there, too. 

Mr. COFFEE. Lots of conflicts in this business. 

Senator CORKER. OK. So I would go back—actually, that was my 

next question. 

Chairman DODD. How about having the underwriter have some 

skin in the game, too? That may increase the likelihood of accountability, I think. 

Mr. COFFEE. The underwriter does have liability and is somewhat better deterred, but the underwriter’s liability is for fraud, 

and if he puts in a lot of boilerplate disclosures, it will say, ‘‘We 

told the market that there was this problem.’’ 

Senator CORKER. There is not, I do not think, any meaningful liability there. But going back to the liability issue—and obviously 

I think all of us are really puzzled to realize that there is just absolutely zero liability. You would have to perform—I am talking to 

the rating agencies now. You would have to perform lots of due 

diligence to take on liabilities, and just sort of the flip side of this 

is obviously fees would be very different if you were taking on liability—is that correct? Rating agency charges would be much, 

much higher, much different if you were taking on liability. Is that 

correct? 

Mr. JOYNT. Yes. 

Senator CORKER. OK. And is it reasonable for us sitting here, realizing the meltdown that has occurred was reliance upon—and the 

reliance that was placed in structured finance being rated AAA, 

AA, whatever. Should you have liability? I mean, would that be a 

good step forward for your various companies? Obviously, it would 


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change your entire business model, but is that something you 

would actually advocate? 

Mr. JOYNT. I would say no. I do not think in the case of the responsibility for the due diligence, which we assume someone else 

is doing, that we would have to structure ourselves in such a way 

that we would be organized to do that and charge for it appropriately. But it is not really our main business function. It is not 

the business that I really want to be in. I certainly would not want 

to take on that business in order to take on liability in that way. 

We would prefer to have a business model that is opinion oriented, 

and so that is the business model that we have now. 

Ms. TILLMAN. If I may add, you know, I do not totally disagree 

with what Professor Coffee was saying, because in some of the 

leadership actions that we are proposing, I think it is important 

that we get better disclosure and make more of an effort on the 

quality of the information that we are receiving. Some of the things 

that we are looking at is just the—yes, the obligation for the due 

diligence is on the bankers, it is on firms like Clayton that do it 

for the bankers. They have a whole different business model. But 

at the same time, we as a rating agency can request and require 

a certain level of reps. and warranties and/or a certification or comfort level that the types of due diligence that is required to ensure 

that the quality of the information we get is, in fact, at that level. 

We do look at—I mean, a lot of the comments here make it appear 

that we do not do anything. In fact, we do do a lot. We do take all 

the loans that are in the pool. We run them through our models. 

We make our model assumptions available to everybody. We publish our scenario analysis. We publish our criteria. 

But I do think that there is an important element around the veracity and the integrity of the data quality, and I think that is 

something the market and the rating agencies need to deal with. 

Senator CORKER. I know we have a bit of an interchange. I just 

have many questions, and I will wait until after Senator Menendez. 

But the last question in this round, Mr. Cifuentes—I may have pronounced that incorrectly. 

Mr. CIFUENTES. No. You pronounced it correctly. 

Senator CORKER. Good. Well, I will not try again. 

Mr. CIFUENTES. AAA for pronunciation. 

Senator CORKER. Thank you very much for being here. The structured finance is basically over. 

Mr. CIFUENTES. I hope not. 

Senator CORKER. Well, it—— 

Mr. CIFUENTES. It is in a state of semi-paralysis right now. 

Senator CORKER. OK. If you could give us a vision of how this— 

whatever potion is going to be used to basically cause it to move 

out of paralysis and how you see the industry being, if you will, in 

6 months. 

Mr. CIFUENTES. Well, your statement was 90 percent correct. It 

is not totally paralyzed, but it is very paralyzed. 

Basically, what we have right now is asset-backed commercial 

paper that is very much—CBOs of ABS, that is totally gone, and 

we slowly see a recovery of CLOs, which are CDOs supported by 

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cause as I said, we are talking about the market in the trillions of 

dollars. So it is a very significant amount when it comes to financing. 

As I said initially, the only way people and investors are going 

to recover the confidence is the confidence in the ratings. I mean, 

that is the end of it. I mean, there is nothing beyond that. 

Now, I just want to make a brief comment, if I may, if I can 

elaborate on an important point. 

Senator CORKER. Let me just—— 

Mr. CIFUENTES. Sure. 

Senator CORKER. That is a big statement. I mean, that is kind 

of like the market will return once people believe in the ratings. 

Mr. CIFUENTES. That is my hope. 

Senator CORKER. But based on the scenario that has just been 

laid out as to how the ratings occur, how could there be faith in 

the ratings when there is no accounting activity, there is no audit 

activity, there is no understanding of how these are really put together. How could there be? 

Mr. CIFUENTES. But let me—I think that is a very valid point, 

and let me elaborate on that, because I work rating CDOs so I do 

not want to give the impression that we just feed data into the 

computer. 

Just to give you an idea regarding—I work rating CDOs, so I am 

not familiar with the process of mortgages as to how—but I will 

tell you about the due diligence, and I think it is something that 

should be recovered, I guess, if it was lost. 

I rated, for example, the first French CLO, a CDO done with 

French bank loans. So the bank came to us, they told us what they 

wanted to do. The first thing we did, I took a plane and I went to 

Paris with a colleague of mine. We met with the CEO of the bank. 

We looked him in the eye. They showed the loans they had. They 

had an internal rating system from 1 to 6. Obviously, we said fine. 

We took a sample of those loans, and we gave it to the people at 

Moody’s who rated bank loans, because I have no idea how to rate 

a bank loan. They gave sort of a correspondence between the internal rating of the bank and what Moody’s had, and then after some 

verification of the data, we used that to proceed. 

My understanding, my recollection, whenever we did CLOs at 

that time, that is the way it was done. The data was verified. So 

the point that Professor Coffee made I think is very valid. A rating 

which is not based on verification of the data, what is it? I mean, 

basically it’s some input that somebody told me that I put into the 

computer program, and then it comes out OK. 

Now, I am not very optimistic about all these things about disclosure and conflict and things like that because, at the end of the 

day, as it was pointed out, the rating is no longer an opinion. It 

is an opinion with regulatory power, and you do not have any 

choice. I mean, you have to use the rating. 

So I think at the very least there should be an element of serious 

due diligence, making sure the quality of the data you are being 

presented, there is some integrity there. I mean, what it will define 

statistical processes so somebody gives you a pool with, say, 1,000 

loans, you can take a small sample, do some analysis, and at least 


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have a rough idea of how good or how bad they are. Apparently 

that was not the case. 

Senator CORKER. Thank you. 

Chairman DODD. Thank you. 

Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. Thank you for 

the hearing, and I appreciate all of our panelists here. 

Let me ask the three rating agencies here, in November and December, all three of your agencies downgraded various Bear ratings 

slightly, but they were still investment grade. The day the collapse 

was announced on that Friday, you all downgraded Bear. S&P 

downgraded them to the second lowest investment grade. Moody’s 

downgraded them to three levels above junk, which is non-investment grade. And the question is: Did you make any changes prior 

to March? Or is that the right timeframe? You did something in 

November and December, but they were all still investment grade. 

And you did not do anything until the collapse. Is that a fair statement? 

Mr. JOYNT. I do not have the answer off the top of my head on 

Bear Stearns. I could look into it for you. 

Ms. TILLMAN. I would say the same thing. I do not have the answer off the top of my head. I would have to check back and get 

back to you. 

Senator MENENDEZ. I would have thought that on one of the big- gest challenges we have had that has spurred $29 billion by the 

Federal Reserve to prop up JP, you would have thought maybe that 

question would have been asked of you. But—— 

Ms. TILLMAN. Yes, but I would like to give you the accurate information. 

Senator MENENDEZ. All right. I will look forward to the accurate 

information. But from all my research, the answer is you did not. 

And in my mind, how is it possible that Wall Street seemed to 

know that Bear was in trouble since they started pulling out and 

demanding their money back before the collapse, yet the regulators 

seemed unaware of the looming downfall, and we got no signs from 

the ratings—you know, which to my knowledge, as I said—you can 

correct me if your facts are different, but remain unchanged until 

after the collapse. 

This goes to the heart of this problem. You know, because at the 

end of the day, as I listened to Professor Coffee and Dr. Cifuentes, 

you know, this is about valuating the underlying debt, the underlying instruments. And if you do not have a good sense of that 

valuation, I do not know how you give these ratings. And if you do 

not look at the transition over time, as Professor Coffee has suggested, how do you continue to maintain a rating in the midst of 

Wall Street acting in a different way, the regulators then following 

up and nothing changing from the rating agencies? 

Ms. TILLMAN. If I may, I do know that we had put out articles 

and made comments on the prime mortgage market, the brokerage 

market, the securities industry. What I cannot tell you exactly is 

the chronology in terms of the rating action. 

Senator MENENDEZ. But just take for a moment, Ms. Tillman my 

facts for a given, just for argument’s sake. And I am pretty sure 

you will find them to be the case. If those are the facts, isn’t someVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00060 Fmt 6633 Sfmt 6602 E:\HR\OC\A399.XXX A399

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thing wrong? Isn’t something wrong that you did absolutely nothing in making the appropriate downgrades until after the collapse? 

What good is it to the investors at the end of the day to have that 

information after the collapse? 

You know, I know you all—I hear you say that you are listening. 

I wonder whether you are—you are hearing. I am wondering 

whether you are listening. I did not hear anything in the testimony 

that leads me to believe that you are ready to make the fundamental changes that I think need to be made and I hope the Securities and Exchange Commission, Mr. Chairman, is going to make, 

and then this Committee will hopefully instigate them to move in 

that direction. 

Let me ask you another question. Recently, the example of 

MBIA, Fitch downgraded MBIA’s rating from AAA to AA citing a 

lack of capital. It also called MBIA’s outlook ‘‘negative.’’ However, 

S&P and Moody’s both kept MBIA’s ratings at the highest level. 

Before Fitch’s announcement, MBIA decided it did not want to be 

rated by Fitch anymore. 

Now, Professor Coffee, is that an example of rating shopping? 

Mr. COFFEE. It may be, but I cannot tell you. I cannot point the 

finger and tell you the answer to that question, but it could be. 

Senator MENENDEZ. Clearly, if MBIA saw it was going to get 

downgraded, it basically could have said, well, let me pull the plug 

and say thanks, but no thanks, because at the end of the day, there 

is a consequence to it. And so this whole effort of transparency and 

openness that some of us have advocated for the SEC is incredibly 

important because it would give people across the spectrum to say, 

you know, we went to an agency, we decided not to take their rating, and that pretty much gives us at least a cautionary flag at the 

end of the day. 

You know, I do not quite understand how ratings without valuation with an uncertainty—it is almost like, you know, you put— 

whatever you put into a process, it is what you are going to get out. 

And if at the end of the day we have ratings without valuations 

of the underlying instruments and the change of these instruments—these instruments have dramatically changed over time, so 

understanding the nature of those instruments and what their underlying values are is incredibly important. Otherwise, I do not 

quite understand how a rating means anything other than the fact 

that you are largely the only game in town. There may be a couple 

other rating agencies, but last year, at the end of 2007, of the 

356,000 asset-backed securities for which there were ratings, you 

three did all but 1,000 of them. So that pretty much makes it the 

only game in town. And when that game is wrong, there is a real 

consequence to the investors in this country. And that is what is 

at stake. 

So, Mr. Chairman, I look forward to working with you to make 

sure that we are more aggressive than what I have heard the agencies are willing to pursue themselves. 

Chairman DODD. Thank you, Senator, very much. 

Let me just follow up on the forum shopping issue to you, Ms. 

Tillman and Ms. Robinson and Mr. Joynt. You have heard Professor Coffee talk about how this works. Do you have anything to 


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add to that discussion? And is the suggestion about how this 

works, do you think, a legitimate point? 

Ms. TILLMAN. Well, I think at least from Standard & Poor’s perspective, we certainly do not like the practice of ratings shopping, 

if that is what you mean by forum shopping. That is what I am 

assuming what you are talking about. 

Chairman DODD. But it is ongoing. 

Ms. TILLMAN. We believe that it does, in fact, happen, yes. But 

the difficulty, for instance, at Standard & Poor’s is we know that 

when someone comes to Standard & Poor’s and requests a rating 

and then does not choose to have that rating. What we do not know 

is then who they eventually go to. So if there is a way that there 

is some kind of disclosure that is involved that can indicate, you 

know, and let there be transparency around who does give ratings 

and who does not and who went to the rating agency and not, that 

is certainly something that Standard & Poor’s would feel comfortable with. 

Chairman DODD. How about you, Ms. Robinson? How do you feel 

about that? 

Ms. ROBINSON. I think our view is that rating shopping does 

exist, and I think issuers naturally wish to obtain the best rating 

they can obtain. 

One of the ways in which we feel that we can kind of counterbalance that tendency of issuers is we feel it is very important that 

we make sure that investors understand what Moody’s rating approach is and what Moody’s point of view is, because ultimately investors are the users of our ratings. So although issuers obtain the 

ratings, it is really ultimately investors’ comfort level and satisfaction with those ratings. 

Chairman DODD. Well, doesn’t it help the investor to feel more 

comfortable if, in fact, they know that maybe they have tried to get 

a rating from someone else and did not get one? As an investor, 

aren’t I in better shape to be more comfortable if I know that? 

Ms. ROBINSON. Oh, well, we are fully supportive of efforts to provide more disclosure in this area. 

Chairman DODD. So you would agree with that. How about you, 

Mr. Joynt? 

Mr. JOYNT. I have a slightly different view than that. I disagree 

with Ms. Tillman on the topic of the rating shopping and the disclosure of the ratings. In the case of MBIA, they asked to withdraw 

the rating from Fitch. We have maintained it so far and subsequently changed the rating to what we thought was the accurate 

rating. But they have suggested that we may not have enough information to keep an accurate rating, and we are dialoguing and 

debating that ourselves. That would be based on public information, the ability to rate on public information. 

Several month ago, a large financing, Texas toll road financing, 

a several-billion-dollar financing, we also were asked not to rate 

that financing because we thought they were taking on additional 

debt load, and our rating was falling below the A category into 

BBB, where the other two rating agencies were continuing ratings 

at A. So we have been asked and have had to, because we do not 

have the information, to withdraw the rating in that case. 


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So I think there is an important job for the SEC and others, in 

the case of the public finance market, to make sure there is adequate information outstanding for any of the rating agencies to do 

an appropriate rating. 

On the second point, I believe that if you force people to disclose 

the fact that they have gone to rating agencies and subsequently 

not accepted their rating, they will limit their initial approach to 

rating agencies, and our view is probably to the largest and dominant rating agencies so that they do not have to disclose that they 

went to others and got more conservative rating opinions. So that 

would discourage competition, I think, in a very significant way. 

Chairman DODD. Professor Coffee, how do you answer that? 

Mr. COFFEE. Well, first of all, the new agencies are subscriberpaid agencies, and they are not going to be getting a fee. So we are 

not going to have forum shopping to them. There may be contact 

and you could ideally disclose any application or any forum submitted. But I do not think that the subscriber-paid agencies are 

going to be deterred by rules that seek to disclose forum shopping. 

Mr. JOYNT. Well, we are not sure all the new agencies will only 

be investor-oriented, though. Yes? 

Chairman DODD. Well, that is why you have got to apply the 

same rules to everybody. 

Mr. JOYNT. Correct. I think the simple remedy, as I was suggesting earlier, is if the SEC had one website and you had all the 

NRSROs up there, you could say there are three agencies that gave 

a rating, two that got an advisory fee but did not rate, and one that 

got an application for a rating but it was withdrawn. You could 

show that all on one simple chart. 

Chairman DODD. Yes. That was, I think, my first or second question to the Chairman. And I think he sort of endorsed the idea. I 

thought he did, anyway. It was unclear. 

Mr. JOYNT. I thought he was at least sympathetic to it, but the 

devil is in the details. 

Chairman DODD. That was the opaque answer I think you talked 

about earlier. 

This has been most fascinating, and it is a very important hearing. Just the hearing itself I think could be helpful to enlighten, 

obviously, our colleagues and the Committee and others who are 

following this, but also I think important for the SEC to hear from 

the office of the legislation about the direction we would like it to 

move in. And it is very enlightening for us to understand how this 

works and how we can get it right, because it is a critical component in all of this. And while we have made some recommendations 

and suggestions on how to deal with the underlying problems of 

foreclosure, which I think we have got to address, if we do that and 

do not also structurally address these issues, then these problems 

can recur again. So it is an important issue to look at. 

I thank you all very, very much for being here. I will leave the 

record open because there were Members who were not able to be 

here this morning who may have questions and others who were 

here may have additional questions for you. And I would ask you 

to respond in a timely fashion, if you could. But I am very grateful 

to all of you for your presence here this morning. 

The Committee will stand adjourned. 


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[Whereupon, at 1:38 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record to follow:] 


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RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD 

FROM CHRISTOPHER COX 

Q.1. Conflicts—Separate Analysts from Business? Dr. Cifuentes’ 

testimony contains a recommendation by Mr. Mark Froeba that a 

rating agency be required to separate its rating business function 

from its rating analysis function. Has the Commission considered 

whether a significant conflict exists in this area and whether it 

should be addressed by regulation? 

A.1. Yes. The Commission recently proposed rule amendments that 

would prohibit issuance of a credit rating if the NRSRO or an affiliate of the NRSRO made recommendations to the obligor or the 

issuer, underwriter, or sponsor of the security about the corporate 

or legal structure, assets, liabilities, or activities of the obligor or 

issuer of the security. The amendments would also prohibit a person within a NRSRO who participates in determining credit ratings, or in developing or approving procedures or methodologies 

used, from participating in any fee discussions or arrangements. 

Q.2. Timeliness of Updates of Ratings. Professor Coffee’s written 

testimony states ‘‘the gravest problem today may be the staleness 

of debt ratings.’’ What standards should NRSROs observe in updating ratings and in withdrawing obsolete ratings for the benefit of 

investors and the integrity of markets? 

A.2. The Commission believes credit ratings should reflect current 

assessments of the credit worthiness of an obligor or debt security. 

Consequently, NRSROs should have policies and procedures for 

monitoring and reviewing existing credit ratings. Furthermore, the 

Commission recently proposed new rules and rule amendments to 

require greater disclosure about the NRSROs’ procedures and 

methodologies for monitoring existing ratings, including how frequently ratings are reviewed and whether different models are 

used in the initial rating and monitoring processes. This proposal 

is designed to provide the market with sufficient information on 

the surveillance processes of the NRSROs to allow for comparisons 

with respect to how actively they monitor and review existing ratings. 

Q.3. Due Diligence. You testified that ‘‘The Commission’s intent is 

to promote greater due diligence by market participants.’’ Would 

the quality of ratings improve if NRSROs themselves performed 

some form of checking or due diligence on the data they receive before issuing ratings? 

A.3. Because of the sheer volume of securities they rate, credit rating agencies may be less suited to performing due diligence than 

issuers and underwriters. But this should not relieve credit rating 

agencies of the responsibility to ensure that their ratings are based 

on reliable information, even if the due diligence is performed by 

others. The Commission recently proposed new rules and rule 

amendments that would require disclosure as to the level of 

verification performed by issuers and underwriters and NRSROs, 

and how the NRSROs take that verification into account when determining credit ratings. 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM CHRISTOPHER COX 

Chairman Cox, in his written testimony, Professor Coffee notes 

that because only a limited number of investment banks underwrite structured finance products, they have leverage over the rating agencies. If they don’t like the ratings they get from one rating 

agency, they can go to another rating agency that has lower standards. Since a few investment banks control which ratings agencies 

receive the large revenues that come from rating structured finance 

products, rating agencies may be compelled to lower their ratings 

to remain competitive. 

Q.1.a. Do you agree with Professor Coffee about the market power 

of investment banks over rating agencies? 

A.1.a. This is one of the issues the Commission is reviewing as part 

of its examination of the role of credit rating agencies in the credit 

market turmoil. The Credit Rating Agency Reform Act and our proposed new rules recognize that this could happen, and therefore 

provide broadened competition and transparency as a remedy. At 

this date, the Commission has not reached any final conclusions as 

to whether investment banks unduly influenced the rating process. 

Q.1.b. Has the SEC’s investigation of the rating agencies revealed 

evidence that (1) the rating agencies compromised the integrity of 

their ratings in order to increase their profits, (2) there is a relationship between securities that have been downgraded and the investment banks that underwrote them or the credit rating agency 

that rated them, or (3) investment banks actively steered business 

to the rating agencies with lower standards? 

A.1.b. The Commission will be making a formal report to you of its 

examination findings on this question very soon. (1) Preliminary 

observations suggest the credit rating agencies were in fact focused 

on how the ratings they issued influenced their market share. (2) 

The staff’s preliminary evaluations have not found any significant 

relationship between the securities whose ratings were downgraded 

and the investment banks that issued those securities. In addition, 

examiners have not found a link between the downgraded securities and certain credit rating agencies. (3) The ongoing reviews 

have not found indications that investment banks actively steered 

business to the rating agencies with lower standards. 

Chairman Cox, many institutional investors can purchase only 

securities rated by the rating agencies listed in the investment 

guidelines that govern their funds. Because S&P and Moody’s have 

historically dominated the ratings market, the investment guidelines for many investment firms list only one or both of those firms. 

It has been suggested that the fact that investors do not regularly 

update or re-consider which rating agencies are specified in their 

investment guidelines places new rating agencies at a competitive 

disadvantage. Even if a new firm produces better ratings than S&P 

and Moody’s, investors may still have to use S&P and Moody’s ratings due to the requirements of their investment guidelines. 

Q.2.a. As matter of good business practice, should institutional investors regularly review their investment guidelines and conduct 

due diligence to determine which credit rating agencies’ ratings 

their guidelines should require? 


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A.2.a. Yes. As with any number of institutional investors’ screening 

methods and evaluation criteria, it is prudent for those investors 

to periodically review their guidelines that incorporate credit ratings. In conducting a review, institutional investors should consider 

the reliability of the agencies on whose ratings they may rely and 

consider available alternative rating firms. Moreover, for many institutional investors, a security’s rating likely would operate only 

as a starting point in a reasonable due diligence process. Further, 

where modeling is a significant part of the rating process, institutional investors should develop an understanding of the credit rating agencies’ models. For example, that understanding could include the various risks those models seek and do not seek to capture. 

Q.2.b. If institutional investors reviewed more regularly the rating 

agencies listed in their investment guidelines, would it provide an 

additional incentive for rating agencies to produce high quality ratings? 

A.2.b. Yes. To the extent they do not do so today, institutional investors’ periodic review of the efficacy and adequacy of their investment guidelines, including the reliability of credit ratings and the 

firms that issue them, could provide an additional incentive for 

credit rating agencies to provide higher quality ratings. In addition, 

it would be useful if issuers seeking ratings and the rating agencies 

themselves were fully aware of investors’ perceptions of, and perspectives on, both those agencies and the ratings they issue. 

Chairman Cox, S&P, Moody’s, and Fitch indicated in their testimony that they are taking steps to make it easier for investors to 

understand the methodologies used in rating different types of securities. However, they have stopped short of proposing that different symbols be used to distinguish ratings on corporate, structured finance, and municipal securities. 

