Some former officials at Moody's said they felt intimidation from bosses to assign rosy ratings to risky debt products, according to testimony to a government panel probing the causes of the financial crisis.
It was very clear to me that my future at the firm and my compensation would be based on the market share, said Eric Kolchinsky, who once ran the Moody's Investors Service unit that rated subprime collateralized debt obligations and is now a whistleblower on Moody's alleged faults.
Wednesday's hearing by The Financial Crisis Inquiry Commission is examining the role of credit rating agencies in the financial crisis, and investors' reliance on ratings themselves to make investment decisions.
Moody's Corp, McGraw-Hill Cos' Standard & Poor's and Fimalac SA's Fitch Ratings have been widely faulted for fueling the crisis by assigning unreasonably high ratings for too long, and then downgrading them too fast.
Warren Buffett, whose company Berkshire Hathaway Inc is one of Moody's largest investors, is testifying later Wednesday under subpoena after initially resisting commission invitations.
Phil Angelides, who chairs the panel, opened Wednesday's hearing by criticizing Moody's for bestowing thousands of high ratings on risky debt that later became unhinged.
To be blunt, the picture is not pretty, Angelides said. He called Moody's a 'triple-A' factory that expanded rapidly in structured finance, causing its stock to rise more than sixfold from 2000 to 2007. Investors who relied on Moody's ratings did not fare so well, he said.
The panel led by Angelides, a former California treasurer, has held several hearings featuring top finance officials including Goldman Sachs Group Inc Chief Executive Lloyd Blankfein. It is expected to issue its findings on what caused the crisis by December 15.
Buffett's testimony is of key interest, since he has long taken seemingly opposite sides of the argument in justifying his attitude toward rating agencies.
He has said he loves the business model, given that rating agencies have little competition and need virtually no capital, and get paid for ratings that issues must have. Yet he has said investors, like himself, should do their own credit homework and not depend on rating agencies to do it for them.
Buffett has used a similar argument to defend Goldman's marketing of securities that led to a U.S. Securities and Exchange Commission civil fraud lawsuit against the Wall Street bank in April.
Numerous congressional hearings have previously exposed the shortcomings of the rating agencies but the crisis commission hearing could add momentum to more fundamental changes to the industry's business model.
Next week congressional negotiators will attempt to reconcile House and Senate versions of financial reform legislation.
One proposal by Senator Al Franken, a Minnesota Democrat, would create a panel to match issuers with rating agencies on a semi-random basis, in an effort to foster competition.
Moody's Chief Executive Raymond McDaniel defended the company's business model of having issuers pay for ratings. He also sought to clarify that rating agencies are not gatekeepers that can stop securities from being issued.
Markets can and do grow without ratings, McDaniel said in prepared comments, citing the market for credit default swaps.
Jay Siegel, another former Moody's managing director, told the commission that while market share was important, analysts did not need to meet a hard and fast number in generating business.
Kolchinsky said the pressure was more extreme.
Asked by Angelides whether pressure to keep up with large volumes of business was like the scene from the I Love Lucy television show, where Lucy Ricardo struggles to package chocolates speeding down a conveyor belt, he answered, Oh yes, all the time.
Meanwhile, in his prepared comments, former Moody's derivatives vice president Mark Froeba said management used intimidation to create a docile population of analysts afraid to upset investment bankers and ready to cooperate to the maximum extent possible.
But McDaniel got support from Brian Clarkson, a former Moody's president credited with the agency's expansion in structured finance before he unexpectedly left the company in 2008.
Calling the integrity of Moody's analysts beyond dispute, Clarkson in his written testimony suggested that the commission look to Wall Street itself as a target for reform.
Mortgage brokers and underwriters are not required to register with any federal regulatory authority, he said. Uniform and meaningful standards for brokers and underwriters are something for this commission to consider.
Moody's in April handed over documents to the crisis commission in response to a subpoena. A month earlier, it had received a Wells notice indicating possible SEC civil charges, after it had failed to downgrade some European debt after learning a computer glitch caused inflated ratings.
McDaniel exercised some stock options the day the Wells notice was received, which the company has said resulted from participation in a prearranged plan. Berkshire also sold some Moody's stock shortly after the Wells notice was received.
(Reporting by Elinor Comlay, Kim Dixon and Jonathan Stempel; Additional reporting by Karey Wutkowski; Editing by Tim Dobbyn)