Senate Hearing, 110TH Congress - Turmoil in U.S. Credit Markets: The Role of Credit Rating Agencies

S. HRG.
110982
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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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota
RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island
ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York
WAYNE ALLARD, Colorado
EVAN BAYH, Indiana
MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware
CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey
JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii
MIKE CRAPO, Idaho
SHERROD BROWN, Ohio
ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania
MEL MARTINEZ, Florida
JON TESTER, Montana
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
Page
Opening statement of Chairman Dodd ..................................................................

Opening statements, comments, or prepared statements of:
Senator Shelby ..................................................................................................
Senator Menendez ............................................................................................
Senator Reed .....................................................................................................
Senator Allard ...................................................................................................
Senator Schumer ..............................................................................................
Senator Tester ..................................................................................................
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WITNESSES
Christopher Cox, Chairman, Securities and Exchange Commission ...................
Prepared statement ..........................................................................................
Response to written questions of:
Chairman Dodd .........................................................................................
Senator Shelby ...........................................................................................
Senator Menendez .....................................................................................
Senator Bunning .......................................................................................
John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia University
Law School ............................................................................................................
Senator Shelby ...........................................................................................
Vickie A. Tillman, Executive Vice President for Credit Market Services,
Standard & Poors ................................................................................................
Chairman Dodd .........................................................................................
Senator Shelby ...........................................................................................
Claire Robinson, Senior Managing Director, Moodys Investors Service ............
Chairman Dodd .........................................................................................
Senator Shelby ...........................................................................................
Stephen W. Joynt, President and Chief Executive Officer, Fitch Ratings ..........
Chairman Dodd .........................................................................................
Senator Shelby ...........................................................................................
Arturo Cifuentes, Ph.D., Managing Director, R.W. Pressprich & Co. .................
Senator Shelby ...........................................................................................
ADDITIONAL MATERIAL SUPPLIED
FOR THE
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RECORD
Aaron Lucchetti, The Wall Street Journal, As housing boomed, Moodys

opened up, article dated April 11, 2008 ............................................................
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TURMOIL IN U.S. CREDIT MARKETS: THE

