Thursday, August 16, 2007

Ratings Agencies and the Subprime Scandal

From the FT today:

Rating agencies hit by subprime probe

Published: August 15 2007 22:02 | Last updated: August 16 2007 00:05

The European Commission is to investigate credit ratings agencies amid growing dismay over their slow response to the subprime mortgage crisis.

Officials in Brussels, and many other critics, believe the ratings agencies failed to act quickly enough to warn investors about the risks of investing in securities backed by US subprime mortgages – the sector whose troubles triggered the recent global market volatility.

In the US, Barney Frank, Democrat chairman of the House financial services committee, said he planned to hold hearings on the agencies’ performance next month. He said the agencies had “not done a good job” in the current crisis.

Banks first warned about a potential crisis in subprime last year. But it was only this spring that S&P and Moody’s started downgrading the ratings of mortgage-backed securities on a significant scale.

“If the rating agencies believe this is going to be business as usual, they are very wrong,” one Commission official said.

“The securitised subprime mortgage market would not have grown to the extent that it did without the favourable ratings given by some agencies.”

Charlie McCreevy, EU internal market commissioner, met senior S&P executives last month and expressed his concern about the subprime mortgage sector and the apparently slow reaction of some agencies. He has invited European securities regulators to meet in September to discuss ratings agencies and the problems that have surfaced with regard to rating structured products.

The agencies have changed their methodologies in response to the rapid rise in subprime mortgage payment problems. But they say downgrades follow once evidence has accumulated that mortgages or other assets are underperforming rather than on a speculative basis.

The agencies have previously defended themselves from legal action by maintaining that their ratings are simply opinions, covered in the US by constitutional free speech protections.

The Commission is not committed to any course of action and is likely to await the outcome of a review of the International Organisation of Securities Commissions’ code of conduct, expected by April, before considering new regulation. The Commission adopted a policy paper last year that dismissed the need for new regulation.

But it did warn that “the position of credit rating agencies must not be compromised by the relationships they have with issuers”, highlighting the fact that agencies are paid by issuers, not the users, of their ratings. Another worry relates to how agencies offer consultancy to issuers.

In the US, the Securities and Exchange Commission introduced rules for agencies in June. French watchdog the Autorité des Marchés Financiers this year cited potential conflicts of interest and a lack of transparency.

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