Q.3. Would having different ratings symbols for each rating category provide investors with useful information about the nature of 

those ratings? 

A.3. Yes. However, there are also questions about the costs of such 

a requirement, which the Commission is carefully evaluating. 

Given the reliance of some investors on ratings of subprime securities, the Commission has proposed requiring NRSROs to provide 

investors and other users of credit ratings with more useful information about credit ratings and processes used by credit rating 

agencies to determine credit ratings. An amendment proposed by 

the Commission would require a NRSRO to attach a report each 

time it publishes a credit rating for a structured finance product 

that describes the rating methodology used to determine the credit 

rating and how it differs from the determination of a rating for any 

other type of obligor or debt security, and how the credit risk characteristics associated with a structured finance product differ from 

those of any other type of obligor or debt security. A NRSRO would 

not be required to attach that report if the rating symbol identifies 

the credit rating as relating to a structured finance product as distinct from a credit rating for any other type of obligor or debt security. Recognizing that market participants have a range of views on 

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larly from a cost-benefit analysis, the Commission looks forward to 

the public’s comments on this proposal. 

Q.4. Chairman Cox, presently if an investor wants to compare the 

accuracy of the ratings of different rating agencies, could an investor easily obtain the necessary information? How would the proposals you outlined in your testimony, if adopted, make it easier for 

investors, analysts, and scholars to analyze the accuracy of ratings? 

A.4. Currently making comparisons across NRSROs is difficult. For 

that reason, the Commission recently proposed new disclosure requirements designed to assist investors and others in comparing 

the performance of NRSROs. Under the proposed new rules a 

NRSRO would need to provide transition statistics for each asset 

class of credit ratings for which an applicant is seeking registration 

broken out over 1, 3, and 10 year periods. Both upgrades and 

downgrades would have to be included in these statistics. In addition, default statistics would show defaults relative to the initial 

rating and incorporate defaults that occur after a credit rating is 

withdrawn. These new rules would make it easier for academics, 

investors, and others to compare how different NRSROs initially 

rated a security, and whether they subsequently changed the rating. 

Q.5.a. Chairman Cox, during our last hearing on rating agencies, 

this Committee heard testimony that the use of ratings by 

NRSROs in financial regulation creates artificial demand for 

NRSRO ratings. Because financial institutions must obtain NRSRO 

ratings to satisfy regulatory requirements, there is a demand for 

ratings even if they are inaccurate. Does demand for NRSRO ratings for regulatory purposes reduce the incentive for credit rating 

agencies to produce accurate ratings? 

A.5.a. Not necessarily, but it could reduce the incentives of investors to be critical users of the ratings. Of course, ratings are used 

for a variety of purposes. One of the major uses of ratings is by 

issuers to give confidence to buyers that the debt instrument offered for sale is of high quality. The reputation of the rating agency 

is critical for that purpose. The Commission staff does not have any 

evidence to suggest that the coincident use of ratings for regulatory 

purposes reduces the NRSROs’ incentive to protect their reputations by producing accurate ratings. To deal with the problem of 

regulatory over-reliance on credit ratings as a shorthand for achieving other regulatory objectives, we will soon consider a rule proposal to provide alternative means of meeting those objectives. 

Q.5.b. Should steps be taken to eliminate or reduce the use of 

NRSROs in financial regulation? If so, how could this be accomplished? 

A.5.b. Yes. Financial regulators, including the SEC, should consider the extent to which the use of ratings for regulatory purposes 

induces investors to over-rely on ratings. The Commission is currently reconsidering the use of NRSRO ratings in its own rules. 

The Commission proposed new rules on June 25 designed to ensure 

that the role assigned to ratings in Commission rules is consistent 

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ment of risks and of making it clear to investors the limits and 

purposes of credit ratings for structured products. 

Q.6. Chairman Cox, NRSRO ratings are widely embedded in our 

economy. We heard testimony at the hearing about the great 

weight investors and regulators place on ratings. Do investors and 

regulators overly rely on ratings by NRSROs? Has over-reliance on 

ratings reduced the amount of due diligence and risk assessment 

undertaken in our economy? 

A.6. The fallout from the credit market turmoil indicates some investors relied too heavily on credit ratings for structured products 

rather than conducting their own assessment of the credit quality 

of the product. While, many of the financial institutions impacted 

in the turmoil had devoted substantial resources to establishing internal risk assessment functions (some of which ultimately failed 

to protect them), there is no question that there is a connection between over-reliance on ratings and the level of due diligence and 

risk assessment. The Commission proposed new rules on June 25 

designed to ensure that the role assigned to ratings in Commission 

rules is consistent with the objective of having investors make an 

independent judgment of risks and of making it clear to investors 

the limits and purposes of credit ratings for structured products. 

Q.7. Chairman Cox, the use of NRSRO ratings for financial regulation appears to multiply the impact inaccurate ratings can have on 

our economy. For example, NRSRO ratings are used in capital requirements and the SEC’s money market rules. This means inaccurate ratings can allow financial institutions to hold too little capital, or force them to sell assets that no longer satisfy regulatory 

requirements. The need for financial institutions to raise more capital or re-allocate assets following large scale ratings downgrades 

could significantly affect the economy. If our financial regulatory 

system had relied less on NRSRO ratings, would our economy have 

been better prepared to weather the impact of the recent large 

scale ratings downgrades? 

A.7. Yes, because the ratings for subprime-related securities were 

categorically wrong due to a variety of methodological factors that 

the agencies have since acknowledged. The large number of subsequent credit rating downgrades played a role in the credit market 

turmoil. However, as noted previously, issuers purchase credit ratings to make their securities marketable and many of the investors 

demanding that securities be rated are not subject to regulations 

that use credit ratings. The link between the use of credit ratings 

in Commission rules and investor over-reliance on credit ratings is 

difficult to quantify with precision. 

Chairman Cox, the Credit Rating Agency Reform Act of 2006 

sought to increase competition among rating agencies by making it 

easier for new firms to become NRSROs. The Act favors no particular business model. Two firms that use an ‘‘investor pays’’ 

model have registered as NRSROs. Some have argued that the ‘‘investor pays’’ model has fewer conflicts of interest than the ‘‘issuer 

pays’’ model because it makes the rating agency directly accountable to investors. 


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Q.8.a. How do we go about fostering innovation and further reducing the conflicts of interest in the credit rating industry? 

A.8.a. The Rating Agency Reform Act of 2006 was designed to 

achieve these goals through requirements that promote accountability, transparency and competition in the credit rating agency 

industry. The Commission recently proposed new rules and rule 

amendments that are designed to further these goals in the context 

of structured finance, including by requiring more comparable performance statistics, the disclosure of ratings history, and greater 

disclosure of the assets underlying structured finance products and 

the methodologies used to determine and monitor structured finance ratings. The goal is to make it easier for the market to assess the quality of NRSRO ratings. 

Q.8.b. What competitive barriers still entrench S&P and Moody’s 

in their dominant market positions? 

A.8.b. In the past, S&P and Moody’s widespread market acceptance has given them an advantage because issuers and investors 

were familiar with their rating record and reputation. Issuers were 

inclined to use their services because they helped issuers sell their 

securities. Following the enactment of the Credit Rating Agency 

Act, it will be easier for competitor firms to become NRSROs and 

for the users of credit ratings to become comfortable with NRSROs 

other than S&P and Moody’s. Ultimately, the test of their quality 

and value in the marketplace will be whether users are willing to 

pay for ratings from these other organizations. At the same time, 

S&P, Moody’s, and the other NRSROs will need to provide significantly more information to the public to demonstrate the quality of 

their ratings and ratings processes. The Commission recently proposed new rules and rule amendments designed to require 

NRSROs to provide more information with which investors and 

other market participants could evaluate the NRSROs’ performance 

record. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ 

FROM CHRISTOPHER COX 

RATING SHOPPING

Without a doubt, one of the most worrisome practices that undercuts the accuracy and reliability of ratings is rating shopping. I am 

pleased to hear your proposal include improvements to disclosure, 

but I am concerned that it doesn’t go far enough to ensure rating 

shopping cannot occur. 

Q.1.a. Would the proposed rules eliminate rating shopping? 

A.1.a. This is exactly what the proposed rules are intended to do. 

Specifically, the proposed new rules and rule amendments are designed to target the problem of rating shopping by making it easier 

to track the ratings of NRSROs, and by making it easier for competitor NRSROs to issue unsolicited ratings for structured products 

that would allow investors to compare these ratings. Currently, the 

information necessary to determine an initial rating for structured 

products typically is not made widely available. If this information 

were made available to all NRSROs, those that are not hired to deVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00150 Fmt 6602 Sfmt 6602 E:\HR\OC\A399.XXX A399

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termine the credit rating could nonetheless issue a credit rating. 

This approach is designed to eliminate the potential harm of rating 

shopping by promoting unbiased ratings. 

Q.1.b. The fundamental problem is that people can still get a preliminary rating and then decide to go elsewhere. Would issuers 

have to disclose if they received a preliminary rating? 

A.1.b. The agreement recently reached between the three largest 

NRSROs and the New York Attorney General to change the payment structure in the industry attacks this problem in a slightly 

different way, by ending the practice of free preliminary ratings. 

Now, issuers will have to pay even if they do not obtain a rating. 

The Commission staff believes this will also avoid the problem that 

arises if issuers forego approaching NRSROs in order to defeat a 

disclosure requirement. 

Q.1.c. On the disclosure proposals you outlined—are you going to 

require issuers to share material non-public information with all 

NRSROs if they provided the same information to one NRSRO? 

Can you describe in detail the proposal for disclosure? 

A.1.c. The Commission recently proposed new rules and rule 

amendments to require the disclosure of information about the assets underlying a structured finance product that are used by an 

NRSRO to determine a rating. The goal is to provide information 

to NRSROs that were not hired to determine the credit rating so 

they would have an opportunity to issue a credit rating. The details 

of this proposal are described in the attached rule release. 

BEAR STEARNS

The Bear Stearns collapse signaled a few problems in our system, one of which was that we seemed to have no idea how faulty 

Bear’s assets were until it was too late. 

Q.2.a. In the days and weeks leading up to Bear Stearns’ collapse, 

it appears we received no signals from the ratings, which to my 

knowledge were unchanged until after the collapse. What does this 

say to you about the reliability of these ratings? Is this an example 

of a broader problem, in your mind? 

A.2.a. Credit ratings issued by the NRSROs are intended to be an 

indicator of the credit risk associated with particular instruments 

or issuers. The extremely rapid deterioration of the financial position of Bear Stearns highlights the limitations of credit ratings and 

demonstrates the importance of considering the total mix of facts 

and circumstances in evaluating a firm, rather than relying on any 

single indicator of firm health. 

Q.2.b. Shouldn’t we be able to use the ratings as some sort of guide 

about the overall health and the risk of a firm’s assets? Would you 

say that in the case of Bear, the ratings failed? Even if this was 

under extraordinary circumstances, shouldn’t the ratings better reflect the actual risk at hand? 

A.2.b. While the NRSROs would argue their definitions of credit 

risk reflected by their ratings accurately described the case of Bear 

Stearns even though it approached bankruptcy, you are right that 

users implicitly expect a correlation between ratings and performance. While the Credit Rating Agency Reform Act of 2006 prohibits 


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the Commission from regulating the substance of credit ratings, 

our proposed new rules are intended to increase the accuracy of 

ratings through better disclosure, transparency, and competition. 

As noted previously, the events at Bear Stearns demonstrate the 

importance of considering the full range of information about a 

firm and broader market conditions in making judgments about the 

health of any firm. 

Q.2.c. Is the SEC looking at the credit rating history for Bear 

Stearns, specifically the relationships between Bear Stearns and 

the rating agencies? 

A.2.c. Yes, one of several areas covered by our examination of the 

three largest credit rating agencies is the relationship between 

issuers and the rating agencies. As a matter of enforcement policy, 

the Commission does not confirm or deny the existence of any ongoing enforcement investigation. 

UPDATING RATINGS

Q.3.a. I’d like you to comment on a proposal by Professor Coffee 

for the rating agencies to periodically update ratings, as is done by 

securities analysts. Is this feasible? Do you think the SEC could require this within its existing authority? 

A.3.a. The NRSROs generally have policies and procedures in place 

to monitor each rating and update it as necessary. The Commission 

has proposed new rules and rule amendments that would require 

greater disclosure about the NRSROs’ procedures and methodologies for monitoring existing ratings including how frequently ratings are reviewed and whether different models are used in the initial rating and monitoring processes. 

Q.3.b. Do you think the issue of ratings becoming ‘‘stale’’ is a concern? Could we argue that the ratings on Bear were in fact ‘‘stale’’? 

A.3.b. Yes, this is a concern. The Commission believes credit ratings should reflect current assessments of the credit worthiness of 

an obligor or debt security. As described above, our proposed new 

rules tackle this problem through new disclosure requirements. 

And although the Commission is statutorily prohibited from second 

guessing credit rating decisions made by the NRSROs, the Commission may evaluate whether an NRSRO followed its stated methodologies. We intend to do this through regular examinations. 

Q.3.c. Will the proposed rules provide sufficient assurance to the 

markets that the ratings are current? 

A.3.c. The proposed new rules that require greater disclosure about 

the NRSROs’ procedures and methodologies for monitoring existing 

ratings such as how frequently ratings are reviewed and whether 

different models are used in the initial rating and monitoring processes are designed to provide the market with sufficient information on the surveillance processes of the NRSROs to allow for comparisons with respect to how frequently and actively they monitor 

and review existing ratings. 

Q.3.d. Is the SEC looking at providing additional interpretation regarding what it means for a credit rating agency’s ratings to be 


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‘‘current assessments’’? Is this an area the Commission should be 

looking at, in your opinion? 

A.3.d. Yes. As part of the notice and comment process for our proposed new rules, we expect to receive useful information on this 

question. The Commission believes credit ratings should reflect current assessments of the credit worthiness of an obligor or debt security, and we will continue to explore ways to effectuate this principle. The Credit Rating Agency Act of 2006 defines a ‘‘credit rating’’ as ‘‘an assessment of the creditworthiness of an obligor as an 

entity or with respect to specific securities or money market instruments.’’ Under this definition an ‘‘assessment’’ must reflect the 

NRSRO’s current view of creditworthiness of the obligor or debt security. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM CHRISTOPHER COX 

Q.1. Should Reg FD be amended to give all investors access to the 

same information that the rating agencies have so as to be able to 

judge for themselves whether the agency’s opinions are valuable? 

A.1. This is the purpose of the proposed new rules that would require the disclosure of information about the assets underlying the 

structured finance products that the NRSROs rate. This would 

allow market participants to better analyze the assets underlying 

structured securities, and reach their own conclusions about their 

creditworthiness. However, these new rules are not an amendment 

to Reg FD, which was designed to address the problem of issuers 

making selective disclosures of material nonpublic information to 

persons who were likely to use that information to their advantage 

in securities trading. 

Q.2. Should Reg FD be amended to allow all NRSROs the same access to information if any NRSRO gets access to that information? 

A.2. While not styled as an amendment to Reg FD, this is the purpose of the Commission’s recently proposed new rules to require 

the disclosure of information about the assets underlying the structured finance products that the NRSROs rate. This data availability could particularly benefit subscriber-based NRSROs, who 

could use it to perform independent assessments of the validity of 

the ratings by their competitors who use the ‘‘issuer pays’’ model. 

Q.3. If issuers pay the rating agencies for the ratings, how should 

investors be protected from rating shopping? Wouldn’t it be better 

if the users of the ratings paid for them so that rating agencies 

that did a bad job and issued inflated ratings would be punished 

by the users in the form of lost market share? Doesn’t the current 

structure reward the softest graders with increased business? 

A.3. The issuer-pay and subscriber-pay models are subject to different types of potential conflicts. Consequently, I believe the users 

of credit ratings are served by having NRSROs that operate under 

both models as they serve as a check on the other. In addition, the 

Commission recently proposed new rules and rule amendments 

that would make it easier for NRSROs to provide unsolicited ratings for structured products. The goal is to create a mechanism to 

expose whether an NRSRO is employing less conservative methVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00153 Fmt 6602 Sfmt 6602 E:\HR\OC\A399.XXX A399

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odologies than other NRSROs to determine ratings in order to increase market share. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM JOHN C. COFFEE, JR. 

Q.1. If these reports are true, what duties would investment banks 

have violated under the securities laws? 

A.1. In the case of an offering registered under the Securities Act 

of 1933, any investment banks that ignored warnings from their 

agents (i.e., the due diligence firms) would almost certainly face 

private liability under Sections 11 and 12 of the Securities Act of 

1933 (plus, of course, liability in SEC enforcement actions based on 

Section 17 of that Act and Rule 10b–5). The provisions of Section 

11 entitle investors who purchased in the offering to sue for any 

material omission, unless the underwriter can establish its due 

diligence defense under Section 11(b)(3) that it ‘‘had, after a reasonable investigation, reasonable ground to believe and did believe, 

at the time such part of the registration statement became effective, that the statements therein were true and that there was no 

omission to state a material fact required to be stated therein or 

necessary to make the statements therein not misleading.’’ (Similar 

provisions are also found in Section 12(a)(2) with only modest differences). I seriously doubt that either affirmative defense could be 

satisfied if the investment were on notice that a significant percentage of the loans in the structured finance product were outside 

usual lending guidelines and these facts were not clearly and specifically disclosed. 

In the case of offerings done by means of a private placement or 

other exemption from registration, the above sections will not 

apply, but the investment banks would still face liability under 

Rule 10b–5 if they made a materially false statement or omitted to 

make a statement necessary to be made in order to make the statement made, in light of the circumstances under which they were 

made, not misleading. Again, I think the investment banks who 

withheld material information will face a high risk of liability (but 

a variety of legal defenses are possible). 

Q.2. Should credit rating agencies, as gatekeepers responsible for 

monitoring the quality of securities offered in our markets, conduct 

an independent assessment of asset-backed structured finance markets? 

A.2. Ideally, yes, because this is what gatekeepers normally do. But 

logistically, it may be very difficult for the major ratings agencies 

to gear up to take such a step. Thus, a second-best alternative 

would be to require that ‘‘NRSRO’’ rating agencies not confer an 

‘‘investment grade’’ rating on a structured finance product in the 

absence of receipt of a verification from an independent expert that 

the latter had conducted an investigation, using such sampling or 

similar procedures as the rating agency deemed reasonable for 

these purposes, and had reached specified conclusions about the 

quality of the collateral underlying the security. These specified 

conclusions might include that not more than a defined percentage 

of the loans were outside traditional lending criteria (i.e., such as 


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that the borrower had an equity stake of at least [20] percent in 

the home). 

The point of this alternative is that the underwriters (and not 

the rating agency) could bear the cost of this ‘‘due diligence’’ investigation, but the rating agency would get an independent certification from an expert firm (which should have both civil and criminal liability for fraud for any knowing misstatements). Other techniques can also be imagined by which the rating agencies receive 

verification from parties other than the loan originators (and that 

is what is important—not that the rating agencies do it themselves). 

Q.3. How often should ratings be reviewed and, if needed, updated 

by rating agencies? 

A.3. All other gatekeepers on whom investors rely for evaluations— 

e.g., securities analysts and auditors—do regularly update their 

evaluators. With credit rating agencies, updates are the exception, 

not the rule. I would suggest two principles: 

First, debt ratings should be reviewed and updated at least annually. The rating agency could at this periodic moment re-affirm, 

change or simply withdraw its rating. But such a withdrawal 

would be public and would alert investors not to continue to rely 

on a ‘‘stale’’ rating. 

Second, whenever the rating agency either (a) updates its model 

or methodology or (b) realizes that there has been an error in its 

model, it should promptly inform the market of the change that the 

new model (or the discovery of the error) would produce. Recent 

press reports have suggested that Moody’s discovered a computer 

error in some ratings on European offerings that resulted in ratings that were three levels too high—and it did nothing! That is 

the kind of culpable omission that should be impermissible. 

Q.4. If ratings were required to be updated more frequently, would 

it significantly increase the cost of ratings? 

A.4. There would be an increase in the cost, which would be largely 

passed onto the issuer in all likelihood (given the weak level of 

competition in the ratings industry). But the costs of updating 

should not approach the cost of the original rating. In the typical 

case, the rating agency would already have developed its methodology and the issue would be largely whether any information 

input had changed (for example, had the default rate on mortgages 

in a particular location risen materially?). These will be relatively 

exceptional events. Where the agency changes its model, it should 

be able to generate all the implications for prior ratings in a single 

computer run (using the new methodology). Thus, while I acknowledge that there would be some cost increases, I do not believe they 

would approach the cost increases that Sarbanes-Oxley imposed 

(justifiably) on the accounting profession. 

Q.5. Would you please comment on Chairman Cox’s testimony 

about the areas of rulemaking that the SEC is considering? 

A.5. It is difficult to comment (and possibly unfair to do so) until 

proposed regulations are released. I did hear Chairman Cox testify 

that he favored rules restricting the currently pervasive conflicts of 

interest in this field, and that is desirable. 


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Nonetheless, I do not yet believe that the SEC is considering 

rules to require increased verification of information in the rating 

process or to address the staleness problems. No ‘‘solution’’ can be 

adequate until these problems are addressed. Complex and sophisticated as any computer model may be, the first rule in this field 

is: ‘‘GIGO: garbage in, garbage out.’’ If loan originators are not subject to close scrutiny in terms of the data they provide, the process 

will inevitably produce distorted and optimistically biased conclusions. 

RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD 

FROM VICKIE A. TILLMAN 

Q.1. Ratings Scoreboard. What are your views on the recommendation that has been made for the creation of a central website which 

investors could access and on which they could compare the accuracy of past ratings by the different NRSROs for the same types 

of securities? 

A.1. We agree that rating agencies should work towards greater 

transparency and disclosure. At S&P, we are regularly considering 

new ways to do so. In our experience, the most effective way to 

measure ratings performance is through historical measures such 

as default and transition studies. These studies can demonstrate 

effectively the existence (or lack) of a correlation between ratings 

assigned by an NRSRO and the likelihood of default. At the same 

time, it is important to note the broad disparities in rating definitions, criteria and methodologies used by various rating agencies 

that help foster competition in the industry. Meaningful differences 

exist among rating agencies, not only in the way ratings are defined, but also in the way defaults and other relevant credit events 

are determined and measured, all of which can affect reported results. We would not object to having each rating agency make 

available—in a central repository—information about its performance history but would caution that such a repository must note 

these differentiations among rating agencies. Investors can then 

judge ratings performance and determine for themselves the value 

to them of a particular rating agency’s opinions. 

Q.2. Due Diligence. Did S&P undertake to verify the information 

it used to decide ratings on the structured finance products that 

were subsequently downgraded? In recent years, there has been 

widespread awareness, through the press and otherwise, about the 

proliferation of so-called ‘‘liar loans’’—mortgage loans with little or 

no documentation required and on which borrowers ultimately 

have stopped paying. Do you feel that NRSROs should have performed some investigation or due diligence on structured debt that 

contained these ‘‘liar loans’’?—Are there circumstances under which 

NRSROs should be required to perform some form of due diligence 

before issuing a rating? 