ROLE OF CREDIT RATING AGENCIES
U.S. SENATE,
URBAN AFFAIRS,
Washington, DC.
The Committee met at 10:12 a.m., in room SD538, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the
Committee) presiding.
COMMITTEE
ON
BANKING, HOUSING,
AND
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
todays 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 yearin 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 companys 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. Moodys 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 fractiona small fractionof 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 SECs 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 examinationI 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
yearin 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 Members 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 visitI appreciate his visitof 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 meand, again, I appreciate that visitthe 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 Chairmans
proposals in this particular regard and the Commissions 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 todays 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 theymeaning the credit rating agenciesknew what they were doing, and
they dont. 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 werent, and they know that they
cant 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.
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 legislationand much of the
action occurred before thatneither the mortgage brokers nor the
credit rating agencies had any real regulation at all. And so it is
difficult to ask the SECthey now have regulation, and we have
met and talked abouthave 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 ofI want to commend
Fitchs for sending their CEO, but where are the heads of Moodys
and Standard & Poors? 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 Moodys a while
ago, and I asked him, Did Moodys 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 Journalwhich 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, Moodys 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. Moodys 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, wellnot 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.
We invited the CEO. Today is their shareholder meeting, and so
hethough 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. Moodys, 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 todays hearing on credit rating agencies as
another in a series of hearings looking into the turmoil in the cred-
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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 Governments 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 months 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 unprecedenteda $29 billion loan from the Government to facilitate
a merger of two of the worlds 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 Bears significant liquidity position. But I
want to hear it officially from you.
So thank you, Chairman Cox. Thank you, Chairman Dodd.
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 Commissions new oversight authority, and subject as well to our newly adopted rules. In the 612
months since the SECs 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 staffs observations from the examinations will be issued by early summer. At this stage, with more
examination work to be completed and the staffs 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 Commissions 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 staffs 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
with an outline of the rulemaking areas that are under consider-
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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 competitors 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 SECs 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 au-
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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 Presidents 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 Coffees 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 allowso 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 consistentlyI am not
talking about, obviouslyand 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 thatwell, anyway, you dont 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 agencys function?
Mr. COX. Well, what the law contemplatesand I think what our
rules will flesh out when they become final later this yearis 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 elses, 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 doingthey 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 downgradedand we
have seen this over and over and over consistentlywouldnt that
call in, just common sense, the confidence of that firm, or whoever
it was? And why wouldnt 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 casesthis is obviously a hypothetical discussionbetween 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 threeor 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 byor, 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 dont 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
Moodys 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, wouldnt 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.
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 claimand the claim has been, I think, affirmedthat 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 forceI
think it is the legislative intent, and we expect it as wellsome
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
areunless 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 regimeand, 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 throughand 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
lookingdo 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 accom-
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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.
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 importantand there are many othersa 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
conflatedI 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 tobecause 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 floatedand we have heard a lot from constituencies about
thisof 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 madeand it is under
careful consideration by the SEC and may be included in our proposed rulesthat 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 havingat 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.
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 experiencedand I gather Senator Schumer
touched upon this before I arrivedat 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 cant 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?
Isnt there just an unavoidable conflict in such an arrangement?
And didnt 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 firms 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 betweenagain, 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 modelis 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 industrys case.
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So as we look at conflicts of interest, compensation wont be off
limits.
Senator BAYH. Oh, it wont. Very good, because it seems to me,
again, you could have, lets 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 anybodys 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 thewe 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 foryou
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 useand 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, isnt 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 betweenI suppose there is because what happens with the rate of returnI
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 itand 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 Presidents 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 wouldand I quote them
herecontribute 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 Presidents 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 basedsome 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 meI 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 toyou
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 Moodys, 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 foundshouldnt 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;
oryou 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
thinkthis 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 thatit 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.
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 somethingin fact, he calls it
the gravest problem may be the staleness of the debt ratings. And
I guess the agenciesare 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 timesand I have talked to some
of themwell, 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 marketand a lot
of people believe they areour linchpin is broken right now as far
as confidence, trust in the financial markets. And I believe it is
going to bea 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.
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
issuewhich I will not raise with you right now becauseunless
Jack wanted to bring it up, but the whole notion of whether or
notI 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 addressas 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 dentists 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 612 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 Dodds 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 Globalthe 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 &
Poors; Claire Robinson, Senior Managing Director of Moodys 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 Moodys 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 Moodys, regardless of conflictthis 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 beenI 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 pricesall of
which tell you a lot. You rate a pile of mortgages3,000 mortgages
in this pileit is opaque, it is non-transparent. It is much more difficult to do, and it is done basically on a quantitative modela
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 themselvesand some of the Senators were making this point earlierbecause 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 othersand they knew it themselvessaw 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 wont
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 analystand
they are functionally similarsecurities analysts update their ratings on a quarterly basis. I would suggest there is a lot of harm
to the smaller institutional investorand 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 rat-
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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 & POORS
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 & Poors, 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 & Poors, 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 & Poors 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 & Poors may rate; working with other NRSROs to pro-
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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 SECs 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 Presidents
Working Group. We fully support the groups 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, MOODYS 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 Moodys 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 Moodys 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 individ-
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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, Moodys 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 Presidents 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.
Moodys 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.
Moodys 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 issuers agent that he or she covered while at Moodys.
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 todays 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 au-
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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.
Todays 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 todays 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.
Fitchs 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, ag-
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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 worlds 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.
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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
shouldI 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 ofI 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 paidthe rating agencies, the lawyers,
the trustee, et cetera. So I do not believe there is a link there between theI 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 problemand 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 believeI 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 ratingsand 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 securityyes, 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 thingI 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 exacerbatedin 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 Moodys Code of Professional
Conduct, and let me quote it. It says, Moodys 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 relyingtheir 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 relyingI mean, people are saying this isMoodys 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, Moodys told me so, Moodys 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 notI 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 meI do not want toI 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 Coffeeswhich
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 occurhere you hadthey 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 becomingI was stunned
as the new Chairman of this Committee to learn it had been 312
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 youit 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 cant 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 CurrencyI 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 notwere 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 thinkwere 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 Amendmentand 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 senseanyone 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 youyou 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
opinionthey 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 liabilityand 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 SECand 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, Moodys 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, Moodys 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 Moodys 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,
wouldnt you think, in the financial world, all the rating agencies,
or challenged deeply now? You wouldnt 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 Moodys tracks debt for more than 11,000 corporate
issuers, 26,000 public finance issuers, and 110,000 structured finance obligations110,000. How often does Moodys 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 SECs 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 didnt 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.
It is a new form of competition. But they are not going to get co-
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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
Coxs 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 seemI 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.
Chairman DODD. Just to make that pointI 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
firmthe 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
10 percent of these loans had no equity stake, no more than 10 per-
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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 wouldnt you have the rating agencywhy
hire a consultant? Why not just do it?
Mr. COFFEE. Becauseyou heard the numbersthere 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 backactually, 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 underwriters 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 issueand obviously
I think all of us are really puzzled to realize that there is just absolutely zero liability. You would have to performI 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 liabilityis 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 uponand 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 theyes, 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 atI 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. CifuentesI 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 muchCBOs of ABS, that is totally gone, and
we slowly see a recovery of CLOs, which are CDOs supported by
bank loans. So, broadly speaking, yes, the structured finance market, it is pretty paralyzed right now. I hope that is not forever, be-
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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 meI 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 regardingI work rating CDOs, so I am
not familiar with the process of mortgages as to howbut 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
Moodys 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 Moodys 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 its 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. Moodys
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 biggest 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 ratingsyou know, which to my knowledge, as I saidyou 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 arguments sake. And I am pretty sure
you will find them to be the case. If those are the facts, isnt some-
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thing wrong? Isnt 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 allI hear you say that you are listening.
I wonder whether you areyou 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 MBIAs rating from AAA to AA citing a
lack of capital. It also called MBIAs outlook negative. However,
S&P and Moodys both kept MBIAs ratings at the highest level.
Before Fitchs 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 uncertaintyit 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 instrumentsthese 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 & Poors 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 & Poors is we know that
when someone comes to Standard & Poors 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 & Poors 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 Moodys rating approach is and what Moodys 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, doesnt 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,
arent 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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141
RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD

