Rating the Raters: Enron
and the Credit Rating Agencies
Committee on Governmental Affairs
Chairman Joe Lieberman
March 20, 2002
Good morning. I’d like to welcome everyone
today to the fourth in a series of Governmental Affairs
Committee hearings on the collapse of Enron and the
implications for Enron employees, investors, and the American
economy as a whole. We are engaged in an ongoing investigation
into whether the private and public watchdogs did all they
could have done to prevent or, at least, anticipate and warn
the rest of us of Enron’s collapse. Today, we will take a
look at the private-sector credit-rating agencies that wield
immense, quasi-governmental power to determine which companies
within the corporate world are creditworthy and which are not.
In pursuit of our purpose here, which is to learn the lessons
of Enron and craft solutions to avoid future calamities of
this sort, we will ask why the credit raters continued to rate
Enron as a good credit risk, right up until four days before
it declared bankruptcy.
Simply put, a credit rating is an assessment
of a company’s credit worthiness or its likelihood of
repaying its debt. The entire corporate credit-rating industry
consists of just three agencies - Moody’s Investors Service,
Standard & Poor’s, and Fitch Ratings - three agencies
that exercise significant power over corporate America, the
markets, and, therefore, over our entire economy. They are
private companies, but the enormous scope of their influence
comes largely as a result of their government-conferred power.
John Moody, the founder of what is now Moody’s
Investors Service, is recognized for devising credit ratings
in 1908 for public debt issues, mostly railroad bond issues.
Moody’s credit ratings, first published in 1909, met a need
for accurate, impartial, and independent information.
Now, almost a century later, an
"investment grade" credit rating has become an
absolute necessity for any company that wants to tap the
resources of the capital markets. The credit raters hold the
key to capital and liquidity, the lifeblood of corporate
America and of our capitalist economy. The rating affects a
company’s ability to borrow money; it affects whether a
pension fund or a money market fund can invest in a company’s
bonds; and it affects stock price. The difference between a
good rating and a poor rating can be the difference between
success and failure, prosperity and bad fortune.
The government - through hundreds of laws
and regulations - requires corporate bonds to be rated if they’re
to be considered appropriate investments for many
institutional investors - and, by the way, 95% of corporate
bonds are held by institutional investors. Most of these laws
and regulations involve banks and securities. But their reach
also extends into education, where schools must be rated in
order to participate in certain financial assistance programs,
and into transportation, where a highway project might need a
rating to qualify for federal funding, and into
telecommunications, where companies must be rated in order to
receive federal loan guarantees.
Along with this power, comes special access
and special protections. The credit raters, for example, are
allowed to look at a company’s inside information when
making assessments and they are exempted from liability when
they participate in securities offerings - two benefits that
give them more information than other analysts working within
the system.
Someone once said that raters hold
"almost biblical authority." On a NewsHour with Jim
Lehrer program in 1996, New York Times columnist Tom
Friedman went so far as to say - and I quote - "there
are two superpowers in the world... the United
States and Moody’s Bond Rating Service... and believe me, it’s
not clear sometimes who is more powerful."
With so much power, access, and protection,
it is not surprising that profitability follows close behind.
Not all the agencies’ books are open for inspection because
they’re subsidiaries of larger corporations. But Moody’s
was spun off into a separate company a few years ago, and is
worth $6.2 billion. Moody’s $40 stock price is almost 50
percent higher today than what it was trading at last year.
It seems reasonable to me that power of this
magnitude should go hand in hand with some accountability. And
yet, once the SEC anoints the credit-rating, they are left
alone. So, I think it’s appropriate, as we try to learn the
lessons of Enron, to ask if the agencies should have some
sense of accountability, some oversight, from the SEC perhaps,
to ensure they properly perform their function as watchdogs.
In the Enron case, I would have to conclude,
that the credit raters appear to have been no more
knowledgeable about the company’s problems than anyone else
who was following the its fortunes in the newspapers. Let’s
look at the events leading up to the raters’ decisions to
withdraw their assessment of Enron as a good credit risk.
After a summer during which Enron stock steadily declined, it
was reported on October 22 last year that the SEC asked the
company to disclose its ties to outside investment
partnerships set up by the company's chief financial officer.
Enron's stock dropped 20 percent that day to a closing price
of $20.65 per share. On October 24, the CFO, Andrew Fastow,
resigned, and the stock dipped to $16.41.
Five days later, on October 29, Standard and
Poor's credit rating analyst appeared on CNN. By this time,
the agencies had put Enron on a "credit watch," but
the company was still considered a good risk. The Standard and
Poor’s analyst predicted that - and I quote here --
"Enron's ability to retain something like the rating that
they're at today is excellent in the long term." End of
quote. When asked about the off-balance sheet partnerships,
the analyst assured investors that there would be no long term
implications. "That's something that's really in the
past," he said.
Now, let me take you back a moment to our
last hearing on Enron, when a Wall Street analyst testified
that his "buy" recommendation was supported by the
confidence expressed by the credit rating agencies - which, he
specifically pointed out, had access to inside information
about Enron’s liabilities that he didn’t have. So, S&P’s
confidence had an effect on others. On November 2, the S&P
analyst once again expressed his strong belief that Enron's
off-balance sheet problems were nothing to worry about. The
analyst said S&P had - quote - "a great deal of
confidence there are no more surprises to come... I think it’s
going to take a little bit more time before everybody can get
fully comfortable that there's not something else lurking out
there." End of quote.
We now know the market was not convinced.
The stock price continued its descent, dropping to $8.41 on
November 8, when Enron disclosed it had overstated earnings by
over half a billion dollars since 1997. Still, the rating
agencies kept Enron at "investment grade." By
November 28, the day Moody's and Standard & Poor's
downgraded Enron to junk bond status, the company's stock was
trading at just over a dollar. Four days later, of course, it
went into bankruptcy. In other words, the credit raters -
despite their unique position to obtain information
unavailable to other analysts - were no more astute and no
quicker to act than others.
The agencies defend their ratings as
"opinions," protected by the First Amendment. They
refer to their assessments as "the world’s shortest
editorials," but, in fact, their endorsements are
required by law.
The mounting problems inside Enron’s
executive suites were missed by many people. None of the
watchdogs barked, including the credit rating agencies, who
had greater access to Enron’s books. The fundamental
question today is why did that happen and what can we do
together to make sure the authority the credit rating agencies
have is used as actively as possible to protect and defend our
capital markets, let alone the average investors and the
institutional investors. Thank you. |