A.2. The information concerning the collateral for the 

securitizations that we rate typically comes from the participants 

in the transaction being rated: the issuers and underwriters. S&P 

is very specific about the data it requires in its rating process. For 

example, with respect to U.S. Residential Mortgage-Backed SecuriVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00156 Fmt 6602 Sfmt 6602 E:\HR\OC\A399.XXX A399

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ties (‘‘RMBS’’), S&P publishes a detailed list of approximately 70 

data points that it requires issuers to submit with respect to each 

loan in each pool that it is asked to rate. We also publish a detailed 

glossary of definitions that the issuer must utilize when providing 

data to S&P. 

S&P does not go on-site to review individual loan files held by 

originators and servicers, or perform an independent verification of 

the information provided to it in connection with its ratings analysis. As others at the hearing noted, we are not auditors and are 

generally not in the position to verify underlying data. The participants in the transactions we rate understand that S&P relies upon 

them for the accuracy of the data they provide. These participants 

issue representations and warranties in the operating documents 

for the transaction we are asked to rate with respect to the loan 

level data, regulatory compliance, and other issues and make disclosures about the collateral in the prospectus. 

However, in light of recent events, we determined that S&P can 

take steps on our own to improve disclosure of information on collateral underlying structured securities, and as I testified, S&P has 

announced and is implementing a comprehensive set of new measures designed to improve the ratings process. In addition, S&P has 

begun to implement procedures to collect more information about 

the processes used by issuers and originators to assess the accuracy 

and integrity of their data and their fraud detection measures so 

that we can better understand their data quality capabilities. 

Q.3. Timeliness of Updates of Ratings. Professor Coffee in his testimony pointed out that major downgrades of CDO securities ‘‘came 

more than a year after the Comptroller of the Currency first publicly called attention to the deteriorating conditions in the 

subprime market and many months after the agencies themselves 

first noted problems in the markets.’’ His testimony also states ‘‘the 

gravest problem today may be the staleness of debt ratings.’’ What 

is S&P doing to update ratings in a timely manner and eliminate 

stale ratings? What standards should NRSROs observe? 

A.3. S&P continually strives to balance the twin goals of updating 

its ratings in a timely fashion while also adhering to its criteria 

and taking action when and only when it has the data to support 

a change in its rating opinion. In response to recent events, we 

have increased the frequency of our reviews of rated transactions. 

As part of our recently announced Actions (discussed at greater 

length in my testimony), we have undertaken several additional 

steps to improve the effectiveness and speed of our surveillance 

process. These include: 

• increasing resources dedicated to surveillance; 

• continuing to separate our new rating and rating surveillance 

functions; 

• expanding our use of search and market based tools; 

• incorporating new capabilities we have gained as part of our 

acquisition of iMake, a leading global provider of structured 

cash flow models and data; and 

• developing an early warning indicator to investors that a key 

credit quality attribute (e.g., delinquencies or losses) of an 


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issue or issuer differs from our expectations and has or may 

trigger a full review by S&P surveillance. 

We believe strongly that these steps will improve our surveillance process and help provide the market with timely and appropriate ratings updates. 

Q.4. Separate Ratings from Business? Dr. Cifuentes’ testimony contains a recommendation that a rating agency separate its rating 

business function from its rating analysis function. What are your 

views on how NRSROs should address this analyst independence 

concern? 

A.4. S&P shares Dr. Cifuentes’ belief in the importance of analyst 

independence and has long sought to protect the integrity of its ratings analysis and opinions through policies and procedures designed to promote that independence. For example, analysts are 

not involved in negotiating fees. Nor can S&P personnel who are 

responsible for negotiating fees vote in ratings committees. Additionally, we specifically structure our analysts’ compensation so 

that it is not dependent on the revenue generated by the ratings 

they assign. Moreover, S&P’s Analytic Firewalls Policy imposes numerous requirements and responsibilities on both ratings analysts 

and other employees of S&P and the McGraw-Hill Companies in 

order to ensure that ratings analysts ‘‘have the freedom to express 

their respective opinions free from the improper influence of other 

Standard & Poor’s/McGraw-Hill employees and free from the influence of the commercial relationships between Standard & Poor’s/ 

McGraw-Hill and third parties.’’ 

Additionally: 

• ratings analysts are prohibited from participating in consulting 

or advisory services; 

• ratings analysts are prohibited from cross-selling of credit ratings or ancillary ratings products and services with any other 

S&P or McGraw-Hill product or service; and 

• ratings employees are prohibited from joint selling or calling 

ratings customers with other S&P or McGraw-Hill employees. 

Q.5. Ratings Shopping. We have heard concerns about ‘‘ratings 

shopping,’’ where an underwriter or an issuer goes to the NRSRO 

that it feels will give it the highest rating, even if it is not necessarily the most accurate. Is ratings shopping a problem? How 

should the negative aspects of it be addressed? 

A.5. We believe that ratings shopping is an issue to be considered 

by the markets as a whole. One suggested measure to address the 

concern is to require structured finance issuers to disclose whether 

they have approached rating agencies other than the ones providing a rating on the applicable transaction. 

Q.6. Professional Analyst Organization. Dr. Cifuentes’ testimony 

suggests ‘‘the creation of a professional organization, independent 

of the rating agencies, to which ratings analysts must belong and 

which sets forth ethical, educational and professional standards.’’ 

Please share your thoughts on the potential merits of such an organization. 


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A.6. At S&P, we believe that all rating agencies should have systematic procedures to help ensure that their analysts are able to 

identify, understand, and analyze information relevant to the 

issues and issuers they rate. In assessing the competence of analysts, S&P considers their level of education; experience within sectors, industries and geographic regions; experience with particular 

transactions and asset classes and other specialty areas; analytical 

ability; decision making; professionalism; time management ability; 

leadership; teamwork; and their written and verbal communication 

skills. S&P has adopted and continues to enhance policies and procedures designed to ensure that its analysts receive sufficient training and support to facilitate the generation of independent, objective and credible rating opinions. A major emphasis of the action 

plan that S&P announced in February is strengthening analyst 

training. 

However, given the importance of rating agency independence 

and the value of having a diversity of opinions in the market, we 

do not believe that Congress or the SEC should impose minimum 

standards for analyst training, background, experience, or other 

characteristics. Standards along these lines would replace independent judgments with those of the government. The result would 

be more homogeneity, and less innovation. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM VICKIE A. TILLMAN 

Q.1. Ms. Robinson, Ms. Tillman, and Mr. Joynt, do you think that 

it is easy for investors to compare the accuracy of the ratings of the 

different credit rating agencies? If not, do S&P, Moody’s, and Fitch 

favor the SEC issuing rules to require enhanced disclosure of ratings performance as Chairman Cox outlined in his testimony? 

A.1. We have a long-standing tradition at Standard & Poor’s 

(‘‘S&P’’) of publishing significant amounts of information about the 

default and transition history of our ratings. We believe the studies 

we publish assist issuers and investors in their evaluation of the 

quality of our rating opinions. And we are always open to considering new ways to inform the public about what we do and the excellent track record of S&P’s ratings. 

We would support having each rating agency make available— 

in a central repository—information about its performance history. 

Investors can then judge that performance and determine for themselves the value, to them, of a particular rating agency’s views. I 

will note, however, that our rating opinions represent an analytic 

judgment based on a wide range of factors, many of which are assessments of future developments. Rating agencies employ different 

definitions of ratings and have different criteria. We believe that 

although this diversity of approaches is beneficial to the markets, 

it makes an ‘‘apples to apples’’ comparison of ratings difficult. 

Q.2. Ms. Robinson, Ms. Tillman, and Mr. Joynt, would you please 

explain the process by which you obtain the information you use 

to rate structured finance securities? 

How much of the information is from issuers, underwriters, or 

other sources? 


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Do you ever seek to verify the accuracy of the information you 

receive? 

A.2. The information concerning the collateral for the 

securitizations that we rate typically comes from the participants 

in the transaction being rated: the issuers and underwriters. S&P 

is very specific about the data it requires in its rating process. For 

example, with respect to U.S. Residential Mortgage-Backed Securities (‘‘RMBS’’), S&P publishes a detailed list of approximately 70 

data points that it requires issuers to submit with respect to each 

loan in each pool that it is asked to rate. We also publish a detailed 

glossary of definitions that the issuer must utilize when providing 

data to S&P. 

We at S&P are not auditors and are generally not in the position 

to verify underlying data. Currently, the participants in the transactions we rate understand that S&P relies upon them for the accuracy of the data they provide. These participants issue representations and warranties in the operating documents for the transaction with respect to the loan level data, regulatory compliance, 

and other issues and make disclosures about the collateral in the 

prospectus. 

As I testified, S&P has announced and is implementing a comprehensive set of new measures designed to further strengthen the 

ratings process, including steps to improve the quality and integrity of information we collect. We are working with market participants to improve disclosure of information on collateral underlying 

structured securities. Specifically: 

On transactions closing after May 1, 2008, we are requesting updated loan level performance data from issuers on a monthly basis, 

consistent with data customarily sent to Trustees and third party 

data vendors in the U.S. RMBS market. 

We are in the process of revamping criteria for assigning overall 

mortgage originator rankings based on operational process and procedures. New criteria should be established by mid-2008. 

We are evaluating various fraud tools and detection policies used 

by originators for improved data integrity and will be incorporating 

these evaluations in the criteria to be established by mid-2008. 

Q.3. Do you have any reason to believe that inaccurate or fraudulent data contributed to the poor performance of your ratings on 

structured finance securities over the last few years? If yes, please 

provide supporting evidence. 

A.3. Published reports indicate that data quality and fraud are 

among the factors that may have impacted loan performance for 

the vintages that have seen worse-than-expected performance, as 

well as a host of other potential factors. Certain published reports 

also suggest a significant increase in fraud with respect to recent 

vintages. For example, the Mortgage Asset Research Institute, commissioned by the Mortgage Bankers Association to conduct a mortgage fraud study in 2006, reported ‘‘findings of fraud were in excess 

of previous industry highs.’’ It noted that key risk variables that 

have historically influenced default patterns, such as FICO, LTV 

and ownership status were proving less predictive. 

Ms. Robinson, Ms. Tillman, and Mr. Joynt, according to testimony provided by Chairman Cox, Moody’s has downgraded 53 perVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00160 Fmt 6602 Sfmt 6602 E:\HR\OC\A399.XXX A399

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cent and 39 percent of all its 2006 and 2007 subprime tranches; 

S&P has downgraded 44 percent of the subprime tranches it rated 

between the first quarter of 2005 and the third quarter of 2007; 

and Fitch has downgraded approximately 34% of the subprime 

tranches it rated in 2006 and the first quarter of 2007. 

Q.4. What steps have each of your companies taken during the 

past three years to hold accountable its executives and analysts for 

the poor performance of its ratings? Has your company dismissed 

or otherwise disciplined any of the executives or analysts responsible for overseeing or producing its ratings of structured finance 

products? Please provide a complete list of disciplinary actions. 

A.4. Ratings transitions, even significant transitions, do not reflect 

errors in our initial analysis as they could be caused by a multitude of unforeseen factors such as the unprecedented market conditions we are currently experiencing. Moreover, the downgrades of 

our 2006 and 2007 subprime tranches do highlight the success of 

our surveillance procedures in place at S&P as we adapt to turbulent market conditions. 

Additionally, S&P considers personnel actions to be confidential 

and does not—as a rule—discuss publicly reasons for promotions/ 

demotions/dismissals. 

We have been listening to and learning from the concerns and 

criticisms raised about our industry. We take very seriously our responsibility to implement whatever measures we can to improve 

the way we do business consistent with our role in the financial 

markets. As a result of our ongoing commitment to improve our 

rating process, we recently announced that we are adopting wideranging set of new measures to increase responsiveness and accountability at S&P from top to bottom. 

Among these numerous initiatives, we are increasing the annual 

training requirements for our analysts, expanding the scope and 

the course offerings of our training programs, including increasing 

our focus on policy requirements and compliance, and are establishing an analyst certification program in partnership with an academic institution. We also recently created and filled two new executive positions in the areas of risk oversight, criteria management 

and quality assurance. These changes add strength and depth to 

our ratings leadership and capabilities, and demonstrate S&P’s 

commitment to serving the broad and growing needs of the global 

credit markets. Among other things, we named a new Executive 

Managing Director of Ratings Risk Management, who will be responsible for identifying, assessing and mitigating potential internal and external risk exposures in our ratings business. Also we 

split Quality and Criteria governance responsibilities into two separate functions to further strengthen their respective independence 

and effectiveness. 

Consistent with these Actions and with our ongoing efforts to do 

what is best both for our company and the financial markets we 

serve, we will continue to evaluate the performance of all of our 

employees and take action where we believe it to be appropriate. 

Q.5.a. Ms. Robinson, Ms. Tillman, and Mr. Joynt, during the last 

3 years, did your firm notice a decline in underwriting standards 

for mortgages being used to create residential mortgage-backed seVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00161 Fmt 6602 Sfmt 6602 E:\HR\OC\A399.XXX A399

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curities? If so, did you alter your ratings process in anyway to account for this decline in underwriting standards? Did you disclose 

to investors that there was a decline in underwriting standards? 

A.5.a. S&P repeatedly and publicly voiced concerns about the 

subprime market and the deteriorating credit quality of RMBS 

transactions as far back as April 2005. These warnings included 

discussion of the various ‘‘affordability’’ mortgage products employed in the subprime market and the risks they entailed, including the risk of loosening underwriting standards. For example: 

In an April 4, 2005 article entitled S&P Comments On Risk In 

Newer Mortgage Products, As Discussed At Industry Event, we 

noted that ‘‘there is growing concern around the increased usage of 

[interest-only, negative amortization, and 40-year amortization] 

mortgages in new RMBS securitization, which may pose significant 

credit risk. . . . [S]ome of the inherent risks that may arise include 

payment shock due to interest rate increases, coupled with the addition of principal repayment, undercollaterlization with regard to 

negative amortization, and home price depreciation.’’ 

In an April 20, 2005 article entitled Subprime Lenders: Basking 

in the Glow of a Still-Benign Economy, But Clouds Forming on the 

Horizon, we stated that we ‘‘remain concerned about how these 

subprime lenders will perform in a prolonged rising interest rate 

environment.’’ We observed that increased competition among 

subprime lenders threatened a relaxation in underwriting standards and warned that the growing popularity of ‘‘affordability’’ 

mortgage products ‘‘suggests that Standard & Poor’s concerns are 

justified.’’ We singled out interest-only mortgages as ‘‘[e]specially 

worrisome,’’ noting that ‘‘these loans are more likely to feature adjustable rates . . . setting borrowers up for potential problems 

should mortgage rates rise dramatically.’’ 

On July 10, 2006, in an article entitled Sector Report Card: The 

Heat Is On For Subprime Mortgages, we noted that downgrades of 

subprime RMBS ratings were outpacing upgrades due to ‘‘collateral 

and transaction performance.’’ The article also identified ‘‘mortgage 

delinquencies’’ as a ‘‘potential hot button,’’ and noted that such delinquencies ‘‘may become a greater concern for lenders and 

servicers.’’ 

On February 14, 2007, we took the unprecedented step of placing 

on CreditWatch negative (and ultimately downgrading) transactions that had closed as recently as 2006. As we informed the 

market in the accompanying release: ‘‘Many of the 2006 transactions may be showing weakness because of origination issues, 

such as aggressive residential mortgage loan underwriting, firsttime home-buyer programs, piggyback second-lien mortgages, speculative borrowing for investor properties, and the concentration of 

affordability loans.’’ In a February 16, 2007 Los Angeles Times article, S&P’s announcement was described as ‘‘ ‘a watershed event’ 

because it means S&P is now actively considering downgrading 

bonds within their first year.’’ See S&P to Speed Mortgage Warnings, Los Angeles Times, Feb. 16, 2007. 

In a February 28, 2007 article entitled RMBS Trends: U.S. 

Subprime Market Continues Correction As Issuers Strengthen Underwriting Standards, we observed that: ‘‘Recent-vintage loans continue to pay the price for loosened underwriting standards and 


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risk-layering in a declining home price appreciation market, as 

shown by early payment defaults and rising delinquencies. Lenders 

have reported tightened underwriting standards during the industry consolidation, with weaker players exiting the origination business or being acquired by larger entities, most prominently investment banks. Although evidence of improved underwriting standards has been represented in loan documentation data, other measures such as LTV have not fully supported the reports. However, 

as there is a lag between loan origination and securitization, we 

may begin to see more evidence in the coming quarters.’’ 

In an April 27, 2007 article entitled Special Report: Subprime 

Lending: Measuring the Impact, we stated: ‘‘The consequences of 

the U.S. housing market’s excesses, a topic of speculation for the 

past couple of years, finally have begun to surface. . . . Recent-vintage loans continue to pay the price for loosened underwriting 

standards and risk-layering in a declining home price appreciation 

market, as shown by early payment defaults and rising delinquencies.’’ 

In a July 25, 2007 teleconference, we observed that the ‘‘poor performance’’ in U.S. RMBS ‘‘results from a combination of factors including but not limited to an environment of loose underwriting 

standards, pressure on home prices, speculative borrowing behavior, risk layering, very high combined loan to value, financial pressure on borrowers resulting from payment increases on first-lien 

mortgages and questionable data quality.’’ 

Q.5.b. Did you alter your ratings processes in any way to account 

for this decline in underwriting standards? 

A.5.b. In response to deterioration in the sub prime mortgage market, which was attributable to a number of factors, we tightened 

our criteria through changes in our LEVELS model targeted to increase the credit enhancement requirements for pools with 

subprime loans. As noted above, in February 2007, we also took the 

unprecedented step of placing on CreditWatch negative (and ultimately downgrading) transactions that had closed as recently as 

2006. We continued taking downward action through as recently as 

this week. We increased the severity of the surveillance assumptions we use to evaluate the ongoing creditworthiness for RMBS 

transactions issued during the fourth quarter of 2005 through the 

fourth quarter of 2006 and downgraded those classes that did not 

pass our heightened stress test scenario within given time frames. 

In addition, we modified our approach for ratings on senior classes 

in transactions in which subordinate classes have been downgraded. We also announced that, with respect to transactions closing after July 10, 2007, we would implement changes that would 

result in greater levels of credit protection (collateral) for rated 

transactions and would increase our review of lenders’ fraud-detection capabilities. 

No one can see the future. The point of these articles and actions, however, is to highlight our reaction to increasing subprime 

deterioration—looking, as we always do, to historical or paradigmshifting behaviors to help analyze long-term performance. Consistent with our commitment to transparency we repeatedly informed the market of our view that the credit quality of subprime 


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loans was deteriorating and putting negative pressure on RMBS 

backed by those loans. And, consistent with our commitment to analytical rigor, we revised our models, took action when we believed 

action was appropriate, and continue to look for ways to make our 

analytics as strong as they can be. 

Q.6. Ms. Robinson, Ms. Tillman, and Mr. Joynt, when each of your 

companies tries to attract new customers, how do you distinguish 

your ratings from the ratings of other rating agencies? 

Do you have empirical data that demonstrates that your ratings 

are better than the ratings of other companies? If yes, please provide documentation supporting your answer. 

Do you compete more on price or ratings accuracy? Please provide documentation supporting your answer. 

A.6. S&P began its credit rating activities 90 years ago, and today 

is a global leader in the field of credit ratings and credit risk analysis. We vigorously protect our reputation and we believe—recent 

criticism notwithstanding—that our excellent historical track 

record of providing the market with independent and rigorous rating opinions and information is widely recognized in the market. 

Investors attach value to our ratings because of this track record, 

and this is and of itself diminishes any leverage that underwriters 

may be perceived to have over the process. It is also this track 

record, along with our commitment to innovation and improvement, 

that we sometimes discuss with potential new customers. We believe, as well, that S&P’s proven role as a market leader will continue to distinguish us from our competitors even as the credit rating industry expands. 

Q.7. Ms. Robinson, Ms. Tillman, and Mr. Joynt, what are the idealized default rates for each of your ratings? 

A.7. There are no idealized default rates for our ratings, since ratings are not mapped to particular expected default rates. Instead, 

we arrive at our rating opinions by applying our published assumptions, methodologies and criteria to the best available information 

in our possession. 

Over the last 30 years (through May 16, 2008), S&P’s cumulative 

default rate by original rating class for all structured finance ratings has been as follows: 

Initial rating Percent of default 

AAA ....................................................................................................................................................... 0.14 

AA ......................................................................................................................................................... 0.60 

A ........................................................................................................................................................... 1.46 

BBB ....................................................................................................................................................... 3.53 

BB ......................................................................................................................................................... 5.21 

B ........................................................................................................................................................... 4.78 

Q.8. Ms. Robinson, Ms. Tillman, and Mr. Joynt, in his written testimony, Professor Coffee notes that because only a limited number 

of investment banks underwrite structured finance products, they 

have leverage over the rating agencies. If they don’t like the ratings they get from one agency, they can go to another with lower 

standards. 

Has your firm ever felt pressure to lower your rating standards 

in order to attract business? 


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How do you attract customers if your ratings use the most stringent standards? Will issuers and underwriters simply go to other 

firms with less demanding standards? 

A.8. At S&P, we do not permit issuers to dictate any aspect of our 

analytical process. Our analytics are driven by our criteria, and we 

do not compromise that criteria to meet a particular issuer’s needs 

or agenda. We have refused to rate whole categories of transactions 

that do not meet our criteria and we believe that we have lost numerous RMBS deals for this reason. 

As noted, we believe our reputation and integrity are our most 

valuable long-term assets. It would be contrary to our best interests to sacrifice these qualities by providing anything other than 

what we believe to be our best opinion of creditworthiness. In some 

instances, this may mean that an issuer will take its business elsewhere, but that is a risk we are willing to take in order to preserve 

the far more valuable asset that is our reputation for independence. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ 

FROM VICKIE A. TILLMAN 

Q.1. During the hearing, I asked you for specifics on the ratings 

your agency provided on Bear Stearns in the months leading up to 

the collapse. Please provide the Committee with a detailed explanation of the ratings for Bear Stearns from November 2007 and 

March 2008. In addition, please answer the following questions. 

A.1. On November 15, 2007, S&P downgraded the Bear Stearns 

Companies’ (‘‘Bear’’) long-term counterparty credit rating from ‘‘A+’’ 

to ‘‘A’’ and affirmed the short-term rating of ‘‘A–1’’. 

This action followed our decision on August 3, 2007 to revise our 

outlook on Bear from stable to negative based in part on the 

reputational harm suffered by Bear in the wake of problems with 

its managed hedge funds, as well as its material exposure to holdings of mortgages and MBS, the valuations of which, we said, remained under ‘‘severe pressure.’’ We further noted on August 3 

that Bear had exposure to debt it had taken up as a result of unsuccessful leveraged finance underwritings and had significant further underwriting commitments. We observed that Bear had a relatively high degree of reliance on the U.S. mortgage and leveraged 

finance sectors, and its revenues and profitability would be especially affected if there were an extended downturn in those markets. We continued this negative outlook in our November 15 rating action. 