FROM CHRISTOPHER COX
Q.1. ConflictsSeparate 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 Coffees 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 Commissions 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

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 dont 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 SECs 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 staffs 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 Moodys 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 Moodys, investors may still have to use S&P and Moodys 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 securitys 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, Moodys, 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
the symbology approach and whether it would be effective, particu-
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larly from a cost-benefit analysis, the Commission looks forward to
the publics 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
with the objective of having investors make an independent judg-
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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 SECs 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 Moodys
in their dominant market positions?
A.8.b. In the past, S&P and Moodys 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 Moodys. 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, Moodys, 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
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 doesnt 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 de-
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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 outlinedare 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
Bears 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. Shouldnt we be able to use the ratings as some sort of guide
about the overall health and the risk of a firms assets? Would you
say that in the case of Bear, the ratings failed? Even if this was
under extraordinary circumstances, shouldnt 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. Id 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 agencys 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
NRSROs current view of creditworthiness of the obligor or debt security.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING

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 agencys 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 Commissions 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? Wouldnt 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? Doesnt 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 meth-
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odologies than other NRSROs to determine ratings in order to increase market share.

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 10b5). 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 10b5 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 importantnot 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 auditorsdo 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 Moodys discovered a computer
error in some ratings on European offerings that resulted in ratings that were three levels too highand 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 Coxs 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.

