Former Moody's analysts say they felt pressure from bosses obsessed with market share to assign rosy ratings to risky debt products, while the company's current chief executive defended the rating agency's business model, according to testimony released on Wednesday.
Three former officials at Moody's Corp described an atmosphere of intimidation and fear, according to prepared comments to the Financial Crisis Inquiry Commission, which is holding a hearing in New York featuring Moody's Chief Executive Raymond McDaniel and legendary investor Warren Buffett.
Buffett, whose company Berkshire Hathaway Inc is one of Moody's largest investors, did not provide written testimony in advance.
Appointed by Congress to uncover the causes of the 2008 financial crisis, the panel is examining credit ratings and how investors use them. It is expected to issue its findings on what caused the crisis by December 15.
In his prepared comments, former derivatives unit vice president Mark Froeba said management's compulsion to boost market share made it clear that investment bankers effectively controlled analysts, encouraging analysts to award high ratings for debt that deserved worse.
Essentially, they used intimidation to create a docile population of analysts afraid to upset investment bankers and ready to cooperate to the maximum extent possible, said Froeba, who left Moody's after 10 years in 2007.
McDaniel defended the model of having issuers pay for ratings, which critics call a recipe for slanted ratings. The chief executive in testimony sought to clarify that ratings agencies are not 'gatekeepers' and they cannot stop securities from being issued or purchased.
Markets can and do grow without ratings, he said, citing credit default swaps as an example.
Moody's, McGraw-Hill Cos ' Standard & Poor's and Fimalac SA's Fitch Ratings are widely criticized for fueling the crisis by assigning unreasonably high ratings for too long, and then downgrading them too fast. Many subprime and other risky securities lost all or much of their value.
Buffett's testimony remains a mystery, especially given that he has long taken seemingly opposite sides of the argument in justifying his attitude toward 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 the marketing of securities by Goldman Sachs Group Inc that led to a U.S. Securities and Exchange Commission civil fraud lawsuit against the Wall Street bank in April.
McDaniel got support from Brian Clarkson, a former president of Moody's Investors Service widely 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 suggested that the commission look to Wall Street itself, not the rating agencies, as a target for reform.
Unlike most financial professionals responsible for selling investment products, 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.
Froeba, the former derivatives vice president, described Clarkson as gleefully threatening analysts with termination if they did not keep investment bankers mollified.
It is important to point out that Brian was not a rogue manager running amok while Moody's Board and CEO/President were deceived about his conduct, Froeba said.
Eric Kolchinsky, who was in charge of the Moody's unit that rated subprime collateralized debt obligations and has become a whistleblower against Moody's alleged faults, said the culture changed in 2007 after managers began taking a significant part of their pay in stock and options.
As he has in past testimony to Congress, Kolchinsky described a culture obsessed with market share. While there was never any explicit directive to lower credit standards, every missed deal had to be explained and defended, he said.
Moody's in April handed over documents to panel chairman Phil Angelides 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; Editing by Tim Dobbyn)