The November 15 rating action followed Bear’s announcement 

that it would take a fourth-quarter writedown on its CDO and 

subprime exposure of $1.2 billion. We considered the writedown to 

be comparatively less than that of its peers, particularly given 

Bear’s substantial business concentration in the U.S. mortgage 

market. We noted that the potential for further writedowns remained given continued dislocation in the mortgage market but 

considered the company’s remaining CDO and subprime exposure 

to be manageable. Nevertheless, we warned that additional 

writedowns could further impair the company’s future earnings 


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performance, particularly in light of Bear’s relatively greater revenue reliance on fixed income markets, which were experiencing a 

general slowdown. 

The negative outlook on the ratings reflected our continuing concern that the general slowdown in Bear’s core fixed income businesses could have a negative impact on its earnings performance 

in the near to medium term. We also remained concerned that 

long-term lingering effects (including litigation) of the widely publicized problems in the company’s managed hedge funds would 

have a negative impact on performance in the company’s asset 

management unit. We noted that the ratings could be lowered if 

earnings failed to stabilize at a satisfactory level beyond the next 

few quarters, which we expected to be difficult ones for the firm. 

We observed that in contrast, if Bear were able to overcome current 

challenges and affect a more rapid earnings recovery than we currently anticipated, the outlook could be revised to stable. 

On March 14, 2008, S&P downgraded Bear’s long-term 

counterparty credit rating from ‘‘A’’ with negative outlook to ‘‘BBB’’ 

and its short-term rating from ‘‘A–1’’ to ‘‘A–3’’. At the same time, 

we placed the long- and short-term ratings on CreditWatch with 

negative implications. 

This rating action followed Bear’s announcement that its liquidity position had substantially deteriorated in the two days prior to 

the rating action. The severe impairment of Bear’s liquidity had resulted in the negotiation of a 28-day, Fed-backed secured loan facility with JP Morgan Chase (‘‘JPMC’’) that was designed to ease 

Bear’s liquidity pressures until it could implement a longer term 

funding structure. 

We noted that Bear had been experiencing significant stress during the week of March 10 because of concerns regarding its liquidity position. Although the firm’s liquidity at the beginning of the 

week had held steady with excess cash of $18 billion, ongoing pressure and anxiety in the markets resulted in significant cash outflows toward the week’s end, leaving Bear with a significantly deteriorated liquidity position at end of business on Thursday, March 

13, 2008. 

We observed that our ratings were based on our expectation that 

Bear would find an orderly solution to its funding problems. We 

noted, however, that although we viewed the liquidity support to 

Bear as positive, we considered it a short-term solution to a longer 

term issue that did not remediate Bear’s confidence crisis. We also 

remained concerned about Bear’s ability to generate sustainable 

revenues in an ongoing volatile market environment. 

Finally, we stated that we expected to resolve the CreditWatch 

in the coming weeks, as more concrete, longer term solutions to 

Bear’s liquidity and confidence crisis were fleshed out. We warned 

that the ratings could be lowered further if there were a failure to 

stabilize liquidity or to achieve a satisfactory longer term funding 

structure. 

On March 17, 2008, we placed our ‘‘BBB’’ long- and ‘‘A–3’’ shortterm counterparty credit ratings on Bear on CreditWatch with developing implications. 

This rating action followed the announcement that JPMC had 

agreed to acquire Bear in an all-stock transaction. 


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We noted that we considered the acquisition of Bear by JPMC as 

positive, as it would permit Bear to meet its obligations through 

funding sources obtained directly from its new parent. We observed 

that we expected that JPMC would assume all of Bear’s obligations 

when the transaction closed. We stated that we would resolve the 

CreditWatch placement when details about the integration of 

Bear’s activities became tangible. 

We warned that if the acquisition by JMPC were not to close as 

expected, the ratings on Bear would come under renewed pressure. 

Conversely, if the acquisition was to proceed as expected and 

Bear’s businesses were successfully integrated into JPMC, the ratings on Bear could be equalized with those on its new parent. 

On March 24, 2008, we raised the counterparty credit ratings on 

Bear to ‘‘AA–/A–1+’’ and removed them from CreditWatch Developing where they had been placed on March 17. We determined 

that the outlook for the ratings was stable. 

This rating action recognized the strengthened immediate guarantee by JPMC of all of Bear’s counterparty obligations. We noted 

that JPMC was also to assume Bear’s debt obligations upon completion of the acquisition. 

We observed that in our view, the price increase for the transaction and the anticipated increase in the amount of shares controlled by JPMC raised the probability that the deal would be completed. We warned that on its own, Bear’s viability was uncertain, 

and that if the deal were to be amended in any way, we would review the circumstances at that time. 

We stated that we expected the acquisition by JPMC to be completed under the revised terms by mid-May. In light of the guaranty and our expectation that Bear’s debt would be assumed by 

JPMC, we believed that Bear’s creditors benefited from JPMC’s 

creditworthiness and participated in the outlook for JPMC. Therefore we equalized the ratings and outlook with those on JPMC. 

Our press releases for each of these ratings actions are attached. 

Q.2. Were any of the ratings downgraded between December 2007 

and March 14, 2008? 

A.2. As noted, on November 15, 2007, S&P downgraded Bear’s 

long-term counterparty credit rating from ‘‘A+’’ to ‘‘A,’’ which followed our decision in August 2007 to change our outlook on Bear 

from stable to negative. 

On March 14, 2008, S&P downgraded Bear’s long-term 

counterparty credit rating from ‘‘A’’ with negative outlook to ‘‘BBB’’ 

and its short-term rating from ‘‘A–1’’ to ‘‘A–3.’’ At the same time, 

we placed the long- and short-term ratings on CreditWatch with 

negative implications. 

Q.3. Were any of the ratings downgraded during the week of the 

collapse (March 10–14)? 

A.3. As noted, on March 14, 2008, S&P downgraded Bear’s longterm counterparty credit rating from ‘‘A’’ with negative outlook to 

‘‘BBB’’ and its short-term rating from ‘‘A–1’’ to ‘‘A–3.’’ We also 

placed Bear’s long- and short-term ratings on CreditWatch with 

negative implications. 


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Q.4. Can you explain from your agency’s point of view how Bear’s 

collapse unfolded and the role the ratings may have played? 

A.4. While we are continuing to review the factors that led to the 

sudden and severe weakening of Bear’s liquidity situation, a number of factors are clear at this time. As noted in our published reports, Bear faced (i) material exposure to CDOs and subprime investments, as well as the general slowdown in its fixed income 

businesses; (ii) significant dislocation in the mortgage market; and 

(iii) severe, ongoing reputational harm that eventually led to a crisis in confidence. The damage to Bear was hastened, in our view, 

by its inability to effect a rapid earnings recovery in the face of 

these challenges. 

As noted, Bear’s situation deteriorated rapidly in March 2008 

when it announced that its liquidity position had substantially and 

rapidly deteriorated over a two-day period, which resulted in part 

from significant cash outflows, as well as ongoing pressure and 

anxiety in the markets. It was also reported that some hedge funds 

suddenly withdrew billions of dollars in assets from Bear, which 

was unexpected and would have contributed to the bank’s rapid decline. The sudden loss in confidence in Bear was critical in our 

view, and was widely unexpected. It became clear that Bear required a long term solution to its liquidity problems, which eventually arose in the form of JPMC’s announced acquisition. 

We do not believe that S&P’s ratings had a role in causing these 

events to occur. Rather, consistent with our long-standing reputation for independence and objectivity, our ratings simply reflected 

our current opinion of the creditworthiness of Bear based on the 

best facts available to us at the time. 

Q.5. Do you think the lack of changes to the Bear Stearns’ ratings 

is an example of a unique event in the markets or an indication 

of larger flaws in the structure of the ratings? 

A.5. We believe the speed with which Bear deteriorated was a 

unique event in the market and broadly unanticipated. 

Q.6. Under ideal circumstances, would you agree that the ratings 

should have been downgraded to more accurately reflect Bear’s 

risk? 

A.6. As with all of our ratings, we downgraded Bear’s rating when 

we concluded that the data available supported such a move. It is 

always easy in hindsight to look back and question whether certain 

ratings should have or could have been different if we knew then 

what we know now. That, however, is different than the reality of 

our work, which is to take the information available to us at the 

time and try as best we can to project what is likely to happen in 

the future. That is what we did with our ratings on Bear. 

Q.7. What lessons do you think we should take from the Bear 

Stearns collapse as it relates to the credit ratings? 

A.7. As noted, our rating on Bear was based on the best information available to us at the time, including statements by management and regulatory filings. We had concerns about Bear’s exposure to CDOs and subprime investments, as well as the consequences of continued harm to its reputation, among other things, 

and made those concerns public. Of course, we are always looking 


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for ways to refine our analytical processes and, in this case, are 

continuing to assess the factors that led to Bear’s rapid decline. 

Q.8. What are your thoughts on a proposal Professor Coffee discussed at the hearing for rating agencies to periodically update ratings? 

A.8. At S&P we believe that timely monitoring of our rating opinions is a key component of the value we bring to investors and the 

market. We are constantly looking for ways to enhance our surveillance process and have made improvements—including increasing 

the frequency of our reviews of rated transactions and the amount 

of resources dedicated to the process—response to recent events. 

While we believe that credit ratings should be ‘‘current’’ assessments of creditworthiness, we do not believe a mandated fixed 

schedule of periodic reviews in the manner that Professor Coffee 

suggests would improve the surveillance process. Ratings are subjective in nature and are typically formulated and disseminated 

after deliberation of whatever duration is appropriate to assess the 

particular issue or issuer being considered. The necessary frequency and scope of any ratings review may vary considerably 

based on issue and issuer-specific factors as well as the original 

method of analysis. Any rule attempting to impose a specific, fixed 

period during which ratings must be updated would divert attention away from surveillance based on risk identification and assessment, and would by its nature be arbitrary, burdensome and, we 

believe, ineffective. 


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RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD 

FROM CLAIRE ROBINSON 

Q.1. Ratings Scoreboard. What are your views on the recommendation that has been made for the creation of a central website which 

investors could access and on which they could compare the accuracy of past ratings by the different NRSROs for the same types 

of securities? 

A.1. Moody’s would support the establishment of a centralized repository, such as an industry portal, for rating performance studies. 

Indeed, we believe such a repository could enhance the ability of 

users of credit ratings to compare and contrast rating agency performance in a more efficient manner. We also would support a centralized repository that lists the ratings of each NRSRO for a particular security, so long as such requirements do not intrude on our 

rating methodologies or the content of our ratings. 

Q.2. Timeliness of Updates of Ratings. Professor Coffee in his testimony pointed out that major downgrades of CDO securities ‘‘came 

more than a year after the Comptroller of the Currency first publicly called attention to the deteriorating conditions in the 

subprime market and many months after the agencies themselves 

first noted problems in the markets.’’ His testimony also states ‘‘the 

gravest problem today may be the staleness of debt ratings.’’ What 

is Moody’s doing to update ratings in a timely manner and eliminate stale ratings? What standards should NRSROs observe? 

A.2. Our initial ratings on these securities reflected our expectation 

of the asset performance in the pools. As always, we monitored our 

published ratings and took rating actions accordingly and when 

warranted by performance data and when our expectation of future 

performance changed due to changes in market conditions. 

Professor Coffee’s comments seem to suggest that rating actions 

on a security should be taken as soon as any significant changes 

in market conditions are observed. Based on our ongoing conversations with investors, issuers and regulators, many market participants have a strong preference for credit ratings that are not only 

accurate but stable. They want ratings to reflect enduring changes 

in credit risk because rating changes have real consequences—due 

primarily to ratings-based portfolio governance rules and rating 

triggers—that are costly to reverse. Market participants, moreover, 

do not want ratings that simply track market-based measures of 

credit risk. Rather, ratings should reflect independent analytical 

judgments that provide counterpoint to often volatile market-based 

assessments. 

However, we do believe that there are additional steps that can 

be taken to enhance the quality and efficiency of our surveillance 

activities. For example: 

• Further enhancing our surveillance function: We are continuing to expand the resources allocated to wholly separate 

monitoring teams within our Structured Finance Group. This 

initiative began before the RMBS and CDO downgrades. More 

recently, as part of our commitment to enhancing surveillance, 

Moody’s created and filled the position of Global Structured Finance Surveillance Coordinator. The executive in this role is 

working with the surveillance managers and departmental 


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heads throughout our global Structured Finance Department 

to enhance our surveillance processes and make them more efficient. 

• Enhancing the automated review of data: Moody’s has also 

been implementing a number of automated processes and systems, including proprietary applications, to routinely sift 

through entire databases of transactions, updating performance statistics and flagging rating outliers. The rollout of these 

initiatives began before the RMBS and CDO downgrades. 

• Enhancing market communication: Moody’s has allocated more 

resources to the function of communicating our monitoring activities to the market. 

• Enhancing review of internal process and market trends: As 

part of the CRA industry initiative, Moody’s has committed to 

evaluating our internal processes and market trends regularly 

so that we maintain the operational flexibility to enable us to 

dedicate the resources needed to monitor existing ratings and 

conduct reviews on a timely basis. 

Q.3. Separate Ratings from Business? Dr. Cifuentes’ testimony 

contains a recommendation that a rating agency separate its rating 

business function from its rating analysis function. What are your 

views on how NRSROs should address this analyst independence 

concern? 

A.3. Moody’s would not object to a clearer distinction between the 

business arm of a credit rating agency and the analytical work that 

it conducts. For our part, Moody’s Code sets forth our policies that 

govern the roles and responsibilities of our rating agency employees, with the primary goal of ensuring that our analytical activities 

remain appropriately distanced from the commercial management 

of our business. In particular, the following provisions are relevant: 

2.11 Reporting lines for Employees and their compensation arrangements will be organized to eliminate or effectively 

manage actual or potential conflicts of interest. Analysts 

will not be compensated or evaluated on the basis of the 

amount of revenue that [Moody’s] derives from Issuers that 

the Analyst rates or with which the Analyst regularly interacts. 

2.12 [Moody’s] will not have analysts who are directly involved 

in the rating process initiate, or participate in, discussions 

regarding fees or payments with any entity they rate. 

Implementation of these and other standards in the Moody’s 

Code is subject to oversight by our internal Compliance Department as well as external examination by authorities such as the 

SEC. 

Furthermore, while we believe that we operate with a high degree of independence and clarity around analytical remuneration, 

greater clarity regarding our policies and practices to protect analysts’ independence may be beneficial for the market. We recently 

have implemented, or are in the process of implementing, several 

other measures to further demonstrate the independence of our rating process. These include: 


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• Formalizing the separation of ratings-related businesses: 

Moody’s recently reorganized its operating businesses to formalize the separation of our ratings-related and non-rating activities into two different business units. 

• Enhancing the Credit Policy function: The Credit Policy function at Moody’s has long been independent from those parts of 

the rating agency with revenue-generating responsibility, and 

we have taken steps to further separate this function. The 

Chairman of Credit Policy now has a reporting responsibility 

to the President of Moody’s. The performance incentives for 

Credit Policy personnel are based exclusively on the effectiveness of the rating process and the analytical quality of their 

oversight. The measurement of the unit’s performance is wholly independent of the financial performance of the company or 

any business unit. 

• Codifying the existing policies about analyst communication 

with issuers: In order to enhance market confidence in the appropriateness of communications between Moody’s analysts 

and issuers or advisors, we are codifying our existing practice 

that such communications are limited to communications about 

credit issues. 

• Implementing ‘‘look-back’’ reviews to confirm integrity of analysis: Moody’s has adopted a new policy related to employees 

who leave Moody’s to work for another market participant. 

When we learn that an issuer or a financial intermediary representing the issuer has hired a Moody’s employee who has 

served as lead analyst for that issuer, we will now review the 

analyst’s work related to the issuer and its securities over a 

six-month ‘‘look-back’’ period to confirm the integrity and rigor 

of that analyst’s work. 

Also, as part of the CRA industry initiative, we have committed 

to conduct formal and periodic, internal reviews of compensation 

policies and practices for analysts and other employees who participate in rating committees to ensure that these policies do not compromise the rating process. 

Q.4. 4. Ratings Shopping. We have heard concerns about ‘‘ratings 

shopping,’’ where an underwriter or an issuer goes to the NRSRO 

that it feels will give it the highest rating, even if it is not necessarily the most accurate. Is ratings shopping a problem? How 

should the negative aspects of it be addressed? 

A.4. Ratings shopping occurs in the structured finance market because there is relatively little information available publicly about 

the transactions prior to their issuance. Arguably, market disciplinary forces and transparency around NRSRO methodologies already operate to some extent to address the negative aspects of rating shopping. For example, because rating methodologies are published, market participants can compare various CRA’s different 

approaches to the same sectors or asset classes. A potential user 

of an NRSRO’s credit ratings can decide for itself whether or not 

the NRSRO’s methodology is more or less stringent than another 

NRSRO’s methodologies and take this into account in deciding 

whether to attach any weight to the NRSRO’s ratings. On the other 


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10Given their complex and mutable nature, structured finance products may not lend themselves to unsolicited ratings before that time. 

hand, this same transparency allows issuers to assess the conservatism of a particular NRSRO and ratings shop at the outset of the 

rating process. 

We believe that the appropriate way to deal with the negative aspects of ratings shopping in the structured finance market is to 

have issuers publicly disclose in a comprehensive and standardized 

manner: 

• the characteristics of each asset in the asset pool; 

• the structure of the transaction and performance data for each 

asset in the asset pool; 

• the validation process used to verify the quality of the information provided and all pertinent representations and warranties; 

and 

• Servicer and Trustee reports prepared after the issuance of the 

transaction. 

Presently, because of the generally limited data in the public 

market about structured securities prior to their issuance, neither 

investors nor CRAs that have not had sufficient contact with the 

issuer are able to formulate an informed opinion on the securities. 

However, if robust information about structured finance products 

were publicly available once the details of the transaction had been 

finalized,10 both the investors and credit rating agencies could form 

higher quality opinions, regardless of whether or not an issuer has 

directly contacted them. As a result, in many circumstances market 

participants would have the benefit of multiple and potentially diverse opinions about the same transaction. Finally, and most importantly, having the underlying data published by the issuers or 

originators would allow investors to form their own opinions about 

the strengths and weaknesses of a particular transaction, which 

could support authorities’ efforts to discourage the use of ratings 

for purposes other than an objective opinion about relative credit 

risk. 

Some policymakers and market commentators have suggested 

that ratings shopping can be addressed by requiring CRAs to disclose the names of issuers who provide data to a credit rating agency and ask for a preliminary assessment but then choose to publish 

the rating of another credit rating agency. We believe that such a 

solution would be unworkable and likely would fail to resolve concerns about the practice because: 

• The CRA would not necessarily know if the issuer contracted 

with another CRA for a final rating of the same structure. 

Even if the CRA tried to monitor the conduct of an issuer, the 

CRA could not know with certainty that it had identified all cases 

requiring disclosure under such a provision because it might not 

have access to all relevant information. Moody’s believes it is inappropriate to impose a disclosure obligation on an entity that cannot, as a practical matter, control the means by which it acquires 

information that triggers that obligation. 


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• Ratings shopping would simply occur at an earlier point in 

time. 

Moody’s believes that requiring credit rating agencies to disclose 

cases of ratings shopping might change the nature of the practice 

but would not eliminate it. Some originators, underwriters and 

sponsors of structured securities who wished to avoid being identified by CRAs as ratings shoppers likely would get around the disclosure trigger by withdrawing earlier in the process. Others might 

simply refrain from approaching CRAs that were believed to have 

more conservative methodologies or were less-well established, and 

whose methodologies were not well-understood or well-tested in the 

market. 

Q.5. Professional Analyst Organization. Dr. Cifuentes in his testimony suggested ‘‘the creation of a professional organization, independent of the rating agencies, to which ratings analysts must belong and which sets forth ethical, educational and professional 

standards.’’ Please share your thoughts on the potential merits of 

such an organization. 

A.5. In evaluating the necessity of a ‘‘professional analyst organization’’, we believe the following points should be considered. 

• We believe that a rigorous credit ratings process involves the 

expertise of a combination of professionals—including lawyers, 

MBAs, accountants and others—who bring their respective and 

possibly divergent points of view to bear upon an analysis. 

Consequently, establishing a single body that establishes one 

set of standards for credit analysts, in our view, may diminish 

some of the advantage of having employees with different educational and professional credentials. 

• Many of our professionals already belong to professional organizations, such as state bars. These organizations impose continuing education requirements and ethical standards. Establishing yet another professional organization may be overly 

burdensome on the analysts. 

• Moody’s Code already has extensive provisions dealing with, 

among other things, the quality, integrity and independence of 

the rating process. There are provisions directed specifically to 

analysts. 

• Moody’s also has an extensive professional development and 

training program that has been designed to enhance the quality of Moody’s rating analysis and analysts’ understanding of 

relevant policies and procedures, including those relating to 

ethics. Moody’s analysts are required to meet annual continuing education requirements by completing Moody’s courses 

or approved, external courses. 

• As part of the CRA industry initiative, we intend to incorporate into the Moody’s Code an explicit commitment to adopt 

and maintain a continuing education program appropriate to 

the nature of our business. Doing so will make our policies and 

practices in this area subject to monitoring by the SEC. 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM CLAIRE ROBINSON 

Q.1. Ms. Robinson, Ms. Tillman, and Mr. Joynt, do you think that 

it is easy for investors to compare the accuracy of the ratings of the 

different credit rating agencies? If not, do S&P, Moody’s, and Fitch 

favor the SEC issuing rules to require enhanced disclosure of ratings performance as Chairman Cox outlined in his testimony? 

A.1. We agree that new ‘‘requirements for enhanced disclosures 

about ratings performance’’ is an important area for consideration 

as the Securities and Exchange Commission (‘‘SEC’’) contemplates 

new rules for our industry. We believe that consideration of ratings 

performance data would create objective criteria for assessing 

whether a credit rating agency’s (‘‘CRA’s’’) ratings are suitable for 

use in regulation. 

For Moody’s part, we publish and make freely available a wealth 

of data on ratings performance so that users of our ratings, as well 

as regulators, can judge the performance of our ratings. For your 

information, we have provided in this packet our ‘‘Guide to Moody’s 

Default Research: March 2008 Update’’, which lists our performance, default, transition and loss severity research reports in reverse chronological order and broken down by topic. Moody’s believes there is substantial value in encouraging agencies to present 

their analysis of their ratings performance in the ways they believe 

to be most relevant, since there is no single agreed upon approach. 

One reason why there is no unique way to measure ratings performance is that different users of ratings place different value on 

different characteristics of the relationship between ratings and 

credit risk and as such different rating agencies seek to measure 

different attributes. For example, users may be concerned with one 

or more of the following: 

• the relationship between ratings and defaults; 

• the relationship between ratings and expected credit losses 

(which are the product of default probabilities and loss severity 

rates in the event of default); 

• ratings stability; 

• the relationship between ratings and ‘‘mark-to market’’ risk; 

• the information in rating outlooks rather than just the ratings 

alone; 

• the ability of ratings to rank relative credit risk at a point of 

time; and 

• the ability of ratings to rank relative credit risk over time. 

We agree in concept that presenting data in a standardized format would facilitate ratings performance comparisons. We believe, 

however, that such a standard may be difficult to implement in 

practice for a number of reasons, including: 

• There may be differences of opinion on the most meaningful 

way to present the data. Any given presentation may advantage or disadvantage one rating agency compared with another. 