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
availablein a central repositoryinformation 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 agencys 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 loansmortgage 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 Securi-
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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&Ps 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 & Poors/McGraw-Hill employees and free from the influence of the commercial relationships between Standard & Poors/
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.

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, Moodys, 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 & Poors
(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&Ps ratings.
We would support having each rating agency make available
in a central repositoryinformation about its performance history.
Investors can then judge that performance and determine for themselves the value, to them, of a particular rating agencys 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, Moodys has downgraded 53 per-
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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 notas a rulediscuss 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&Ps
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 se-
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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 & Poors 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&Ps 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 markets 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
deteriorationlooking, 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 believerecent
criticism notwithstandingthat 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&Ps 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&Ps cumulative
default rate by original rating class for all structured finance ratings has been as follows:
Initial rating
Percent of default
AAA .......................................................................................................................................................
AA .........................................................................................................................................................
A ...........................................................................................................................................................
BBB .......................................................................................................................................................
BB .........................................................................................................................................................
B ...........................................................................................................................................................
0.14
0.60
1.46
3.53
5.21
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 dont 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 issuers 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.

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 A1.
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 Bears 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
Bears 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 companys remaining CDO and subprime exposure
to be manageable. Nevertheless, we warned that additional
writedowns could further impair the companys future earnings
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performance, particularly in light of Bears 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 Bears 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 companys managed hedge funds would
have a negative impact on performance in the companys 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 Bears long-term
counterparty credit rating from A with negative outlook to BBB
and its short-term rating from A1 to A3. At the same time,
we placed the long- and short-term ratings on CreditWatch with
negative implications.
This rating action followed Bears announcement that its liquidity position had substantially deteriorated in the two days prior to
the rating action. The severe impairment of Bears 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
Bears 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 firms 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 weeks 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 Bears confidence crisis. We also
remained concerned about Bears 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
Bears 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 A3 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 Bears obligations
when the transaction closed. We stated that we would resolve the
CreditWatch placement when details about the integration of
Bears 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
Bears 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/A1+ 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 Bears counterparty obligations. We noted
that JPMC was also to assume Bears 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, Bears 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 Bears debt would be assumed by
JPMC, we believed that Bears creditors benefited from JPMCs
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 Bears
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 Bears long-term
counterparty credit rating from A with negative outlook to BBB
and its short-term rating from A1 to A3. At the same time,
we placed the long- and short-term ratings on CreditWatch with
Q.3. Were any of the ratings downgraded during the week of the
collapse (March 1014)?
A.3. As noted, on March 14, 2008, S&P downgraded Bears longterm counterparty credit rating from A with negative outlook to
BBB and its short-term rating from A1 to A3. We also
placed Bears long- and short-term ratings on CreditWatch with
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Q.4. Can you explain from your agencys point of view how Bears
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 Bears 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, Bears 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 banks 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 JPMCs announced acquisition.
We do not believe that S&Ps 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 Bears
risk?
A.6. As with all of our ratings, we downgraded Bears 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 Bears 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 Bears 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 improvementsincluding increasing
the frequency of our reviews of rated transactions and the amount
of resources dedicated to the processresponse 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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186

FROM CLAIRE ROBINSON
of securities?
A.1. Moodys 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.
is Moodys 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 Coffees 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 consequencesdue
primarily to ratings-based portfolio governance rules and rating
triggersthat 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,
Moodys 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: Moodys 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: Moodys 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, Moodys 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
concern?
A.3. Moodys 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, Moodys 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 [Moodys] derives from Issuers that
the Analyst rates or with which the Analyst regularly interacts.
2.12 [Moodys] 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 Moodys
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:
Moodys 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 Moodys 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 Moodys. 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 units 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 Moodys 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: Moodys has adopted a new policy related to employees
who leave Moodys to work for another market participant.
When we learn that an issuer or a financial intermediary representing the issuer has hired a Moodys employee who has
served as lead analyst for that issuer, we will now review the
analysts work related to the issuer and its securities over a
six-month look-back period to confirm the integrity and rigor
of that analysts 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
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 CRAs different
approaches to the same sectors or asset classes. A potential user
of an NRSROs credit ratings can decide for itself whether or not
the NRSROs methodology is more or less stringent than another
NRSROs methodologies and take this into account in deciding
whether to attach any weight to the NRSROs ratings. On the other
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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. Moodys 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.
10 Given their complex and mutable nature, structured finance products may not lend themselves to unsolicited ratings before that time.
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Ratings shopping would simply occur at an earlier point in
time.
Moodys 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 professionalsincluding lawyers,
MBAs, accountants and otherswho 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.
Moodys 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.
Moodys also has an extensive professional development and
training program that has been designed to enhance the quality of Moodys rating analysis and analysts understanding of
relevant policies and procedures, including those relating to
ethics. Moodys analysts are required to meet annual continuing education requirements by completing Moodys courses
or approved, external courses.
As part of the CRA industry initiative, we intend to incorporate into the Moodys 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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196

