, the credit rating agencies would serve investors better by providing greater transparency. credit rating agencies should, for example, publish sufficient information about the assumptions underlying their rating methodologies and models so that users can understand how a particular rating was determined. it is also important for the credit rating agencies to clarify that a given rating applied to a structured credit product may have a different meaning than the same rating applied to a corporate bond or a municipal security. indeed, some have suggested that the agencies use different rating nomenclatures for different types of products. transparency about methods should also help to reduce concerns about conflicts of interest that might arise from the fact that issuers of securities pay the rating agencies for their work in rating those securities. the credit rating agencies themselves clearly appreciate that concerns about the quality of ratings and potential conflicts of interest represent a fundamental challenge to their business model, and they have begun to address these issues. the sec, which has regulatory responsibility for the credit rating agencies, is conducting a broad review of issues regarding potential conflicts of interest at the rating agencies and is likely to identify further measures that should be implemented. as i noted earlier, the turmoil in financial markets has also revealed significant weaknesses in the risk - management practices of some large, globally active financial institutions ; these weaknesses have exacerbated the problems in the markets by compromising the abilities of these key firms to absorb risk and serve as intermediaries. prudential supervisors in the affected financial markets began joint work late last summer to identify common deficiencies on which they and the firms should focus. the supervisors concluded that the firms that suffered the most significant losses tended to exhibit common problems, including insufficiently close monitoring of off - balance - sheet exposures, inadequate attention to the implications for the firm as a whole of risks taken in individual business lines, dependence on a narrow range of risk measures, deficiencies in liquidity planning, and inadequate attention to valuation issues. to be sure, firms varied in the degree to which they were subject to these weaknesses, with better performance on these dimensions generally being reflected in better financial performance. correcting these weaknesses is, first and foremost, the responsibility of the firms'managements and they have powerful incentives to do so. but prudential supervisors, including the federal reserve, must also review their existing policies and guidance to identify areas where changes could help firms strengthen their risk management – a process that is already under way. two areas of focus in this review will be capital and liquidity, the principal buffer

distribute model, as implemented in this case, created for the originators. notably, the incentive structures sometimes often tied originator revenue to loan volume, rather than to the quality of the loans being passed up the chain. investors normally have the right to put loans that default quickly back to the originator, which should tend to apply some discipline to the underwriting process. however, in the recent episode, some originators had little capital at stake, reducing their exposure to the risk that the loans would perform poorly. so long as house prices were rising, subprime borrowers saw their home equity increase and were often able to refinance into more - sustainable mortgages. however, when house prices began to fall, borrowers'refinancing options disappeared and the problems with subprime mortgage underwriting were exposed. delinquency rates soared, particularly on subprime mortgages with adjustable rates. because subprime mortgages were frequently securitized, often as part of complex structured credit products, the losses associated with these delinquencies spread throughout the system. although subprime mortgages were the most obvious example, the loosening of credit standards and terms occurred more broadly, reflecting a general boom in credit markets that peaked and then reversed last summer. this boom was characterized by a general erosion of market discipline, underpricing of risk, and insufficient attention by investors to the quality or riskiness of the instruments they purchased. for example, in the market for so - called leveraged loans, used to finance mergers or buyouts, investors showed themselves willing to purchase debt with few covenants or other protections. the pwg also concluded that investors often took insufficient care in evaluating the risks of structured credit products, in part because they over - relied on the evaluations provided by the credit rating agencies. unfortunately, the methodologies and assumptions the agencies used to rate many credit products proved faulty, and their data were inadequate ( in part because of the lack of extensive experience with these products ). when rising delinquencies and losses on mortgages forced the agencies to sharply downgrade many structured credit products, investors lost confidence in those ratings and became unwilling to provide new funds. as financing disappeared, the markets for these products and for related investments, such as asset - backed commercial paper, seized up. another factor that the pwg identified as contributing to the financial turmoil was weakness in the risk - management practices of large global financial institutions that created and held complex