• Rating agencies do not all define their ratings in the same 

way, which may result in standardized performance reports 


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1Moody’s Analytics is a subsidiary of our corporate parent, Moody’s Corporation. It is legally 

and operationally separate from Moody’s Investors Service, the rating agency, and is a provider 

of research, data, analytic tools and related services that are distinct from credit ratings. 

not being perfectly comparable. For example, Moody’s ratings 

are intended to be opinions of expected loss whereas some 

other rating agencies may intend their ratings to measure 

other indicators of credit risk, such as just probability of default. Therefore, a standardized format that focuses on default 

experience alone may not effectively capture the overall predictive content of a Moody’s rating. 

• Rating agencies have different approaches to dating defaults 

on structured finance securities because events of default are 

more subjective in structured finance than in corporate finance. In particular, many securitizations are structured as 

pass-through securities and, as such, are not at risk of payment defaults in a strict contractual sense until they reach 

their legal final maturity dates (in perhaps 30 years) even 

though cash flows to investors may cease many years prior to 

maturity. 

Q.2. Ms. Robinson, Ms. Tillman, and Mr. Joynt, would you please 

explain the process by which you obtain the information you use 

to rate structured finance securities? 

A.2. At Moody’s, the analyst or analysts assigned to a particular 

structured finance transaction begin the credit analysis by assembling relevant information on the transaction. Information about 

the specific transaction may come from the originator or a market 

intermediary in meetings or other communications with the analyst(s). Our analysts compare this transaction-specific information 

with data we have regarding past transactions, deals effected by 

other market participants, thematic research generated by Moody’s 

analysts regarding industry trends, credit research generated in 

other rating departments (e.g., regarding the creditworthiness of 

the financial institutions participating in the securitization) and 

macro-economic trend research generated by Moody’s Analytics.1

We have provided in this packet the Moody’s Investors Service 

Code of Professional Conduct (‘‘Moody’s Code’’), which presents the 

various policies that we have in place to address issues of (1) quality and integrity of the rating process; (2) independence and management of conflicts of interest; (3) responsibilities to investors and 

issuers; and (4) enforcement and disclosure of the Code of Professional Conduct and communication with market participants. Of 

particular relevance to this question is the following provision: 

1.4 Credit Ratings will be determined by rating committees and 

not by any individual Analyst. Credit Ratings will reflect 

consideration of all information known, and believed to be 

relevant, by the applicable [Moody’s] Analyst and rating committee, in a manner generally consistent with [Moody’s] published methodologies. In formulating Credit Ratings, 

[Moody’s] will employ Analysts who, individually or collectively, have appropriate knowledge and experience in developing a rating opinion for the type of credit being analyzed. 


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Our primary contact for transaction-specific information is typically the intermediary (‘‘Arranger’’ ‘‘Underwriter’’ or ‘‘Investment 

Banker’’) that chooses the assets to be included in the transaction 

and sets up the structure of the transaction, divides the structure 

into different classes of securities (‘‘tranches’’) and markets the 

tranches. We may also deal with and obtain information from: 

• one or more ‘‘Originators’’, which either originate the underlying assets in the course of their regular business activities or 

source them in the open market; 

• the ‘‘Servicer’’, which collects payments and may track pool 

performance; 

• in managed transactions, an ‘‘Asset Manager’’, which may assemble the initial pool and may subsequently buy and sell assets in the transaction; q 

• the ‘‘Trustee’’, who oversees cash distributions to investors and 

monitors compliance with transaction documentation; 

• a ‘‘Financial Guarantor’’, who may provide guarantees on principal and/or interest payments to, or may sell credit default 

swaps on, particular tranches; and 

• in asset-backed commercial paper (‘‘ABCP’’) programs, an ‘‘Administrator’’ of the ABCP conduit that funds several asset 

pools. 

In addition, it is not unusual for the Arranger to ask us to communicate directly with the transaction lawyer in order for us to get 

a better understanding of the transaction structure. 

Q.2.a. How much of the information is from issuers, underwriters, 

or other sources? 

A.2.a. The relative proportions of the information we obtain from 

the different sources vary depending on the asset class and the 

transaction in question. In general terms, our primary source of 

transaction-specific information is the Arranger (or its agents). As 

noted above, however, our analysts compare this transaction-specific information with data we have regarding past transactions, 

deals effected by other market participants, thematic research generated by Moody’s analysts regarding industry trends, credit research generated in other rating departments (e.g. regarding the 

creditworthiness of the financial institutions participating in the 

securitization) and macro-economic trend research generated by 

Moody’s Analytics. 

Q.2.b. Do you ever seek to verify the accuracy of the information 

you receive? 

A.2.b. Our analysis takes into consideration and compares data 

from a variety of sources. Moody’s Code of Professional Conduct 

Provision 1.7 states: 

1.7 [Moody’s] will invest resources sufficient to carry out highquality credit assessments of Issuers or obligations. When 

deciding whether to rate or continue rating an obligation or 

Issuer, [Moody’s] will assess whether it is able to devote sufficient personnel with appropriate skills to make a proper 

rating assessment, and whether its personnel likely will have 


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2For more information, please see the enclosed ‘‘Moody’s Proposed Enhancements to U.S. Residential Mortgage Securitizations: Call for Comments’’. 

access to sufficient information needed in order to make such 

an assessment. 

When rating a corporate issuer, we receive audited financial data 

and regulatory filings. When rating a structured finance product, 

the Originator and/or Arranger of the structured product make representations and warranties to the other parties in the transaction 

as to the quality of the loan level data describing the collateral. 

With respect to the publicly offered securities in the structured finance market, the prospectus also contains information that must 

be provided to investors in accordance with U.S. securities laws. 

The named underwriter performs due diligence on the security 

being issued to help verify the accuracy of information in the prospectus. These underwriters frequently hire a due diligence firm to 

examine the underlying loans. Accounting firms also are frequently 

hired by underwriters to verify that the summary information 

about the loan pools matches the information in the related loan 

files. 

As part of the credit rating process, we do consider, among other 

factors: 

(a) the source of the data we receive; 

(b) the track record of the source in providing quality data; 

(c) the predictive powers associated with the data; and 

(d) whether or not the data (such as financial information) has 

been subject to review by a third party. 

In addition, as noted in our response to the preceding question, 

we also assess the transaction-specific information in the context of 

the much broader and deeper data sets and other information we 

possess as a result of our credit rating and credit-related research 

activities. However, others in the market (e.g. auditors, issuers and 

underwriters) are far better positioned—given their expertise and 

resources—to certify the accuracy of data. 

Our experience over the decades that we have been rating structured securities has been that most of the issuers operated in good 

faith and provided reliable information to us, and we have relied 

upon them to do so. Nevertheless, our analysts seek to exercise 

skepticism in our analysis of information provided to us. Furthermore, if we believe we have inadequate information to provide an 

informed credit opinion to the market, we will exercise our editorial 

discretion and either refrain from publishing an opinion or withdraw our published credit rating. 

In light of recent market difficulties, we believe that the due diligence process conducted by the parties who originate, arrange, and/ 

or service residential mortgage backed securities (‘‘RMBS’’) needs 

to be further strengthened. We have proposed a series of measures 

to improve transparency, data integrity and accountability in U.S. 

residential mortgage securitizations, including 2: 

• Stronger representations and warranties; 

• Independent third-party pre-securitization review of underlying mortgage loans; 


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• Standardized post-securitization forensic review; 

• Expanded loan-level data reporting of initial mortgage pool and 

ongoing loan performance; and 

• More comprehensive originator assessments. 

We believe that these measures taken together will provide more 

standard and reliable information on RMBS transactions than currently available. 

Q.3. Do you have any reason to believe that inaccurate or fraudulent data contributed to the poor performance of your ratings on 

structured finance securities over the last few years? If yes, please 

provide supporting evidence. 

A.3. While the sharp decline in home prices and contraction of 

mortgage credit availability across the U.S. have been key factors 

contributing to the current market turmoil, numerous market 

sources have identified certain market practices—including lenient 

lending practices by mortgage originators and misrepresentations 

by certain mortgage brokers, appraisers and some borrowers themselves—as also contributing to the unexpectedly poor payment performance of recent subprime mortgage loans. This is why we are 

supporting the strengthened due diligence measures noted in our 

response to question 2a above. 

Q.4. Ms. Robinson, Ms. Tillman, and Mr. Joynt, according to testimony provided by Chairman Cox’s testimony, Moody’s has downgraded 53 percent and 39 percent of all its 2006 and 2007 subprime 

tranches; S&P has downgraded 44 percent of the subprime 

tranches it rated between the first quarter of 2005 and the third 

quarter of 2007; and Fitch has downgraded approximately 34% of 

the subprime tranches it rated in 2006 and the first quarter of 

2007. 

What steps have each of your companies taken during the past 

three years to hold accountable its executives and analysts for the 

poor performance of its ratings? Has your company dismissed or 

otherwise disciplined any of the executives or analysts responsible 

for overseeing or producing its ratings of structured finance products? Please provide a complete list of disciplinary actions. 

A.4. Moody’s is committed to providing the most accurate, objective 

and independent credit assessments available in the global credit 

markets. As in any company, Moody’s regularly evaluates the performance of its employees, including its executives and analysts. 

The assessment of the performance of each employee, which is 

measured by the ability of the employee to perform his/her job 

function, is an assessment that is distinct from ratings performance. Moody’s does make disciplinary decisions, including employment termination decisions, based on poor performance in a job 

function. Moody’s individual personnel decisions, however, are confidential and the Company is therefore not in a position to provide 

more detailed information on specific personnel actions. 

Also, as you know, the Securities and Exchange Commission 

(‘‘SEC’’) has been conducting a non-public examination of certain 

NRSORs, including Moody’s. Under the Credit Rating Agency Reform Act of 2006 (‘‘Reform Act’’) and related rules the SEC is entitled to inspect Moody’s books and records, including those relating 


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3Please see Annex I, which sets out in a table excerpts from our publications on this issue. 

We have also provided you with all of the documents referenced in Annex I. 4Please see ‘‘Early Defaults Rise in Mortgage Securitization,’’ Moody’s Special Report, January 18, 2007. We have included this document in Annex II, which also provides a list of the 

updates we provided to the market as well as the actual published research for your information. 5Please see Annex II. 

to Moody’s compliance function, credit policy function and human 

resources function. Moody’s has been cooperating fully with this extensive examination. 

We recognize that the unprecedented financial turmoil that has 

developed in the past year has caused a great deal of anxiety and 

uncertainty in the markets. While examination of the root causes 

of the situation reveals multiple points of market failure, we believe the speed and extent of rating downgrades have been one contributor to the loss of confidence in the credit markets and undermined the credibility of credit rating agencies. 

For Moody’s part, we have been and will continue working hard 

to respond quickly and sensibly to rapidly changing market conditions, and we continue to refine our practices to improve our performance in the future, based on what we have observed from this 

confluence of events. We can and must always strive to improve the 

quality of our work. Lessons from the recent market turmoil highlight opportunities for improvements in assessing the quality of information used in our rating process, the modeling and explanation 

of risk factors, and the application of multi-disciplinary analysis to 

even the most highly specialized instruments. 

Q.5. Ms. Robinson, Ms. Tillman, and Mr. Joynt, during the last 3 

years, did your firm notice a decline in underwriting standards for 

mortgages being used to create residential mortgage-backed securities? If so, did you alter your ratings process in any way to account 

for this decline in underwriting standards? 

A.5. Yes. Beginning in 2003, Moody’s observed an increase in the 

risk profile of subprime mortgage portfolios that we were asked to 

review prior to assigning ratings and adjusted our ratings standards accordingly. Our response to these increased risks can be categorized into three broad sets of actions: 

(1) We began warning the market starting in 2003. 

We provided early warnings to the market, commenting frequently and pointedly over an extended period on the deterioration 

in origination standards and inflated housing prices. We frequently 

published reports on these issues starting in July 2003 and 

throughout 2004, 2005 and 2006.3 In January 2007, we published 

a special report highlighting the rising defaults on the 2006 vintage 

subprime mortgages 4 and we have continued to publish on similar 

trends in the market.5

(2) We tightened our ratings criteria. 

in the riskiness of loans made during the last few years and the 

changing economic environment, Moody’s steadily increased its loss 

projections and levels of credit protection for each rating level we 

looked for on pools of subprime loans. Our loss projections and 

credit protection (or ‘‘enhancement’’) levels rose by about 30% over 

the 2003 to 2006 time period, and as a result, bonds issued in 2006 


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and rated by Moody’s had significantly more credit protection than 

bonds issued in earlier years. 

(3) We took rating actions as soon as warranted by the performance data. 

As illustrated by Figure 1, the earliest loan delinquency data for 

the 2006 mortgage loan vintage was largely in line with the performance observed during 2000 and 2001, at the time of the last 

U.S. real estate recession. Thus, the loan delinquency data we had 

in January 2007 was generally consistent with the higher loss expectations that we had already anticipated. As soon as the more 

significant collateral deterioration in the 2006 vintage became evident in May and June 2007, we took prompt and deliberate action 

on those transactions with significantly heightened risk. 

Figure 2 shows the significantly higher loan delinquencies in the 

2006 vintage, as of July 2007. For example, at 10 months of seasoning, 8.6% of the underlying loans in the 2006 vintage were seriously delinquent, nearly twice the level of delinquencies of the 2001 

vintage 10 months after closing. 

Moody’s observed the trend of weakening conditions in the 

subprime market and adjusted our rating standards to address the 

increased risk. Along with most other market participants, however, we did not anticipate the magnitude and speed of the deterioration in mortgage quality (particularly for certain originators), the 

rapid transition to restrictive lending that subsequently occurred or 

the virtually unprecedented national decline in home prices. 

Q.5.a. Did you disclose to investors that there was a decline in underwriting standards? 

A.5.a. Yes. Please see Annex I, including in particular, the excerpts 

quoted from the following publications: 


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(1) 2003 Review and 2004 Outlook: Home Equity ABS (January 

20, 2004); 

• ‘‘Moody’s expects relatively high defaults and losses for these 

mortgage types and has set credit enhancement levels to offset 

the risks.’’ (Page 5) 

• ‘‘Potentially indicating deteriorating credit quality, the percentage of full documentation loans in subprime transactions continues to decline as borrowers choose more expensive low and 

no doc alternatives to minimize the time and scrutiny taken by 

lenders to underwrite new loans.’’ (Page 6) 

• ‘‘Not only are borrowers susceptible to payment shock in a rising interest rate environment, but at the end of the TO period 

borrowers will again suffer payment shock with the introduction of principal in their monthly payment. Because of the 

shorter amortization period, that principal amount will also be 

significantly higher.’’ (Page 6) 

(2) 2004 Review and 2005 Outlook: Home Equity ABS (January 

18, 2005); and 

• ‘‘Because these loans are generally underwritten based on 

lower initial monthly payments, many subprime borrowers 

may not be able to withstand the payment shock once their 

loans reset into their fully indexed/amortizing schedule. The 

resulting higher default probability, which may be exacerbated 

with slowing home price appreciation, could have a very negative effect on home equity performance in the future.’’ (Page 3) 

• ‘‘The increase in reduced documentation in the subprime sector 

is particularly worrisome because for borrowers with weaker 

credit profiles the need for establishing repayment capability 

with stronger asset and income documentation becomes even 

more important.’’ (page 6) 

• ‘‘Moody’s increases credit enhancement on such loans to account for the lower borrower equity and the higher borrower 

leverage’’ (page 6) 

(3) 2005 Review and 2006 Outlook: Home Equity ABS (January 

24, 2006). 

• ‘‘Full documentation levels fell by almost 10 percent on average 

per transaction from the beginning of 2004 to the end of 2005. 

Therefore, in 2005 not only did we see a proliferation of riskier 

’affordability’ products, but also a gradual weakening of underwriting standards.’’ (Page 5) 

• ‘‘Moody’s loss expectations on the interest-only mortgages are 

about 15%-25% higher than that of fully amortizing mortgages.’’ (Page 6) 

• ‘‘In Moody’s view, credit risk for this product is approximately 

5% higher than the standard 30 year fully amortizing product, 

all other credit parameters being equal.’’ (Page 6) 

• ‘‘Moody’s considers hybrid ARM loans to be riskier than equivalent fixed-rate loans primarily because of the risk of payment 

shock associated with adjustable-rate products.’’ (Page 6) 


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Q.6. Ms. Robinson, Ms. Tillman, and Mr. Joynt, when each of your 

companies tries to attract new customers, how do you distinguish 

your ratings from the ratings of other rating agencies? 

A.6. When endeavoring to attract new customers for our credit rating services, Moody’s seeks to distinguish our rating services from 

those of other CRAs on the basis of a number of factors, including 

the following: 

• Moody’s overall reputation for trustworthiness and credibility 

in the market place, based on the aggregate performance of our 

ratings over time, our objectivity and independence, the depth 

and breadth of our research and ratings coverage, transparency and the quality of services. 

• The analytical capabilities of the rating teams that cover the 

particular sector or asset class in question. 

• The transparency and analytical rigor of our rating methodologies for the sectors or asset classes in question. 

• The depth and breadth of our research and ratings coverage 

for the particular sector, geographic region and/or asset class 

in question. 

• The quality of the services we provide to users of our credit 

ratings, as well as to issuers and their agents in the credit rating process. We believe that both users of our credit ratings 

and issuers and their agents appreciate the efficiency, effectiveness, accessibility, and courtesy of our rating teams, issuer 

relations teams and investor services teams. 

• The ability of Moody’s analysts to access and use the research, 

data and analytic tools produced by Moody’s Analytics, an 

operationally and legally separate business unit within 

Moody’s Corporation. 

• Moody’s credit ratings seek to opine on ‘‘expected loss’’, which 

reflects an assessment of both probability of default and loss 

given default. This approach is a distinctive feature of our 

credit ratings and differs from our competitors. 

Q.6.a. Do you have empirical data that demonstrates that your ratings are better than the ratings of other companies? If yes, please 

provide documentation supporting your answer. 

A.6.a. No. We do not possess the comprehensive, comparative ratings data histories for each CRA that would be needed to undertake such analyses. Moreover, we believe performance comparisons 

should be made by others, not the ratings agencies themselves, because ratings agencies naturally have an interest in the subject 

matter of such comparisons. However, if we were to become aware 

of performance comparisons made by others that we believed were 

incorrect or subject to misinterpretation, we would try to correct 

the resulting misunderstandings. 

Having said that, we would also note that credit default studies 

show that our ratings have been remarkably consistent and reliable predictors of default over many years and across many economic cycles. The predictive quality of credit ratings is empirically 

verifiable and has been evaluated by Moody’s and independent 

third parties. We would refer you to our Guide to Default Research, 


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6 Moody’s primary objective for its ratings is to provide an informative ordinal ranking of 

credit risk at each point in time. As such, in our view the most appropriate measure of Moody’s 

accuracy is the ‘‘power’’ of its ratings, the information content of their rank orderings at specific 

points in time with respect to expected credit losses (the product of default probability and expected loss severity) as realized over a long horizon. Credits that have low ratings today should 

on average prove to be more risky than credits that have high ratings today. 

In addition to a relative ranking of risk at a point in time, some investors desire a consistent 

relative ranking of credits across time, so that the riskiness of a credit today can be compared 

to similarly rated debt instruments in the past. To measure the accuracy of Moody’s ratings 

across time, the most appropriate metric is the ‘‘power’’ of a pool of ratings assigned to multiple 

credits, and possibly even the same credits, observed at different points over time. 

Continued 

which is attached. Examples of rating performance reports that we 

publish include: 

• Quarterly global and regional reports on corporate bond rating 

performance, both with respect to rating accuracy and rating 

stability. 

• Semi-annual reports on global structured finance rating performance, both in the aggregate and disaggregated by asset 

class sub-sectors. 

• Annual reports on corporate and structured finance default 

rates, loss given default rates and rating transitions. 

• Periodic reports on default and loss characteristics of bonds, 

bank loans and preferred stocks for specific company sectors 

and regions. 

In addition to publishing issuer or obligation-specific rating actions and credit opinions, Moody’s also publishes our rating methodologies and various studies relating to the historical, aggregate 

performance of our credit ratings. These and other publications facilitate the assessment of our ratings’ relevance and usefulness by 

potential users of our credit ratings as well as other third parties. 

As noted in question 6 above, however, our credit ratings seek to 

offer an opinion on expected loss, which differs from what some of 

our competitors attempt to address, which consequently makes direct comparison difficult. We believe that we serve users of our 

credit ratings best by being as transparent as possible about our 

rating methodologies, the reasoning in support of our credit opinions and the aggregate performance of our ratings. 

Q.6.b. Do you compete more on price or ratings accuracy? Please 

provide documentation supporting your answer. 

A.6.b. Moody’s seeks to compete on the basis of the quality of our 

products (including credit ratings and related research), the trustworthiness of our reputation, and the quality of the services we 

provide to users of credit ratings and the people and firms with 

which we interact as part of the credit rating process. We believe 

that the aggregate performance of our credit ratings over time is 

a very important factor in the assessment of the quality of our 

work. In this regard, we refer you to our Guide to Default Research. 

Q.7 Ms. Robinson, Ms. Tillman, and Mr. Joynt, what are the idealized default rates for each of your ratings? 

A.7 Moody’s does not target specific default or loss rates for its ratings.6 That is to say, Moody’s credit rating scale does not measure 


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Moody’s believes that as a consequence of its relative rating approach, the meaning of its ratings should be highly consistent over time. Since the relative creditworthiness of bond issuers 

does not, on average, change rapidly, there should not generally be any need to change average 

rating levels sharply over time. As a practical matter, therefore, Moody’s does not manage its 

ratings to achieve cardinal accuracy or to maintain constant default rates by rating category. 

Doing so would require Moody’s to change its ratings en masse in response to changes in cyclical 

conditions. Rather, ratings are changed ‘‘one-at-a-time’’ as needed in order to improve the current rank ordering of credit risk. 

‘‘absolute’’ credit risk; rather it provides an ordinal ranking of credit risk. 

When, however, we need to associate specific default or loss rates 

with ratings for quantitative modeling purposes, we refer to a table 

of idealized expected credit loss rates. (Expected credit loss rates 

are the products of default probabilities and expected amounts of 

loss suffered if defaults occur.) These idealized loss rates are broadly consistent with the long-term average historical loss rates of securities that carry the same ratings and are used for associating 

modeled expected losses of both structured and corporate securities 

with corresponding ratings. 

Some models require default rates, rather than expected loss 

rates, as inputs. In those cases, we are able to derive idealized default rates from the idealized loss rates simply by dividing every 

value in the idealized loss table by an appropriate expected loss severity rate. To derive an idealized default rate for senior unsecured 

corporate bonds, for example, we could assume an average expected 

loss severity of 55%. For secured bonds and loans, we would typically assume a lower severity rate, and for subordinated bonds a 

higher severity rate. For structured securities, expected loss severity rates (and hence idealized default rates) have varied by asset 

class and potentially other features of the security. 

Since Moody’s first began rating municipal securities in 1920, 

municipal securities have been rated on a separate scale that 

places greater weight on default risk than expected loss severity. 