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 agencys (CRAs) ratings are suitable for
use in regulation.
For Moodys 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 Moodys
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. Moodys 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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not being perfectly comparable. For example, Moodys 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 Moodys 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.
A.2. At Moodys, 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 Moodys
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 Moodys Analytics.1
We have provided in this packet the Moodys Investors Service
Code of Professional Conduct (Moodys 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 [Moodys] Analyst and rating committee, in a manner generally consistent with [Moodys] published methodologies. In formulating Credit Ratings,
[Moodys] will employ Analysts who, individually or collectively, have appropriate knowledge and experience in developing a rating opinion for the type of credit being analyzed.
1 Moodys Analytics is a subsidiary of our corporate parent, Moodys Corporation. It is legally
and operationally separate from Moodys Investors Service, the rating agency, and is a provider
of research, data, analytic tools and related services that are distinct from credit ratings.
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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 Moodys 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
Moodys 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. Moodys Code of Professional Conduct
Provision 1.7 states:
1.7 [Moodys] 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, [Moodys] 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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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 positionedgiven their expertise and
resourcesto 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;
2 For more information, please see the enclosed Moodys Proposed Enhancements to U.S. Residential Mortgage Securitizations: Call for Comments.
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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.
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 practicesincluding lenient
lending practices by mortgage originators and misrepresentations
by certain mortgage brokers, appraisers and some borrowers themselvesas 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 Coxs testimony, Moodys 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. Moodys is committed to providing the most accurate, objective
and independent credit assessments available in the global credit
markets. As in any company, Moodys 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. Moodys does make disciplinary decisions, including employment termination decisions, based on poor performance in a job
function. Moodys 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 Moodys. Under the Credit Rating Agency Reform Act of 2006 (Reform Act) and related rules the SEC is entitled to inspect Moodys books and records, including those relating
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to Moodys compliance function, credit policy function and human

resources function. Moodys 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 Moodys 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
A.5. Yes. Beginning in 2003, Moodys 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, Moodys 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
3 Please 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.
4 Please see Early Defaults Rise in Mortgage Securitization, Moodys 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.
5 Please see Annex II.
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Moodys 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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and rated by Moodys 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.
203
(1) 2003 Review and 2004 Outlook: Home Equity ABS (January
20, 2004);
Moodys 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)
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)
Moodys increases credit enhancement on such loans to account for the lower borrower equity and the higher borrower
leverage (page 6)
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)
Moodys loss expectations on the interest-only mortgages are
about 15%-25% higher than that of fully amortizing mortgages. (Page 6)
In Moodys 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)
Moodys 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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A.6. When endeavoring to attract new customers for our credit rating services, Moodys seeks to distinguish our rating services from
those of other CRAs on the basis of a number of factors, including
the following:
Moodys 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 Moodys analysts to access and use the research,
data and analytic tools produced by Moodys Analytics, an
operationally and legally separate business unit within
Moodys Corporation.
Moodys 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 Moodys and independent
third parties. We would refer you to our Guide to Default Research,
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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, Moodys 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. Moodys 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 Moodys does not target specific default or loss rates for its ratings.6 That is to say, Moodys credit rating scale does not measure
6 Moodys 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 Moodys
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 Moodys 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
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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 Moodys 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.
Moodys 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, Moodys does not manage its
ratings to achieve cardinal accuracy or to maintain constant default rates by rating category.
Doing so would require Moodys 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.
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208
have leverage over the rating agencies. If they dont like the ratings they get from one agency, they can go to another with lower
standards.
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, Moodys reputation and long-term success are critically
dependent on the markets 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
Moodys Code and our annual reports on implementation of the
Moodys 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 Moodys
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 Moodys 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.
7 We make these documents publicly available on the Regulatory Affairs webpage at
moodys.com and have included them in Annex III to this response.
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As noted above, Moodys long-term success is critically dependent

