Hearing
Committee Holds Hearing on “Credit Rating Agencies and the Financial Crisis”
October 22, 2008
Statement of Rep.
Ranking Republican Member
Committee on Oversight and Government Reform
“Credit Rating Agencies and the Financial Crisis”
Like the “UL Approved” tag on electric appliances, a triple-A credit rating is meant to insulate investors against nasty shocks. But as the collapse of the mortgage-backed securities boom has seen billions in once high-grade investments fall quickly to junk status, many are asking how and why the Nationally Recognized Statistical Rating Organizations (NRSRO) – credit rating agencies – got it so wrong. We agree with Chairman Waxman, these critical questions warrant the Committee’s attention as we attempt to untangle the causes and effects of the current crisis.
We were also pleased to learn the Chairman has finally agreed to schedule a hearing on the Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac, their 2005 plunge into the deep end of the subprime lending pool, and the resulting shock waves still causing such turbulence in housing markets and the broader economy. It’s disappointing those issues won’t be addressed before November. With our financial house afire, we seem more interested in studying accelerants than asking who lit the match.
Clearly, credit rating agencies did enable and accelerate use of the unique, complex and vaguely understood financial instruments now polluting vital capital streams. As purportedly impartial arbiters of credit worthiness and risk, the raters play a key role in sustaining trust and stability in national and global financial markets. So we need to understand how they got swept up in the mass delusion of ever-increasing housing prices and best-case risk scenarios. And we need to ask why they literally bought into the game of packaging opaque, risky investment vehicles to look like clear winners.
The analysis and pricing of complex mortgage-backed instruments, collateralized debt obligations and other esoteric products demanded transparency and objectivity. Both appear to have been lacking.
Transparency was thwarted by the use of antiquated or inadequate analytical tools that could not see below the surface of intricately structured, multi-tiered investment pools. A lack of due diligence in looking behind the data provided by applicants validated the “Garbage In/Garbage Out” axiom. Statistical models told the raters what had happened in a simpler age, not what would happen when vastly more sophisticated algorithms triggered automated trading and tectonic market shifts.
And key data that would help investors understand the prospects and risks of individual products, or classes of investments, was not readily available. For the most part, it remains locked in impenetrable piles of paper reports. Efforts to standardize and digitize critical disclosure elements, including use of XBRL, or Extensible Business Reporting Language, are only beginning to shed some light into the murky world of securitization.
And the objectivity of credit ratings was compromised by turning a blind eye to apparent conflicts of interest on the part of raters being paid by those being rated. The explosion of new investment schemes, and “rating shopping” by issuers, produced irresistible pressures to take the business before another agency did. It was a lucrative race to the bottom, and no one can be sure we’ve found it yet.
The Securities and Exchange Commission, which only in late 2007 required registration of qualified credit rating agencies, has proposed regulations to increase disclosures about structured finance products, track rating agency performance more carefully, require more information about rating methodologies, and weed out conflicts of interest. We look to our witnesses today to help us evaluate those proposals and suggest additional steps to restore confidence in the admittedly subjective business of rating credit worthiness and investment risk.