This rating scale has been associated with lower overall credit risk 

by rating category than comparably rated corporate and structured 

securities. For municipal securities, we have developed a similar 

idealized default rate table that is sometimes used to model expected portfolio defaults on a pool of municipal securities. Given 

the very limited number of defaults in the municipal sector and 

secular changes in credit risk profiles in the sector, the derivation 

of this table is less closely tied to historical data and is more likely 

to be reviewed from time to time. 


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7We make these documents publicly available on the Regulatory Affairs webpage at 

moodys.com and have included them in Annex III to this response. 

Q.8. Ms. Robinson, Ms. Tillman, and Mr. Joynt, in his written testimony, Professor Coffee notes that because only a limited number 

of investment banks underwrite structured finance products, they 

have leverage over the rating agencies. If they don’t like the ratings they get from one agency, they can go to another with lower 

standards. 

Has your firm ever felt pressure to lower your rating standards 

in order to attract business? 

A.8. Issuers, arrangers, underwriters, investors and other users of 

credit ratings naturally have strong incentives to try to influence 

CRAs’ credit rating analysis and decisions, both when a credit rating is first issued and over the lifetime of the securities in question. 

It is not surprising, therefore, that from time to time, various members of these groups try to exert pressure on us, e.g. to: (a) change 

our methodologies, models or assumptions; (b) reach a decision on 

a rating that favors their interests; and/or (c) make a rating decision faster or slower than we consider appropriate in light of the 

information available. Since various market participants and users 

of credit ratings often have diverging interests, we are accustomed 

to our actions being unpopular with one group or another. 

However, Moody’s reputation and long-term success are critically 

dependent on the market’s confidence in our ethics, objectivity and 

credit judgments. Consequently, we have long had in place strong 

policies and procedures to ensure the independence and objectivity 

of our ratings. (For a more detailed descriptions in Section 2 of 

Moody’s Code and our annual reports on implementation of the 

Moody’s Code.7) For example: 

• ratings are decided on by committees, not individuals; 

• analyst compensation is unconnected to either ratings or fees; 

• a separate surveillance team reviews the performance of most 

structured transactions; 

• a separate and independent credit policy group within Moody’s 

is responsible for reviewing and vetting methodologies and 

models; and, 

• perhaps most significantly, our methodologies, models and 

processes are publicly available and transparent so all market 

participants can assess our integrity and rigor. 

Q.8.a. How do you attract customers if your ratings use the most 

stringent standards? Will issuers and underwriters simply go to 

other firms with less demanding standards? 

A.8.a. In our view, the best mechanism to discourage rating-shopping is investor confidence in our ratings. If investors believe that 

our ratings are thoughtful opinions about the credit quality of a security, they ultimately will demand that issuers seek our ratings. 

Alternately, if investors believe that the models, assumptions and 

methodologies from Moody’s or another CRA are inappropriately 

conservative or lax and therefore fail to produce predictive ratings, 

over time, we believe investors, issuers and their agents will prefer 

the ratings of another CRA whose ratings appear to be better predictors of credit quality. 


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8See Moody’s Code of Professional Conduct. Provision 1.9 states our policy regarding monitoring of credit ratings: 

‘‘Except for Credit Ratings that clearly indicate that they do not entail ongoing surveillance, 

once a Credit Rating is published, Moody’s will monitor the Credit Rating on an ongoing basis 

and update it by: 

1.9.1 periodically reviewing the creditworthiness of the Issuer or other relevant entity or 

debt or debt-like securities; 

1.9.2 initiating a review of the status of the Credit Rating upon becoming aware of any information that might reasonably be expected to result in a Credit Rating action (including termination of a Credit Rating), consistent with the applicable rating methodology; and 

1.9.3 updating on a timely basis the Credit Rating, as appropriate, based on the results of 

such review. 

As noted above, Moody’s long-term success is critically dependent 

on the market’s confidence in our ethics, objectivity and credit judgments. 

Q.9. Ms. Robinson, in your written testimony you stated that 

Moody’s tracks debt for more than 11,000 corporate issuers, 26,000 

public finance issuers, and 110,000 structured finance obligations. 

How often does Moody’s review and, if necessary, update each 

rating? 

A.9. The frequency with which Moody’s periodically reviews the 

creditworthiness of issuers and obligations varies across sectors 

and asset classes based on the unique characteristics of each.8 In 

very general terms, the frequency of our regular, periodic reviews 

typically is associated with the frequency with which new information about the issuer or obligation is made available. (Ratings may 

also be reviewed between these regular, periodic reviews when information indicates that the creditworthiness of a security could be 

materially affected.) 

For example, the frequency of our regular, periodic reviews for 

structured finance securities typically is determined by the scheduled payment dates for the rated securities. This is the case for two 

reasons. First, the receipt of transaction underlying asset performance information from the Trustee or the Servicer is driven by 

these payment dates. Second, until the performance information is 

received, it will not be clear whether there has been any deterioration in underlying asset performance and thus whether a rating adjustment needs to be considered. Consequently, Moody’s structured 

finance monitoring process typically occurs either monthly or quarterly, depending on the frequency with which the trustees or 

servicers generate and provide information to us. If we receive performance data or other information between scheduled payment 

dates that indicates material deterioration or improvement in the 

creditworthiness of securities, we would take appropriate action. 

The transaction performance data is further informed by Moody’s 

analysis of macroeconomic conditions. 

With corporations and financial institutions, analysts for the 

issuer in question typically conduct periodic reviews that are timed 

to coincide with the publication of financial statements and other 

key, periodic filings with authorities (e.g. on a quarterly, semiannual or annual basis, depending on the filing and jurisdiction in 

question). They may also listen to investor briefings organized by 

the issuer, monitor the business and specialized industry press and 

relevant authorities’ websites. In addition, if they identify information from the issuer or other sources that would indicate material 


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deterioration or improvement in the creditworthiness of securities, 

they take appropriate action at that time. Furthermore, rating 

teams conduct regular (e.g. annual) portfolio reviews. In a portfolio 

review, all of the analysts involved in rating issuers or securities 

belonging to a particular sector, together with their supervisors, 

credit officers for the sector and possibly related sectors, and relevant specialists (e.g. corporate governance, accounting and risk 

management analysts) are invited to participate in a meeting 

where the credit ratings of all issuers in a sub-sector are considered relative to each other and in light of Moody’s methodology for 

the sector and outlook for the industry as a whole. 

Within a given sector or sub-sector, there can be differences in 

the frequency with which issuers are brought to a committee for review. For example, all things being equal, an issuer whose ratings 

are under review for possible upgrade or downgrade likely will be 

brought to a rating committee within a shorter period of time than 

an issuer to whom Moody’s has assigned a ‘‘stable’’ outlook. 

Q.9.a. Does Moody’s review municipal ratings as often as it reviews 

corporate and structured finance ratings? 

A.9.a. As indicated above, the frequency of our review will depend 

upon the specific characteristics of each sector and asset class. In 

our public finance group the level of issuance activity in a particular sector, the level of issuance activity by a particular issuer, 

the rating level of a particular issuer (lower rated credits are reviewed more frequently) and the overall volatility in that issuer’s 

sector are important factors in determining the frequency of reviews. There are certain issuers in the public finance sector who 

are very active in the debt market, who are not highly rated and 

who are in a more credit-sensitive sector. These issuers generally 

will have their ratings reviewed on a more frequent basis than 

those who, in contrast, are small issuers in less volatile sectors who 

access the market very infrequently and whose credit characteristics are not as complex as some of the larger issuers. 

Consequently, the frequency of our review is directly linked to 

the complexity of the credit, the volatility of the sector, and the 

susceptibility of the credit to change. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ 

FROM CLAIRE ROBINSON 

Q.1. During the hearing, I asked you for specifics on the ratings 

your agency provided on Bear Stearns in the months leading up to 

the collapse. Please provide the Committee with a detailed explanation of the ratings for Bear Stearns from November 2007 and 

March 2008. 

A.1. 

• November 14, 2007: Moody’s placed the long-term ratings of 

The Bear Stearns Companies Inc. (‘‘Bear’’) and its subsidiaries 

on review for possible downgrade. This rating action was taken 

in response to Bear’s announcement that it expected to post a 

net loss in the fourth quarter of 2007, resulting from $1.2 billion in net market valuation losses on its exposures to 

subprime mortgage-related assets and CDOs. The loss also folVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00214 Fmt 6602 Sfmt 6602 E:\HR\OC\A399.XXX A399

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lowed weak third quarter 2007 earnings. Moody’s stated in its 

rating action that it ‘‘expected that on a go-forward basis, 

Bear’s exposure to these specific assets would pose only modest 

downside risk but that during its review Moody’s would evaluate Bear’s firm-wide exposures and valuations in other asset 

classes.’’ Moody’s also expressed the opinion that Bear’s performance through the market inflection and dislocation was 

more challenged than some competitors, which reflected not 

only tough markets, but certain risk and strategic decisions 

made by the firm. Specifically, we stated that ‘‘[A]lthough Bear 

had improved its earnings diversification over the past five 

years, its level and scale of product and geographic diversification still lagged that of its peers and had not provided a sufficient buffer to offset write-downs in mortgages and leveraged 

lending.’’ 

• December 20, 2007: Moody’s lowered the long-term senior debt 

rating of Bear to A2 from A1 and changed the rating outlook 

to stable, ‘‘concluding the review for downgrade that was initiated on November 14, 2007’’ (see above). Factors considered included the sizeable write-downs on its mortgage and CDO portfolios, Bear’s elevated risk appetite at the time, and Moody’s 

ongoing concern regarding Bear’s corporate governance, including board oversight of management’s strategic risk decisions 

and leadership succession planning. The A2 rating and stable 

outlook factored in Moody’s expectations at that time for the 

future risk of loss posed by Bear’s net exposures, as well as 

Moody’s expectations for a reduced, but acceptable, level of operating profitability in 2008. Moody’s also indicated that Bear’s 

ratings benefited from an ample capital position and strong liquidity profile. Bear had recently announced a partnership 

agreement with CITIC Securities Co. Ltd., which included a $1 

billion preferred stock investment in Bear, further bolstering 

its capital position. 

• March 14, 2008: Moody’s lowered the long-term senior debt 

rating of Bear two notches to Baa1 from A2 and its short-term 

ratings to Prime–2 from Prime–1, and placed the company’s 

long-term and short-term ratings on continued review for a 

possible downgrade. The rating action was in response to the 

rapidly deteriorating liquidity position of Bear, which necessitated an emergency secured funding line from JPMorgan 

Chase & Co. (‘‘JPMorgan’’) back-stopped by the Federal Reserve Bank of New York. The 28-day funding facility represented a temporary liquidity respite for Bear as it looked to 

identify a long-term resolution to its liquidity problems. 

The rating action reflected Moody’s opinion that Bear’s customer 

franchise had been hurt by the crisis, and would continue to erode 

if a long-term stabilizing solution was not quickly achieved. The review would focus on the financial and strategic alternatives under 

consideration by Bear and the likelihood for a timely resolution. 

Given the fluidity of the situation, Moody’s stated that it would 

re-address its ratings within 7–10 days. Importantly, Moody’s indicated that Bear had a number of attractive franchises that could 

facilitate a strategic solution. 


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• On March 17, 2008: Moody’s placed Bear’s ratings on review 

for possible upgrade in response to the announcement by 

JPMorgan that it would acquire Bear with assistance from the 

Federal Reserve. 

• March 28, 2008: Moody’s announced it was continuing its review for possible upgrade of Bear’s Baa1 ratings and those of 

its rated subsidiaries. This rating action followed revisions to 

the original March 16, 2008 merger agreement and operating 

guaranty from JPMorgan. 

In addition, please answer the following questions. 

Q.1.a. Were any of the ratings downgraded between December 

2007 and March 14, 2008? 

A.1.a. Response: Yes. 

• December 20, 2007: Moody’s downgraded the following ratings 

of Bear Stearns and its subsidiaries: 

— long-term senior unsecured debt to A2 from A1 

— issuer rating to A2 from A1 

— subordinated debt to A3 from A2 

— trust preferred stock to A3 from A2 

— preferred stock to Baa1 from A3 

• March 14, 2008: Moody’s downgraded the following ratings of 

Bear Stearns and its subsidiaries, and placed the ratings on review for possible further downgrade: 

— long-term senior unsecured debt to Baa1 from A2 

— commercial paper to Prime–2 from Prime–1 

— issuer rating to Baa1 from A2 

— subordinated debt to Baa2 from A3 

— trust preferred stock to Baa2 from A3 

— preferred stock to Ba1 from Baa1 

Q.1.b. Were any of the ratings downgraded during the week of the 

collapse (March 10–14)? 

A.1.b. Yes. Please see our response to the above question. On 

March 14, 2008, Moody’s lowered Bear’s long-term senior debt rating two notches to Baa1 from A2, and placed the company on review for further downgrade. We expressed the opinion that the liquidity crisis was the result of sudden diminishing market confidence in Bear by its counterparties and customers, compounded 

by persistently negative market conditions. The downgrade also reflected our opinion that Bear’s franchise had been hurt by the liquidity crisis and would continue to erode if a long-term, stabilizing 

solution was not quickly achieved. Moody’s also noted that Bear 

had a number of attractive franchises that could facilitate a strategic solution—which is what ultimately occurred. 

Q.1.c. Can you explain from your agency’s point of view how Bear’s 

collapse unfolded and the role the ratings may have played? 

A.1.c. During the week of March 10, 2008, the market was flooded 

with rumors about liquidity problems at Bear. Although Bear did 

not face any sizeable net writedowns or credit losses, and the bulk 

of its franchises were intact, rampant rumors about its liquidity poVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00216 Fmt 6602 Sfmt 6602 E:\HR\OC\A399.XXX A399

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sition, compounded by persistently negative market conditions, further eroded confidence in Bear by its counterparties and customers. 

Investor concerns over the impact that the failure of the Peloton 

and Carlyle hedge funds would have on Bear added to the pressure. 

Because market participants value both accuracy and stability in 

credit ratings, Moody’s manages its ratings so that they are 

changed only in response to changes in relative credit risk that we 

believe will endure, rather than in response to market rumors, 

transitory events or shifts in market sentiment. We recognize, however, that rumors about liquidity problems at a financial institution 

can, in and of themselves, contribute to liquidity problems and that 

liquidity problems for such an institution can have an enduring impact on creditworthiness. Consequently, Moody’s analysts were actively reviewing Bear’s evolving liquidity position on a daily basis 

throughout the week. 

It is our understanding that Bear’s liquidity situation declined 

precipitously between March 12 and March 14, 2008. What was 

originally market perception and rumors had become reality. This 

sudden erosion in liquidity severely constrained Bear’s financial 

and operating flexibility. Prime brokerage clients pulled cash and 

investment balances out of the firm, haircut requirements rose on 

Bear’s short-term collateralized funding and an increasing amount 

of short-term collateralized funding failed to roll at maturity. As a 

result, Bear’s liquidity pool, which had started the week at about 

$18 billion, rapidly declined to around $5 billion by the end of 

Thursday, March 13. On March 14, we downgraded Bear’s longterm senior unsecured debt ratings from A2 to Baa1 and shortterm debt ratings from Prime–1 to Prime–2 and left those ratings 

on review for further downgrade. We expressed the opinion that 

the liquidity crisis was the result of diminishing market confidence 

in Bear by its counterparties and customers, compounded by persistently negative market conditions. The downgrade also reflected 

our opinion that Bear’s franchise had been hurt by the liquidity crisis and would continue to erode if a long-term, stabilizing solution 

was not quickly achieved. Moody’s also noted that Bear had a number of attractive franchises that could facilitate a strategic solution—which is what ultimately occurred. 

Q.1.d. Do you think the lack of changes to the Bear Stearns’ ratings is an example of a unique event in the markets or an indication of larger flaws in the structure of the ratings? 

A.1.d. Moody’s believes that our credit ratings of Bear and its securities were appropriate in light of the information available to us 

throughout the relevant time period. Moreover, although the company’s equity suffered a dramatic loss in value as a result of this 

crisis, Moody’s maintained our credit rating on Bear’s debt at investment grade, in part because Bear had a number of attractive 

franchises that could facilitate a strategic solution—which is what 

ultimately occurred. As noted earlier, Moody’s ratings speak to 

whether a debt investor who holds the securities to maturity will 

be made whole, and not whether a company’s equity will retain its 

value. 


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9Specifically, by the implementing the primary dealer credit facility. 

Ultimately, the issue with Bear was a severe and extreme crisis 

of confidence based on a liquidity problem that arose suddenly and 

materialized in a matter of days. This crisis of confidence denied 

Bear’s access to short-term secured financing, even when the collateral consisted of agency securities with a market value in excess 

of the funds to be borrowed. Confidence sensitivity was expected to 

be less of an issue in the secured funding markets, particularly 

where franchise impairment was limited. (Notably, Bear had survived prior crises utilizing many of the same tools that were at its 

disposal this time.) However, access to the secured funding markets, which had operated smoothly throughout many previous market crises, evaporated over the span of week. The market dislocation was so extreme that Bear could not borrow against high-grade 

collateral. This is a situation that Bear—or any other securities 

firm—would find difficult to protect against, and as a result the 

Federal Reserve was prompted on March 16, 2008 to provide liquidity to the securities firms.9

Our analysis suggested that Bear was more vulnerable than the 

other major securities firms because it had slightly weaker liquidity, was less diversified and had concentrations in stressed asset 

classes. Bear’s long-term ratings were lower than those of its peers, 

reflecting this risk. However, it also appears to us that a high degree of risk avoidance by market participants (due to persistently 

negative market conditions and market-wide opacity with respect 

to counterparty exposures) may have led to the very unusual situation where market participants refused to accept high-grade collateral at any haircut. In addition, during the week of March 10 the 

departure of client balances that had financed prime brokerage 

lending contributed to Bear’s liquidity difficulties. 

Q.1.e. Under ideal circumstances, would you agree that the ratings 

should have been downgraded to more accurately reflect Bear’s 

risk? 

A.1.e. We believe that our credit ratings of Bear and its securities 

appropriately reflected the credit risks of which we were aware in 

light of the information available to us at the time. It is important 

to note that while Bear Stearns suffered a severe crisis of confidence, it has not defaulted on any of its debt instruments, and its 

ratings are currently on review for upgrade in connection with its 

pending acquisition by JPMorgan. In hindsight, a lower rating on 

such instruments would have overstated the risk of default. 

Q.1.f. What lessons do you think we should take from the Bear 

Stearns collapse as it relates to the credit ratings? 

A.1.f. Moody’s credit ratings intend to offer an opinion on the risk 

of default and severity of loss in the event of default. As stated 

above, we believe that our credit ratings of Bear and its securities 

appropriately reflected the risks of which we were aware given the 

information available to us at the time. We also believe that, more 

generally, Moody’s long-term credit ratings strike the appropriate 

balance between accuracy and stability. Our conversations with investors, issuers and regulators have led us to conclude that they 

have a strong preference for credit ratings that are both accurate 


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and stable. They want ratings to reflect enduring changes in credit 

risk because rating changes have real consequences—due primarily 

to ratings-based portfolio governance rules and rating triggers— 

that are costly to reverse. Market participants, however, do not 

want us to provide ratings that simply track market-based measures of credit risk (although such measures can be a useful supplementary source of information in the investment decision-making 

process). They want our credit ratings to reflect independent analytical judgments that provide a counterpoint to often volatile market-based assumptions. 

Having said that, the recent market turmoil has highlighted a 

vulnerability of securities firms, namely the loss of access by a solvent firm to secured funding, even when secured by high quality 

collateral. This scenario had not previously occurred in the history 

of the industry. The SEC is also now more focused on this vulnerability, as SEC Chairman Cox recently noted: ‘‘We are discussing 

with each of the firms various stress scenarios that include not 

only impairment of unsecured funding but also of secured funding. 

We now live in a post Bear Stearns reality.’’ (Reuters, May 26) In 

addition, the increased complexity of these firms and of the financial instruments in which they deal have elevated the analytic 

challenge. Moody’s is and will continue to evaluate the appropriateness of our rating methodology for securities firms in light of the 

recent events. 

Q.1.g. What are your thoughts on a proposal Professor Coffee discussed at the hearing for rating agencies to periodically update ratings? 

A.1.g. Moody’s believes that credit rating announcements should 

be made when the credit rating agency has new or relevant information to share with the market. Generally, these instances are either: a change in rating (the rating opinion has changed); or a rating affirmation (there is a significant event in the market and investors are unsure whether the rating remains unchanged). 

Moody’s does not believe that publishing rating announcements 

according to a prescribed timetable or schedule would prevent mass 

downgrades or improve the appropriateness of existing ratings for 

the following reasons: 

• Ratings are already monitored on an ongoing basis and 

Moody’s changes our ratings when our opinion about the fundamental creditworthiness of the obligation changes. 

• A requirement to announce on a quarterly, semi-annual or annual basis that our rating has not changed would saturate the 

market with redundant and potentially confusing or obfuscating information. 

• Arbitrary review dates could inappropriately focus investor and 

issuer attention on those dates, rather than on credit-relevant 

events and thereby inadvertently conceal significant rating actions. 

• Paradoxically, publishing more information could reduce the 

usefulness of the rating and impair transparency. 


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RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD 

FROM STEPHEN W. JOYNT 

Q.1. Ratings Scoreboard. What are your views on the recommendation that has been made for the creation of a central website which 

investors could access and on which they could compare the accuracy of past ratings by the different NRSROs for the same types 

of securities? 

A.1. In our Joint Response to the Technical Committee of the 

International Organization of Securities Commissions’ (‘‘IOSCO’’) 

Consultation Report on the Role of Credit Rating Agencies in 

Structured Finance Markets, dated April 25, 2008, the participating rating agencies (Fitch, AM Best, DBRS, Moody’s and Standard & Poor’s) stated our commitment to create a centralized, industry portal to house our ratings performance studies and other relevant data. 

I note that the SEC will soon publish its recently announced proposed rules (the ‘‘Proposed Rules’’), which will include a requirement that certain performance statistics be made publicly available 

to facilitate comparisons among rating agencies. Fitch looks forward to working with the SEC in the context of the Proposed Rules 

to enhance the availability of performance data for users of ratings. 

Q.2. Due Diligence. Did Fitch undertake to verify the information 

it used to decide ratings on the structured finance products that 

were subsequently downgraded? In recent years, there has been 

widespread awareness, through the press and otherwise, about the 

proliferation of so-called ‘‘liar loans’’—mortgage loans with little or 

no documentation required and on which borrowers ultimately 

have stopped paying. Do you feel that NRSROs should have performed some investigation or due diligence on structured debt that 

contained these ‘‘liar loans’’? Are there circumstances under which 

NRSROs should be required to perform some form of due diligence 

before issuing a rating? 

A.2. The principal contacts at the initial stages of the rating process are with the originator, the issuer and/or the arranger. Fitch 

will also receive information and documentation from the transaction lawyers. These parties will typically provide an overview of 

the transaction and the originator, as well as a detailed term sheet 

setting out the main features of the legal and financial structure. 

The arranger often acts as the conduit between Fitch and the originator for information on the underlying assets and their historic 

performance. It may also act as a conduit for outside opinions from 

other experts, such as accountants. 