on the markets confidence in our ethics, objectivity and credit judgments.
Q.9. Ms. Robinson, in your written testimony you stated that
Moodys tracks debt for more than 11,000 corporate issuers, 26,000
public finance issuers, and 110,000 structured finance obligations.
How often does Moodys review and, if necessary, update each
rating?
A.9. The frequency with which Moodys 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, Moodys 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 Moodys
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
8 See Moodys 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, Moodys 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.
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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 Moodys 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 Moodys has assigned a stable outlook.
Q.9.a. Does Moodys 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 issuers
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.

March 2008.
A.1.
November 14, 2007: Moodys 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 Bears 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 fol-
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lowed weak third quarter 2007 earnings. Moodys stated in its
rating action that it expected that on a go-forward basis,
Bears exposure to these specific assets would pose only modest
downside risk but that during its review Moodys would evaluate Bears firm-wide exposures and valuations in other asset
classes. Moodys also expressed the opinion that Bears 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: Moodys 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, Bears elevated risk appetite at the time, and Moodys
ongoing concern regarding Bears corporate governance, including board oversight of managements strategic risk decisions
and leadership succession planning. The A2 rating and stable
outlook factored in Moodys expectations at that time for the
future risk of loss posed by Bears net exposures, as well as
Moodys expectations for a reduced, but acceptable, level of operating profitability in 2008. Moodys also indicated that Bears
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: Moodys lowered the long-term senior debt
rating of Bear two notches to Baa1 from A2 and its short-term
ratings to Prime2 from Prime1, and placed the companys
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 Moodys opinion that Bears 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, Moodys stated that it would
re-address its ratings within 710 days. Importantly, Moodys indicated that Bear had a number of attractive franchises that could
facilitate a strategic solution.
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On March 17, 2008: Moodys placed Bears 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: Moodys announced it was continuing its review for possible upgrade of Bears 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: Moodys 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: Moodys 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 Prime2 from Prime1
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
A.1.b. Yes. Please see our response to the above question. On
March 14, 2008, Moodys lowered Bears 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 Bears franchise had been hurt by the liquidity crisis and would continue to erode if a long-term, stabilizing
solution was not quickly achieved. Moodys also noted that Bear
had a number of attractive franchises that could facilitate a strategic solutionwhich is what ultimately occurred.
Q.1.c. Can you explain from your agencys point of view how Bears
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 po-
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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, Moodys 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, Moodys analysts were actively reviewing Bears evolving liquidity position on a daily basis
throughout the week.
It is our understanding that Bears 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 Bears financial
and operating flexibility. Prime brokerage clients pulled cash and
investment balances out of the firm, haircut requirements rose on
Bears short-term collateralized funding and an increasing amount
of short-term collateralized funding failed to roll at maturity. As a
result, Bears 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 Bears longterm senior unsecured debt ratings from A2 to Baa1 and shortterm debt ratings from Prime1 to Prime2 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 Bears franchise had been hurt by the liquidity crisis and would continue to erode if a long-term, stabilizing solution
was not quickly achieved. Moodys also noted that Bear had a number of attractive franchises that could facilitate a strategic solutionwhich 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. Moodys 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 companys equity suffered a dramatic loss in value as a result of this
crisis, Moodys maintained our credit rating on Bears debt at investment grade, in part because Bear had a number of attractive
franchises that could facilitate a strategic solutionwhich is what
ultimately occurred. As noted earlier, Moodys ratings speak to
whether a debt investor who holds the securities to maturity will
be made whole, and not whether a companys equity will retain its
value.
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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
Bears 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 Bearor any other securities
firmwould 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. Bears 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 Bears liquidity difficulties.
Q.1.e. Under ideal circumstances, would you agree that the ratings
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
A.1.f. Moodys 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, Moodys 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
9 Specifically,
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and stable. They want ratings to reflect enduring changes in credit
risk because rating changes have real consequencesdue 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. Moodys 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. Moodys 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).
Moodys 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
Moodys 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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FROM STEPHEN W. JOYNT
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, Moodys and Standard & Poors) 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 loansmortgage 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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Fitchs 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 SECs
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 IOSCOs 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.
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 eventsno process could realistically
assure thisbut 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 Fitchs 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
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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agreement with the SECs 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
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.
1 Paragraph 165 of CESRs 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.
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Membership of such an organization would also have to be voluntaryit 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

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, Moodys and Standard &
Poors) 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.
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.,
of individual loans within a consumer loan portfolio). This also represents an opportunity for Fitch to resolve any outstanding ques-
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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.
Fitchs 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 SECs
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 IOSCOs 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.
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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 Fitchs 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 Coxs testimony, Moodys 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
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.
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 Fitchs
case, has resulted in investorsvoluntarily and at their own initiativeincorporating Fitch in their investment guidelines over the
past five years, on an equal footing with the two larger agencies.
This greater recognitionbased on the quality of our work and not
the level of our ratingshas 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 ratingsthat is, ratings are a relative ranking, rather than a specific percentage predictionFitch
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.
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.
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 banks 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 Moodys and
S&P across all products and market segments. We believe that one
of the Proposed Rulesrequiring the public disclosure of the information a rating agency uses to determine a rating on a structured
productwould 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 informationi.e., originators, arrangers and issuersrather 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 Moodys?
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 Moodys and
S&P across all products and market segments. We believe that one
of the Proposed Rulesrequiring the public disclosure of the information a rating agency uses to determine a rating on a structured
productwould 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 informationi.e., originators, arrangers and issuersrather than the receivers of the information.

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
Can you explain from your agencys point of view how Bears
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
risk?
What lessons do you think we should take from the Bear
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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 Fitchs 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
firms 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 Fitchs view that Bear Stearns near term profitability
was expected to be weak, pressured by its exposure to the U.S.
mortgage market as a whole. Its global clearing and equities busi-
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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 1013, 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 firms 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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240

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 nave 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 Moodys 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 Moodys 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 dont 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 Moodys
and S&P have.
Q.3. Would this disclosure also make rating agencies more accountable to investors?
A.3. I dont 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, MOODYS OPENED UP