Where relevant, Fitch will meet the originator to conduct an onsite servicer review, the purpose of which is to understand the 

asset origination process, the way the assets are administered and 

what steps are undertaken in the event of non-performance (e.g., 

of individual loans within a consumer loan portfolio). This also represents an opportunity for Fitch to resolve any outstanding questions about the data that it has already received. Following this review any further questions on the origination, underwriting or administration process are addressed directly to the originator or via 

the arranger. 


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Fitch’s own lawyers (internal or external) may discuss legal and 

structural aspects of the transaction with transaction counsel, to 

better understand the transaction and whether and how legal risks 

relevant to our credit analysis have been mitigated. However, in all 

cases, these reviews are not designed to supplant or replace the 

legal analysis performed by transaction counsel, and are instead 

undertaken simply to understand the legal analysis provided by 

transaction counsel. In cases where Fitch receives reports and information from other external advisors or experts, such as auditors, 

actuaries and consultants, we may discuss these reports and information with such third parties to understand their impact on our 

credit analysis. Fitch also utilizes data gathered from servicers, 

trustees and data services in the course of monitoring existing 

transactions to evaluate new transactions. 

As part of this process, we consider, among other factors, (a) the 

source of the data we receive; (b) the track record of that source 

in providing quality data; (c) the predictive powers associated with 

any one piece of data; and (d) whether or not the data (such as financial information) has been subject to review by a third party. 

However, as we make clear in our Code of Conduct and other 

documents and publications, Fitch does not audit or verify the 

truth or accuracy of any information provided or available to it. 

This responsibility is not one which it is feasible or appropriate for 

rating agencies to discharge, and one that, in a clear, statutory context, already exists for other parties. We do agree with the SEC’s 

position, in the Proposed Rules, that it would be very helpful to 

users of our ratings for us to disclose the extent to which we rely 

on the due diligence of others to verify the assets underlying structured products. In addition, we will be amending our Code of Conduct, in line with IOSCO’s recently amended Code of Conduct Fundamentals for Credit Rating Agencies, to state that we will adopt 

reasonable steps to assess that the information provided to us for 

use in ratings is of sufficient quality to support credible ratings. 

Indeed, we have already introduced additional measures aimed 

at reviewing the plausibility of data used in the rating process. In 

November 2007, we announced a reassessment of the risk management processes of originators, conduits and/or issuers for product 

being securitized going forward. Beginning in January 2008, our 

RMBS rating process has incorporated a more extensive review of 

mortgage origination/acquisition practices, including a review of 

originator/conduit/issuer due diligence reports, and a sample of 

mortgage origination files. Additionally, Fitch is studying how a 

more robust system of representation and warranty repurchases 

could help to provide more stable RMBS performance. Fitch will 

not rate subprime RMBS without completion of the review process. 

Q.3. Timeliness of Updates of Ratings. Professor Coffee in his testimony pointed out that major downgrades of CDO securities ‘‘came 

more than a year after the Comptroller of the Currency first publicly called attention to the deteriorating conditions in the 

subprime market and many months after the agencies themselves 

first noted problems in the markets.’’ His testimony also states ‘‘the 

gravest problem today may be the staleness of debt ratings.’’ What 

is Fitch doing to update ratings in a timely manner and eliminate 

stale ratings? What standards should NRSROs observe? 


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A.3. We believe that a number of recent steps will improve our 

timeliness. 

In order to better signal concerns about potential ratings pressure, Fitch is rolling out the use of Rating Outlooks for all structured finance securities. Outlooks indicate those securities for 

which the risk of rating actions is heightened, but has not yet 

reached the level of Rating Watch. 

Additionally, Fitch has made substantial investments in automation to provide for more frequent in-depth analysis of the large 

portfolios of rated RMBS, CDO and other structured products. This 

allows for the ability to more quickly communicate the impact of 

fast-moving events on large portfolios. 

More broadly, as with many other market participants, we have 

learned lessons from the precipitous changes in performance and 

environment for several asset classes and are adding additional review steps to the process by which criteria assumptions are determined. These will not guarantee that future assumptions will always be replicated in actual events—no process could realistically 

assure this—but they will incorporate recent experience regarding 

origination standards, product correlation and risk-layering. 

We have introduced structural changes to a number of groups, 

from senior management rotation down to increased resources devoted to dedicated surveillance work. We have also added Credit/ 

Risk Officers to each of the ratings groups, to bring enhanced analytical oversight, experience and training to these groups. The 

Credit and Risk Officers will work with each group to identify important trends and to ensure that Fitch’s analytical process is both 

rigorous and balanced. 

At the same time, we are conscious of the need to manage expectations of the degree to which the timing of rating actions will ever 

meet universal acclaim. Ratings are a ‘‘single-point’’ representation 

which inevitably will be subject to change as different risks 

crystallise and others recede. Particularly when market conditions 

are volatile, rating efficacy can also be measured in terms of the 

swiftness with which the ratings are revised to reflect a change in 

circumstances, rather than their absolute ability to have predicted 

a series of unexpected events. It is in this spirit that we continue 

to place significant focus on the timeliness of our continued surveillance. 

Q.4. Separate Ratings from Business? Dr. Cifuentes’ testimony contains a recommendation that a rating agency separate its rating 

business function from its rating analysis function. What are your 

views on how NRSROs should address this analyst independence 

concern? 

A.4. Fitch acknowledges and addresses the potential conflicts of 

being an issuer-paid rating agency in four primary ways. One, we 

have separated business development from credit analysis, to keep 

each group focused on its core task. Two, we have relocated all of 

our non-rating operations into a separate division, Fitch Solutions, 

which operates behind a firewall. Three, we have established and 

enforce a Code of Conduct and related policies to address these conflicts. Four, no analyst or group of analysts is directly compensated 

on the revenues related to their ratings. To that end, we are in 


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1Paragraph 165 of CESR’s Second Report to the European Commission on the compliance of 

credit rating agencies with the IOSCO Code and The role of credit rating agencies in structured 

finance, May 2008. 

agreement with the SEC’s Proposed Rule that would prohibit anyone who participates in determining a rating from negotiating the 

fee that is paid for such rating. 

Q.5. Ratings Shopping. We have heard concerns about ‘‘ratings 

shopping,’’ where an underwriter or an issuer goes to the NRSRO 

that it feels will give it the highest rating, even if it is not necessarily the most accurate. Is ratings shopping a problem? How 

should the negative aspects of it be addressed? 

A.5. We understand the concerns surrounding ‘‘rating shopping’’, 

which have arisen most recently in the context of structured finance ratings. To address these concerns, Fitch has consistently 

advocated greater transparency regarding transaction data. 

As it stands today, generally there is limited data in the public 

market about structured securities prior to their issuance such that 

neither investors nor rating agencies who lack direct contact with 

the issuer are able to formulate an informed opinion on structured 

securities. However, if robust information about structured finance 

products were publicly available once the details of the transaction 

had been finalized, agencies could provide ratings, regardless of 

whether or not an issuer requested a preliminary rating. 

The dissemination of unsolicited ratings, where possible, likely 

would reduce the frequency of rating shopping, since rating opinions could be disseminated into the market regardless of whether 

the issuer specifically contracted with the agency or not. As a result, in many circumstances market participants would have the 

benefit of multiple and potentially diverse opinions about the same 

transaction. 

Additionally, and most importantly, as mentioned above under 

Response I, having the underlying data published by the issuers or 

originators would allow investors to form their own opinions about 

the strengths and weaknesses of a particular transaction, which 

could support authorities’ efforts to discourage the use of ratings 

for purposes other than an objective measure of relative credit risk. 

Voluntary efforts currently in progress being coordinated by the 

American Securitization Forum will potentially provide much more 

standardized data to all participants in the U.S. RMBS market. 

Q.6. Professional Analyst Organization. Dr. Cifuentes in his testimony suggested ‘‘the creation of a professional organization, independent of the rating agencies, to which ratings analysts must belong and which sets forth ethical, educational and professional 

standards.’’ Please share your thoughts on the potential merits of 

such an organization. 

A.6. Fitch typically is sympathetic to any industry initiative which 

seeks to support analysts from rating agencies, and other institutions, in their professional development. At the same time, we note 

that recent market feedback to the Committee of European Securities Regulators (‘‘CESR’’), with which CESR concurred,1 was that 

there was no need to impose educational and professional qualifications upon the staff of rating agencies. 


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Membership of such an organization would also have to be voluntary—it is unlikely we could compel membership by our employees. Equally, it would be important for operational, compliance, and 

regulatory reasons that the formal, mandatory policies of each individual agency, including our policies on the management of conflicts of interest, be understood as the standard by which employee 

behavior is judged. 

RESPONSE TO WRITTEN QUESTIONS OF SENATORS SHELBY 

FROM STEPHEN W. JOYNT 

Q.1. Ms. Robinson, Ms. Tillman, and Mr. Joynt, do you think that 

it is easy for investors to compare the accuracy of the ratings of the 

different credit rating agencies? If not, do S&P, Moody’s, and Fitch 

favor the SEC issuing rules to require enhanced disclosure of ratings performance as Chairman Cox outlined in his testimony? 

A.1. In our Joint Response to the Technical Committee of the International Organization of Securities Commissions’ (‘‘IOSCO’’) Consultation Report on the Role of Credit Rating Agencies in Structured Finance Markets, dated April 25, 2008, the participating rating agencies (Fitch, AM Best, DBRS, Moody’s and Standard & 

Poor’s) stated our commitment to create a centralized, industry portal to house our ratings performance studies and other relevant 

data. 

I note that the SEC will soon publish its recently announced proposed rules (the ‘‘Proposed Rules’’), which will include a requirement that certain performance statistics be made publicly available 

to facilitate comparisons among rating agencies. Fitch looks forward to working with the SEC in the context of the Proposed Rules 

to enhance the availability of performance data for users of ratings. 

Q.2. Ms. Robinson, Ms. Tillman, and Mr. Joynt, would you please 

explain the process by which you obtain the information you use 

to rate structured finance securities? 

• How much of the information is from issuers, underwriters, or 

other sources? 

• Do you ever seek to verify the accuracy of the information you 

receive? 

A.2. The principal contacts at the initial stages of the rating process are with the originator, the issuer and/or the arranger. Fitch 

will also receive information and documentation from the transaction lawyers. These parties will typically provide an overview of 

the transaction and the originator, as well as a detailed term sheet 

setting out the main features of the legal and financial structure. 

The arranger often acts as the conduit between Fitch and the originator for information on the underlying assets and their historic 

performance. It may also act as a conduit for outside opinions from 

other experts, such as accountants. 

Where relevant, Fitch will meet the originator to conduct an onsite servicer review, the purpose of which is to understand the 

asset origination process, the way the assets are administered and 

what steps are undertaken in the event of non-performance (e.g., 

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tions about the data that it has already received. Following this review any further questions on the origination, underwriting or administration process are addressed directly to the originator or via 

the arranger. 

Fitch’s own lawyers (internal or external) may discuss legal and 

structural aspects of the transaction with transaction counsel, to 

better understand the transaction and whether and how legal risks 

relevant to our credit analysis have been mitigated. However, in all 

cases, these reviews are not designed to supplant or replace the 

legal analysis performed by transaction counsel, and are instead 

undertaken simply to understand the legal analysis provided by 

transaction counsel. In cases where Fitch receives reports and information from other external advisors or experts, such as auditors, 

actuaries and consultants, we may discuss these reports and information with such third parties to understand their impact on our 

credit analysis. Fitch also utilizes data gathered from servicers, 

trustees and data services in the course of monitoring existing 

transactions to evaluate new transactions. 

As part of this process, we consider, among other factors, (a) the 

source of the data we receive; (b) the track record of that source 

in providing quality data; (c) the predictive powers associated with 

any one piece of data; and (d) whether or not the data (such as financial information) has been subject to review by a third party. 

However, as we make clear in our Code of Conduct and other 

documents and publications, Fitch does not audit or verify the 

truth or accuracy of any information provided or available to it. 

This responsibility is not one which it is feasible or appropriate for 

rating agencies to discharge, and one that, in a clear, statutory context, already exists for other parties. We do agree with the SEC’s 

position, in the Proposed Rules, that it would be very helpful to 

users of our ratings for us to disclose the extent to which we rely 

on the due diligence of others to verify the assets underlying structured products. In addition, we will be amending our Code of Conduct, in line with IOSCO’s recently amended Code of Conduct Fundamentals for Credit Rating Agencies, to state that we will adopt 

reasonable steps to assess that the information provided to us for 

use in ratings is of sufficient quality to support credible ratings. 

Indeed, we have already introduced additional measures aimed 

at reviewing the plausibility of data used in the rating process. In 

November 2007, we announced a reassessment of the risk management processes of originators, conduits and/or issuers for product 

being securitized going forward. Beginning in January 2008, our 

RMBS rating process has incorporated a more extensive review of 

mortgage origination/acquisition practices, including a review of 

originator/conduit/issuer due diligence reports, and a sample of 

mortgage origination files. Additionally, Fitch is studying how a 

more robust system of representation and warranty repurchases 

could help to provide more stable RMBS performance. Fitch will 

not rate subprime RMBS without completion of the review process. 

Q.3. Do you have any reason to believe that inaccurate or fraudulent data contributed to the poor performance of your ratings on 

structured finance securities over the last few years? If yes, please 

provide supporting evidence. 


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A.3. The very high delinquency and default performance of recent 

vintage subprime RMBS and Alternative-A RMBS has a variety of 

causes, including declining home prices and the prevalence of highrisk mortgage products such as stated-income loans and 100% combined-loan-to-value loans. However, as indicated in your question, 

these factors do not fully account for the large number of early defaults that are occurring. Many industry observers have noted that 

poor underwriting, together with borrower/broker fraud, also appear to be playing a role in high defaults. 

For example, for an origination program that relies on owner occupancy to offset other risk factors, a borrower fraudulently stating 

intent to occupy will dramatically alter the probability of the loan 

defaulting. When this scenario happens with a borrower who purchased the property as a short-term investment, based on the anticipation that the value would increase, the layering of risk is 

greatly multiplied. If the same borrower also misrepresented his income, and cannot afford to make the payments, the loan will almost certainly default and result in a loss, as there is no type of 

loss mitigation, including modification, which can rectify these 

issues. 

It is not possible to confidently make a broad statement of how 

pervasive these problems are across the range of originators and 

issuers in Fitch’s rated portfolio. However, given the combination 

of our review of historical loan performance, the level of problems 

identified in recent Fitch studies and the findings of third-party reviews, Fitch believes that poor underwriting quality and fraud may 

account for as much as one-quarter of the underperformance of recent vintage subprime RMBS. More details on this can be found in 

our November 28, 2007 report ‘‘The Impact of Poor Underwriting 

Practices and Fraud in Subprime RMBS Performance’’, a copy of 

which is attached to this letter. 

Q.4. Ms. Robinson, Ms. Tillman, and Mr. Joynt, according to testimony provided by Chairman Cox’s testimony, Moody’s has downgraded 53 percent and 39 percent of all its 2006 and 2007 subprime 

tranches; S&P has downgraded 44 percent of the subprime 

tranches it rated between the first quarter of 2005 and the third 

quarter of 2007; and Fitch has downgraded approximately 34% of 

the subprime tranches it rated in 2006 and the first quarter of 

2007. 

What steps have each of your companies taken during the past 

three years to hold accountable its executives and analysts for the 

poor performance of its ratings? Has your company dismissed or 

otherwise disciplined any of the executives or analysts responsible 

for overseeing or producing its ratings of structured finance products? Please provide a complete list of disciplinary actions. 

A.4. Like all of the major rating agencies, our structured finance 

ratings have not performed well and have been too volatile, but we 

have found no evidence of violations of our policies or procedures 

which would indicate disciplinary action is either warranted or appropriate. 

We have, however, seen merit in making a number of changes 

to the senior management team to introduce additional perspectives into the work of our structured finance groups. On January 


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22, 2008, Fitch appointed successors to the positions of Global 

Head of Structured Finance Ratings, responsible for all structured 

finance ratings globally, and Global Head of Structured Credit Ratings, responsible for all CDO ratings globally. In making these and 

other appointments, we have reflected a belief that adding senior 

managers with experience of corporate and financial sector assets 

is an important addition to the robustness of the rating process. 

Q.5. Ms. Robinson, Ms. Tillman, and Mr. Joynt, during the last 3 

years, did your firm notice a decline in underwriting standards for 

mortgages being used to create residential mortgage-backed securities? If so, did you alter your ratings process in any way to account 

for this decline in underwriting standards? 

Did you disclose to investors that there was a decline in underwriting standards? 

A.5. Some degree of decline was apparent in the migration to higher risk products such as ‘‘no-money-down’’ and ‘‘no documentation’’ 

loans. The rating process accounted for these factors by assuming 

higher default and loss rates for these mortgages than for other, 

less risky mortgages. We described to investors the risks of various 

mortgage products in our criteria reports, and we discussed the 

trends to higher risk products in numerous investor presentations 

and special reports, e.g., the 2006 and 2007 Global Structured Finance Outlook reports. 

Fitch did not change the rating process until it became apparent 

that not only the underwriting standards, but the underwriting 

processes and controls, had become so weak that RMBS became exposed to very high-risk loans, in many instances exhibiting evidence of borrower and broker fraud. In response to these developments Fitch announced an enhanced originator review process described in Response B above. 

Q.6. Ms. Robinson, Ms. Tillman, and Mr. Joynt, when each of your 

companies tries to attract new customers, how do you distinguish 

your ratings from the ratings of other rating agencies? 

• Do you have empirical data that demonstrates that your ratings are better than the ratings of other companies? If yes, 

please provide documentation supporting your answer. 

• Do you compete more on price or ratings accuracy? Please provide documentation supporting your answer. 

A.6. While we can point to occasions where we believe our methodologies and rating actions have demonstrated greater prescience 

than those of our competitors, at a very high level, it is difficult to 

argue conclusively that one set of ratings is demonstrably ‘‘better’’ 

than another. Our aim has always been to provide a valid, independent opinion that investors can use as one additional data point 

to include in their own analysis, and that can be judged on its own 

merits, based on the quality of our rating commentary, accompanying research and the published performance data. 

The decision by an entity as to which CRA to approach is based 

on a variety of factors, including the efficiency of the rating process, the quality of the analysis and the accompanying research reports, the relative cost and, most importantly, the reputation of the 

agency with investors. Ultimately, the long-term success or failure 


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of an agency is measured in terms of the latter, which, in Fitch’s 

case, has resulted in investors—voluntarily and at their own initiative—incorporating Fitch in their investment guidelines over the 

past five years, on an equal footing with the two larger agencies. 

This greater recognition—based on the quality of our work and not 

the level of our ratings—has been the greatest spur to increased 

business opportunities for our agency. 

Q.7. Ms. Robinson, Ms. Tillman, and Mr. Joynt, what are the idealized default rates for each of your ratings? 

A.7. Given the ordinal nature of ratings—that is, ratings are a relative ranking, rather than a specific percentage prediction—Fitch 

has not historically benchmarked individual ratings to cardinal default expectations. In our public transition and default studies, we 

have measured our performance using a variety of traditional 

measures, including comparisons of cumulative default rates, Gini 

coefficients and Lorenz curves. 

Q.8. Ms. Robinson, Ms. Tillman, and Mr. Joynt, in his written testimony, Professor Coffee notes that because only a limited number 

of investment banks underwrite structured finance products, they 

have leverage over the rating agencies. If they do not like the ratings they get from one agency, they can go to another with lower 

standards. 

• Has your firm ever felt pressure to lower your rating standards 

in order to attract business? 

• How do you attract customers if your ratings use the most 

stringent standards? Will issuers and underwriters simply go 

to other firms with less demanding standards? 

A.8. We do not view the nominal concentration of investment banks 

active in the capital markets as representing increased leverage 

such as to threaten the objectivity of our work. The banks in question operate across multiple asset classes, in dozens of geographies. 

In this work, the decision on which rating agency to approach and 

ultimately to engage is not steered centrally by any one individual, 

or any one group of individuals within any of the banks. The decision to hire or not hire a given agency is based on the variety of 

factors outlined above in Response F, rather than a narrow consideration of the treatment of that bank’s prior transaction. 

Where the level of credit enhancement is also used by banks as 

a determining factor, we believe that our track record amply demonstrates many segments where our market share was lower in 

part because of the credit view which Fitch took. We understand 

this as a natural part of the business of being an independent rating agency, and believe, as noted above in Response F, that ultimately the long-term success or failure of our agency will be measured relative to our reputation with investors, not short-term gains 

in market share. 

Q.9. Mr. Joynt, Chairman Cox outlined in his testimony the rulemaking areas the SEC is considering. 

The outline contains several ideas for improving competition in 

the ratings industry. 

Are there any additional measures the SEC should consider to 

foster competition? 


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A.9. Fitch supports competition in the marketplace and has been 

working diligently to provide an alternative global, full-service rating agency capable of successfully competing with Moody’s and 

S&P across all products and market segments. We believe that one 

of the Proposed Rules—requiring the public disclosure of the information a rating agency uses to determine a rating on a structured 

product—would be very constructive in furthering competition. 

Such disclosure would also have the added benefit of assisting investors in conducting their own investment analysis process. However, it may be most practical that this disclosure requirement 

should apply to the sources of the information—i.e., originators, arrangers and issuers—rather than the receivers of the information. 

Q.10. Mr. Joynt, Chairman Cox indicated in his testimony that the 

SEC may consider rules that would require all NRSROs to have access to the information underlying credit ratings. 

Would this make it easier for your company and the other smaller rating agencies to compete against S&P and Moody’s? 

A.10. Fitch supports competition in the marketplace and has been 

working diligently to provide an alternative global, full-service rating agency capable of successfully competing with Moody’s and 

S&P across all products and market segments. We believe that one 

of the Proposed Rules—requiring the public disclosure of the information a rating agency uses to determine a rating on a structured 

product—would be very constructive in furthering competition. 

Such disclosure would also have the added benefit of assisting investors in conducting their own investment analysis process. However, it may be most practical that this disclosure requirement 

should apply to the sources of the information—i.e., originators, arrangers and issuers—rather than the receivers of the information. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ 

FROM STEPHEN W. JOYNT 

Q.1. During the hearing, I asked you for specifics on the ratings 

your agency provided on Bear Stearns in the months leading up to 

the collapse. Please provide the Committee with a detailed explanation of the ratings for Bear Stearns from November 2007 and 

March 2008. In addition, please answer the following questions. 

• Were any of the ratings downgraded between December 2007 

and March 14, 2008? 

• Were any of the ratings downgraded during the week of the 

collapse (March 10–14)? 

• Can you explain from your agency’s point of view how Bear’s 

collapse unfolded and the role the ratings may have played? 

• Do you think the lack of changes to the Bear Stearns’ ratings 

is an example of a unique event in the markets or an indication of larger flaws in the structure of the ratings? 

• Under ideal circumstances, would you agree that the ratings 

should have been downgraded to more accurately reflect Bear’s 

risk? 

• What lessons do you think we should take from the Bear 

Stearns collapse as it relates to the credit ratings? 


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• What are your thoughts on a proposal Professor Coffee discussed at the hearing for rating agencies to periodically update 

ratings? 

A.1. The ‘‘A+’’ long-term Issuer Default and senior debt ratings reflected Fitch’s view that Bear Stearns’ capacity for payment of financial commitments was strong, but more vulnerable to changes 

in circumstance or economic conditions than higher rated obligors. 