The Wall Street Journal, Friday, April 11, 2008
By AARON LUCCHETTI
Bond-rating agency Moodys 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, Moodys was
a small player in analyzing complex securities based on home mortgages. Then,
Moodys 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, Moodys 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, Moodys and the other two major rating firms, the Standard & Poors 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.
Moodys 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, Moodys underwent the deepest cultural change
amid the housing boom. At the heart of the firms 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 Moodys friendlier to Wall Street was what the company needed early this decade. Were in a service business, he says. I dont apologize for that.
When Mr. Clarkson first joined Moodys, the agency was known as a place where
analysts often didnt 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 Moodys.
Mr. Clarkson himself had dealt with Moodys 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 Moodys are hired by companies, governments and other organizations that seek to sell bonds. The firms rate
bonds based on the likelihood theyll default and, in Moodys 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: Theyre the ones paying the bill. Moodys toughness gave issuers reason
to go elsewhere, and back in the mid-1990s, Fitch and S&P were both rating more
mortgage bonds than Moodys, in large part because their standards were considered
easier. For instance, in commercial mortgage-backed securities, Moodys trailed its
two main competitors by 30 percentage points in market coverage in 1996.
That year, Mr. Clarkson took over the group at Moodys that analyzed such securities. The firm added new analysts and overhauled its ratings approach, allowing
for higher ratings in the area. Within a year, Moodys moved ahead of both Fitch
and S&P in the sector. Rivals said Moodys 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 firms structured finance business that oversaw bonds and complex securities based on home mortgages. Moodys
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.)
Moodys 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, Moodys 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
isnt critical of Mr. Clarksons management. Mr. Clarkson is what Moodys needs,
Mr. Adelson says. Hes very smart, capable and driven.
By 2001, Moodys 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 Moodys business and had his Berkshire Hathaway Inc. raise its stake in
D&B. Berkshire is now Moodys biggest shareholder, with a 19 percent interest. In
some areas, Moodys continued to make it hard to get a high rating, with the result
that it didnt 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 Moodys methodologies. Customer-service coaches gave sessions on improving relationships with bond
issuers and investors.
Brian (Clarkson) created a dialogue between Moodys and the Street that was
good, says Paul Stevenson, a former Moodys 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 Moodys voted to require that the issuer put about 4.25 percent of the deals 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, Moodys 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 Moodys managing director who was then co-head of mortgagebacked securities, says she doesnt recall the deal. She says Moodys reconsidered
its view on deals when issuers presented new information affecting credit quality.
She adds that Moodys mortgage ratings at the time held up well.
In 2002, Mr. Clarksons 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. Moodys was already rating 90 percent of the
dollar value of CDOs. Mr. Clarkson told an analyst he didnt 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 Moodys 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 Moodys
raised on deals. I have no problem losing deals for the right reasons, he says. We
dont change methodology to garner market share.
Some supporters say that while Mr. Clarkson cared about market share, he cared
more about the quality of Moodys ratings. Bill May, a Moodys 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, Moodys 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 famil-
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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, Moodys president from 1989 to 1996, says he used to tell recruits that
Moodys was a special business where you cant go out for beers with friends who
worked for investment banks.
Mr. Clarksons view is that its 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 Moodys sought to rate more deals for GMACs residential-finance unit in
the late 1990s, Moodys officials traveled to the companys Minneapolis offices several times. Mr. Clarkson and several others from Moodys 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 Moodys had just rated. Moodys 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 Moodys 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 Moodys executives entertained by wrestling in fat suits.
Mr. Clarksons structured-finance group grew to account for about 43 percent of
Moodys 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 Moodys surging share price and their stock options. According to a regulatory filing, Mr. Clarksons compensation totaled $3.8 million in
2006. The firms chief executive, Raymond McDaniel, earned $8.2 million that year,
more than twice what his predecessor made in 2000. Moodys 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 Moodys 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, Moodys 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. Moodys says
some bonds it rated were backed by fraudulent loans. It also notes that it wasnt
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 Moodys 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 Moodys 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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Senate Hearing, 110TH Congress - Turmoil in U.S. Credit Markets: The Role of Credit Rating Agencies

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TURMOIL IN U.S. CREDIT MARKETS: THE ROLE

TUESDAY, APRIL 22, 2008

tjames on DSKG8SOYB1PROD with HEARING

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03:01 Mar 20, 2010

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

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SHAWN MAHER, Staff Director

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

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ADDITIONAL MATERIAL SUPPLIED

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Aaron Lucchetti, The Wall Street Journal, As housing boomed, Moodys

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TURMOIL IN U.S. CREDIT MARKETS: THE

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OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

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

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OPENING STATEMENT OF SENATOR RICHARD C. SHELBY

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

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OPENING STATEMENT OF SENATOR ROBERT MENENDEZ

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

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STATEMENT OF SENATOR WAYNE ALLARD

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STATEMENT OF SENATOR CHARLES E. SCHUMER

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

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OPENING STATEMENT OF SENATOR JON TESTER

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