Positive rating considerations included leading franchises in clearing and securities settlement and fixed income and equities securities sales and trading. The company had a conservative market and 

credit risk culture as regards proprietary trading and investment 

banking relative to peers. Senior executives at Bear Stearns had 

established a culture of no surprises and accountability which had 

served them well, demonstrated by a very long history of good and 

steady profits. There was minimal turnover at high ranks and material employee ownership indicated a degree of alignment of the 

firm’s interests with those of its customers. 

Fitch analysts meet with broker dealer issuers several times a 

year to assess business risk and strategies as well as review principal ratings factors already listed above. We also maintain an 

open dialogue through regular conversations, pre-earnings calls 

and regular information requests on business and balance sheet 

conditions. 

Fitch published a special analysis on liquidity in August 2007, 

following market liquidity pressures in July and August. Information requests also increased once the volatile markets began in earnest in August 2007. Bear Stearns and other issuers provide us 

with updates on exposures and commitments to leveraged loans, 

commercial real estate, ABS CDOs, mortgage inventory, 

counterparty credit relationships to financial guarantors and hedge 

funds. We also obtain regular updates on liquidity and market volatility trends. 

Bear Stearns’ funding structure was similar to peers although 

net adjusted leverage was slightly lower. Bear Stearns assumed 

significant operational and reputation risk from its global clearing 

and prime brokerage business but had managed this risk very well 

historically. Strategic expansion was thoughtful and carefully balanced against its expenses resulting in reduced revenue diversification as compared to peers. Product expansion typically lagged industry trends. Diversification was limited by this both geographically and on the product side. The firm had more limited revenues 

outside the U.S. The firm had recently been investing in its asset 

management business to build higher fee revenues often seen as 

ballast against trading results. Its support of a managed hedge 

fund in June 2007 was a marked departure for Bear Stearns. 

On November 14, 2007, Fitch downgraded a number of Bear 

Stearns’ ratings. Full rating histories are attached. At the parent 

company level, the Short-term Issuer Default Rating of BSC was 

lowered to ‘‘F1’’ and the Individual rating (a measure of standalone 

financial strength) was lowered to ‘‘B/C’’. Additionally, the rating 

outlook was revised to ‘‘Negative’’ from ‘‘Stable’’. The downgrades 

reflected Fitch’s view that Bear Stearns’ near term profitability 

was expected to be weak, pressured by its exposure to the U.S. 

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nesses were performing well, however; Fitch believed financial performance in 2008 would remain challenging given the scale of Bear 

Stearns’ fixed income business and more limited international 

scope. Liquidity had been managed well and remained adequate 

but deteriorating conditions in the capital markets were considered 

a potential threat to Bear Stearns’ financial flexibility. Fitch highlighted that future downgrades could result from declines in earnings, severe negative valuation adjustments, an increased risk profile, diminished liquidity, rising leverage and/or tangible equity erosion. 

In December, Fitch continued the Negative Outlook following 

Bear Stearns’ earnings release of FY07 results in a published press 

release. Bear Stearns posted its first quarterly loss in its history 

and was mildly profitable for FY07. The firm took $1.9 billion in 

mortgage inventory write-downs. Liquidity measures had improved 

during the last half of 2007. Ratings were not downgraded further 

during the period March 10–13, 2008. 

On March 14, 2008, Fitch lowered all ratings on Bear Stearns 

and its subsidiaries rated by Fitch. The parent company Long-term 

Issuer Default Rating was lowered to ‘‘BBB’’ from ‘‘A+’’ and the 

Short-term Issuer Default Rating was lowered to ‘‘F3’’ from ‘‘F1’’. 

The Individual rating was lowered to ‘‘C/D’’ from ‘‘B/C’’. All issue 

ratings were also placed on Rating Watch Negative. The Support 

rating was raised from ‘‘5’’ to ‘‘3’’, reflecting the secured loan agreement concluded with JP Morgan Chase. 

Bear Stearns suffered a rapid decline in liquidity over a 24-hour 

period. In February and early March, there was unprecedented 

spread widening in all credit and particularly in mortgage products 

as the failure of several high profile hedge funds pressured prices. 

Liquidity had dried up in almost the entirety of the domestic mortgage-backed securities market, including unprecedented credit 

spread widening in ‘‘AAA’’-rated US Agency paper. 

Bear Stearns had a capital base that was the smallest of the 

bulge bracket and had the highest percentage of its securities inventory in mortgage based assets. It was the lowest rated broker 

dealer at Fitch. As indicated above, Fitch had downgraded its 

Short-term ratings to ‘‘F1’’ in November and the Negative Outlook 

indicated a probability that its rating may face further downgrades. 

Bear Stearns also possessed a high market share in providing financing to fixed income hedge funds. Fitch believes these factors 

all led to increasing reluctance by investors to hold its paper, particularly as their quarter end was approaching. 

Fitch believes that market conditions were highly volatile for several weeks preceding the Bear Stearns’ failure. Unique elements 

include the unprecedented spread widening in products that had 

been highly liquid for years and through multiple stress scenarios. 

While similarities can be drawn between this period and market 

conditions in the fall of 1998, there are numerous unique elements 

including the turmoil in domestic RMBS markets, the absence of 

Fannie Mae and Freddie Mac in active purchases of mortgages due 

to portfolio caps, the existence of the mortgage-based ABX indexes 

allowing greater speculation and accumulation of short positions, 

and the increase in hedge fund and statistically-based program 

trading in fixed income and equities. Fitch believes these market 


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conditions likely resulted in the acceleration of the rate of deterioration. 

It is very difficult to attribute ‘‘what if’’ scenarios to the operations of financial markets since human reaction can be so unpredictable. Ratings consider the diversification of sources, tenor and 

types of unsecured funding as well as its reliance and ability to 

withstand periods of illiquidity. Treasury management is an integral part of the culture and management of these firms and risk 

mitigation takes multiple forms including short term limits to rollover risk, investor concentrations and availability of unencumbered 

assets. Contingency funding plans are detailed and make various 

assumptions on the firm’s ability to shift from an unsecured to a 

secured environment. 

Fitch noted a shift in industry trends since 1998. The industry 

and Bear Stearns, in particular, reduced reliance on unsecured 

credit sources, emphasizing the extension of long-term funds, the 

use of bank charters to support certain businesses and increased 

reliance on secured bank funding agreements to support the growing inventory of illiquid assets. 

Bear Stearns’ liquidity ratios were on target with peers. Its funding coverage of less liquid assets was the strongest of peers having 

limited credit granted to investment banking clients, merchant 

bank and private equity funds and generally conservative posture 

in expanding its balance sheet. It also maintained a relatively conservative capital structure with minimal levels of hybrid capital 

issuances versus peers. 

While we strive to incorporate a prospective view in our ratings, 

Fitch believes that the evolving credit stress has elements of great 

severity and rapidity not previously foreseen. We are evaluating 

this scenario, as well as the recent programs modified by the U.S. 

Federal Reserve in the ongoing ratings assessment of the other 

U.S. based brokers. Three of the remaining four are presently assigned a Rating Outlook of Negative. 

Our ratings are subject to continuous review, other than where 

expressly disclosed as point-in-time in nature. This means that any 

material event can cause a rating action for any rating at any time. 

Fitch is staffed to ensure that sufficient analysts of appropriate experience are available to attend whenever committees need to be 

called. 

The topic of ‘‘bunching’’ actual rating actions to meet pre-determined dates has also recently been discussed in the context of regulatory consultations in Europe, and we understand that the overwhelming majority of rating users do not see a benefit in such an 

idea. 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM ARTURO CIFUENTES, PH.D. 

Q.1. Dr. Cifuentes, in your testimony you point out that rating 

agencies were originally created to provide investors with information about credit risk. Later, ratings were used by regulators for a 

variety of other purposes including determining capital requirements and establishing investment guidelines for financial institutions. 

Would you please elaborate on your view that ratings that are 

useful for investors may not be necessarily as useful for regulators? 

A.1. A regulator is mostly concerned with the soundness (solvency) 

of financial institutions; to be precise, whether a financial institution has enough capital. In that sense, a regulator prefers conservative ratings (that is, ratings that err in the direction of ‘‘safety’’) 

and stability (that is, ratings that do not change frequently for nobody wants to check the solvency of an institution on a daily basis). 

An investor or portfolio manager, on the contrary, benefits from 

accurate (that is, neither conservative not aggressive) and unbiased 

ratings. Moreover, to the extent that investors trade securities, 

they would benefit from timely changes in ratings. These objectives 

lend themselves to ratings that should be more ‘‘dynamic’’ (change 

more frequently). 

Therefore, the needs of these two constituencies (stable versus 

dynamic ratings; conservative versus accurate and unbiased ratings) are not one-hundred per cent aligned. 

A final observation: Some naı ̈ve commentators think that the ratings agencies secretly welcome the use of ratings by regulators because this would help the agencies to secure a reliable and steady 

source of revenue. Actually, the opposite is true. In fact, T. J. 

McGuire, a former Moody’s Executive Vice President, gave a speech 

to the SEC in 1995 in which he expressed the view that this practice would eventually erode the integrity and objectivity of the ratings system. (See T. J. McGuire speech delivered on April, 1995 at 

the Fifth Annual International Institute for Securities Market Development, U.S. Securities and Exchange Commission, available 

from www.Moodys.com.) 

Q.2. Dr. Cifuentes, the credit rating industry is highly concentrated 

with S&P and Moody’s each rating more than 90 percent of rated 

corporate bonds. Fitch is the only other firm that has significant 

market share. Chairman Cox has indicated that the SEC is considering rules to require disclosure about the performance of the ratings of each rating agency. 

Do you believe that disclosure of ratings performance data would 

help new credit rating agencies compete with more established 

firms? 

A.2. No. I don’t think so. Ratings performance data are available 

already and have done little to help potential new agencies to compete with the existing ones. 

In my opinion, the most significant obstacles faced by a new 

agency are a bit different: (i) the three-year ‘‘waiting’’ period (essentially, they need to survive for three years while selling ratings 

that are not accepted by regulators: an incredibly tough barrier to 

entry); (ii) the fact that the existing rating agencies have not been 


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sanctioned for their bad performance; and (iii) the fact that the new 

agencies do not have access to historical data (bond default frequencies, recovery values for defaulted securities, etc.) that Moody’s 

and S&P have. 

Q.3. Would this disclosure also make rating agencies more accountable to investors? 

A.3. I don’t believe so. Rating agencies, to the extent that they can 

protect themselves under the First Amendment, are accountable to 

nobody. And worse, whether they are accountable to investors or 

not, it is in a sense an academic issue: being approved by the SEC 

is the only thing that matters. 


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ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

AS HOUSING BOOMED, MOODY’S OPENED UP

The Wall Street Journal, Friday, April 11, 2008 

By AARON LUCCHETTI 

Bond-rating agency Moody’s Investors Service used to be an ivory tower of finance. Analysts were discouraged from having a drink with a client. Phone calls 

from bankers went unanswered if they rang during intense, almost academic debates about credit ratings. 

A decade ago, as the housing market was just beginning to take off, Moody’s was 

a small player in analyzing complex securities based on home mortgages. Then, 

Moody’s joined Wall Street and many investors in partaking of the punch bowl. 

A firm once known for a bookish culture began to focus on the market share that 

affected its own revenue and profit. The rating firm became willing, on occasion, to 

switch analysts if clients complained. An executive overseeing mortgage ratings 

went skydiving with a client. By the height of the mortgage-securities frenzy in 

2006, Moody’s had pulled even with its largest competitor, rating nine out of every 

10 dollars raised in these instruments. It gave many of the bonds its coveted tripleA rating. 

Profits at the 99-year-old firm, which John Moody started to rate railroad bonds, 

rose 375 percent in six years. The share price quintupled. 

Now, Moody’s and the other two major rating firms, the Standard & Poor’s unit 

of McGraw-Hill Cos. and the Fitch Ratings unit of Fimalac SA, are under fire for 

putting top ratings on securities that ultimately collapsed in value. Investors, many 

of whom relied on ratings to signal which securities were safe to buy, have lost more 

than $100 billion in market value. The credibility of the ratings system is in tatters 

as new downgrades of mortgage securities come almost weekly. Investigators from 

Congress, the Securities and Exchange Commission and several state attorneys general are examining the rating firms’ practices. 

Moody’s acknowledges it sometimes got things wrong in judging mortgage bonds, 

but says these were honest mistakes and not the result of efforts to garner market 

share. It says it has maintained its rigor and objectivity in a rating process that 

is still adversarial toward big investment banks. 

Of the three big rating agencies, Moody’s underwent the deepest cultural change 

amid the housing boom. At the heart of the firm’s gradual transformation into a 

player in the mortgage game was Brian Clarkson, 51 years old, who joined the company as an analyst in 1991 and became president last August. Mr. Clarkson maintains that his focus on making Moody’s friendlier to Wall Street was what the company needed early this decade. ‘‘We’re in a service business,’’ he says. ‘‘I don’t apologize for that.’’ 

When Mr. Clarkson first joined Moody’s, the agency was known as a place where 

analysts often didn’t even promptly pick up their phones, much less talk extensively 

to companies whose bonds they were rating. A magazine story in the mid ’90s attempted to answer the question ‘‘Why Everyone Hates Moody’s.’’ 

Mr. Clarkson himself had dealt with Moody’s as an outsider, and been frustrated 

with its manner. As he began to rise within the firm, he set out to make it more 

client-friendly and focused on market share. Firms like Moody’s are hired by companies, governments and other organizations that seek to sell bonds. The firms rate 

bonds based on the likelihood they’ll default and, in Moody’s case, also based on how 

much of their principal bondholders are likely to get back. 

Top-rated triple-A bonds rarely miss payments, and even if they do, investors can 

expect to get nearly all of their money back. Bonds rated B and C are more likely 

to lose money for their owners. To compensate for the added risk, they pay higher 

interest rates. Bond buyers depend heavily on the ratings, and conservative investors often buy only triple-A bonds. 

Bond issuers, knowing that a higher rating means they pay a lower interest rate, 

have an incentive to shop around among rating agencies. And they have clout as 

they shop: They’re the ones paying the bill. Moody’s toughness gave issuers reason 

to go elsewhere, and back in the mid-1990s, Fitch and S&P were both rating more 

mortgage bonds than Moody’s, in large part because their standards were considered 

easier. For instance, in commercial mortgage-backed securities, Moody’s trailed its 

two main competitors by 30 percentage points in market coverage in 1996. 

That year, Mr. Clarkson took over the group at Moody’s that analyzed such securities. The firm added new analysts and overhauled its ratings approach, allowing 

for higher ratings in the area. Within a year, Moody’s moved ahead of both Fitch 

and S&P in the sector. Rivals said Moody’s had cut its standards. Mr. Clarkson was 


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quoted as calling this ‘‘sour grapes.’’ He says now that the change in the ratings 

approach was the right call. 

In 1999 Mr. Clarkson took over the part of the firm’s ‘‘structured finance’’ business that oversaw bonds and complex securities based on home mortgages. Moody’s 

rated just 14 percent of high-quality ‘‘prime’’ bonds in that area in the year before 

he took over, compared with 51 percent that Fitch rated and 89 percent that S&P 

rated, as calculated by the publication Asset-Backed Alert. (The same bond often 

gets a rating from two different firms.) 

Moody’s top home-mortgage analyst at the time, Mark Adelson, took a cautious 

approach that resulted in fewer triple-A ratings. Mr. Clarkson shook things up, firing or reassigning about two dozen analysts and hiring new ones who started giving 

higher grades under a new methodology. Mr. Adelson left for an investment bank. 

In 2001, Moody’s market coverage was up to 64 percent. Mr. Adelson says ‘‘the 

world thought differently than I did’’ about mortgage bonds in 1998 and 1999. He 

isn’t critical of Mr. Clarkson’s management. Mr. Clarkson ‘‘is what Moody’s needs,’’ 

Mr. Adelson says. ‘‘He’s very smart, capable and driven.’’ 

By 2001, Moody’s was an independent company. It had long been tucked inside 

financial publisher Dun & Bradstreet Corp., but D&B spun it off as a new public 

company in 2000. Just before it did so, Warren Buffett saw the growth and profitability of Moody’s business and had his Berkshire Hathaway Inc. raise its stake in 

D&B. Berkshire is now Moody’s biggest shareholder, with a 19 percent interest. In 

some areas, Moody’s continued to make it hard to get a high rating, with the result 

that it didn’t do much business in those areas; these areas included the riskier part 

of home-mortgage bonds and products known as net-interest margin securities. 

Mr. Clarkson encouraged his people to be more responsive picking up the phone 

when in the office and to find ways deals could get done within Moody’s methodologies. Customer-service coaches gave sessions on improving relationships with bond 

issuers and investors. 

‘‘Brian (Clarkson) created a dialogue between Moody’s and the Street that was 

good,’’ says Paul Stevenson, a former Moody’s executive who now works at BMO Financial Group. But ‘‘the most recent problem,’’ he says, ‘‘is that the rating process 

became a negotiation.’’ 

Consider a Bank of America mortgage deal in early 2001. As in most such deals, 

the vast majority of the securities based on the pool of mortgages would be rated 

triple-A. The question was how big a chunk would be rated lower paying a higher 

interest rate and bearing the brunt of any defaults that occurred. 

A rating committee at Moody’s voted to require that the issuer put about 4.25 percent of the deal’s value in the lower-rated section, to provide extra protection for 

buyers of the top-rated section. But after Bank of America complained and said it 

might go with a different rating firm, Moody’s reduced the size of the lower-rated 

chunk slightly saving the issuer some interest costs according to people with knowledge of the matter. 

Linda Stesney, a Moody’s managing director who was then co-head of mortgagebacked securities, says she doesn’t recall the deal. She says Moody’s reconsidered 

its view on deals when issuers presented new information affecting credit quality. 

She adds that Moody’s mortgage ratings at the time held up well. 

In 2002, Mr. Clarkson’s realm extended to the fast-growing business of CDOs. In 

this complex product, already-sliced-up bonds are further sliced into new pieces, 

based on risk and potential return. Moody’s was already rating 90 percent of the 

dollar value of CDOs. Mr. Clarkson told an analyst he didn’t want bad service to 

cause that to slip, say people familiar with the matter. 

‘‘There was never an explicit directive to subordinate rating quality to market 

share,’’ says Mark Froeba, a former Moody’s analyst who recently started a bond 

valuation company that may compete with rating firms. 

‘‘There was, rather, a palpable erosion of institutional support for rating analysis 

that threatened market share.’’ An example would be raising too many legal issues 

on deals, slowing them down unnecessarily. 

Mr. Clarkson says the goal was maintaining consistency about the issues Moody’s 

raised on deals. ‘‘I have no problem losing deals for the right reasons,’’ he says. ‘‘We 

don’t change methodology to garner market share.’’ 

Some supporters say that while Mr. Clarkson cared about market share, he cared 

more about the quality of Moody’s ratings. Bill May, a Moody’s managing director, 

recalls Mr. Clarkson warning him in 2002 about the things that could get a managing director fired. He says inaccurate ratings topped the list, followed by ‘‘arrogant or rude’’ behavior toward market participants. 

On occasion, Moody’s agreed to switch analysts on deals after bankers complained. 

Among banks that requested that a different analyst look at their deals were Credit 

Suisse Group, UBS AG and Goldman Sachs Group Inc., according to a person familVerDate Nov 24 2008 03:01 Mar 20, 2010 Jkt 050399 PO 00000 Frm 00247 Fmt 6621 Sfmt 6621 E:\HR\OC\A399.XXX A399

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iar with the matter. The banks declined to comment. Mr. May says analysts were 

switched on ‘‘rare’’ occasions to accommodate such a request. 

Mr. Clarkson stressed relationships, in a break with tradition at the firm, whose 

office in Lower Manhattan is adorned with sepia-toned pictures of its founder. John 

Bohn, Moody’s president from 1989 to 1996, says he used to tell recruits that 

Moody’s was a ‘‘special business’’ where ‘‘you can’t go out for beers’’ with friends who 

worked for investment banks. 

Mr. Clarkson’s view is that ‘‘it’s important to socialize.’’ The onetime mountain 

climber and recreational weightlifter met with investment-bank officials and gave 

speeches at industry conferences peppered with movie quotes and references to television shows like ‘‘Survivor.’’ 

When Moody’s sought to rate more deals for GMAC’s residential-finance unit in 

the late 1990s, Moody’s officials traveled to the company’s Minneapolis offices several times. Mr. Clarkson and several others from Moody’s accepted an invitation to 

go skydiving with officials of the GMAC unit. ‘‘We paid our own way,’’ Mr. Clarkson 

recalls. 

Some analysts say they occasionally would attend the dinners that celebrated the 

launch of a new CDO Moody’s had just rated. Moody’s says it has rules to prevent 

conflicts, including a $50 limit on gifts, and that building better relationships with 

Wall Street officials was part of its effort to be more transparent in its rating methodologies. 

As Moody’s staff grew to accommodate the surging mortgage market, Mr. 

Clarkson arranged off-site meetings for employees to get to know each other better. 

At one, he sung as a Blues Brother, while at another, two Moody’s executives entertained by wrestling in fat suits. 

Mr. Clarkson’s structured-finance group grew to account for about 43 percent of 

Moody’s revenue in 2006, up from 28 percent in 1998. By 2006, the firm had more 

revenue from structured finance $881 million than its entire revenue had been in 

2001. 

Employees, though paid a fraction of what they could earn on Wall Street, sometimes grew wealthy from Moody’s surging share price and their stock options. According to a regulatory filing, Mr. Clarkson’s compensation totaled $3.8 million in 

2006. The firm’s chief executive, Raymond McDaniel, earned $8.2 million that year, 

more than twice what his predecessor made in 2000. Moody’s says the rise in their 

compensation reflected growth in the overall business, not just the mortgage area, 

and that much of the rise came from the increasing value of stock options that had 

been granted years before. 

By early 2007, some Moody’s analysts were growing worried about the market for 

securities backed by subprime mortgages. But Mr. McDaniel told a group of investors in May 2007: ‘‘The good-news story for us’’ includes ‘‘very strong growth coming 

out of our largest business, which is the structured-finance business. It is both large 

and a significant growth engine for the company.’’ 

Despite some analysts’ concerns, Moody’s rated about 94 percent of the $190 billion in mortgage-related and other structured-finance CDOs issued in 2007, the second busiest year ever. Many of those CDOs have since been downgraded, some from 

triple-A to levels that suggest investors will have significant losses. Moody’s says 

some bonds it rated were backed by fraudulent loans. It also notes that it wasn’t 

alone in being surprised by the depth of the housing decline. ‘‘We were preparing 

for a rainstorm and it was a tsunami,’’ Mr. Clarkson says. 

Since becoming Moody’s president in August, he is spending up to half of some 

weeks dealing with regulators. ‘‘They want the same things we do,’’ he says. Some 

options that Moody’s is considering to improve its process such as adding new labels 

to structured-finance ratings to convey the products’ unique attributes and risks 

were earlier raised by regulators. 

Mr. Clarkson says analysts have kept their ‘‘adversarial’’ approach, but adds, 

‘‘One of the things we have to do going forward is be more skeptical.’’ 


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