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Do IT this week: Layering
Company purges executives who warned service was risking its reputation
By Kevin G. Hall
McClatchy Newspapers
Published on Sunday, Oct 18, 2009
WASHINGTON: As the housing market collapsed in late 2007, Moody's Investors Service, whose investment ratings were widely trusted, responded by purging analysts and executives who warned of trouble and promoting those who helped Wall Street plunge the country into its worst financial crisis since the Great Depression.
A McClatchy Newspapers investigation has found that Moody's punished executives who questioned why the company was risking its reputation by putting its profits ahead of providing trustworthy ratings for investment offerings.
Instead, Moody's promoted executives who headed its ''structured finance'' division, which assisted Wall Street in packaging loans into securities for sale to investors. It also stacked its compliance department with the people who awarded the highest ratings to pools of mortgages that soon were downgraded to junk. Such products have another name Please see Moody's, A8
Continued from Page A1
now: ''toxic assets.''
As Congress tackles the broadest proposed overhaul of financial regulation since the 1930s, however, lawmakers still aren't fully aware of what went wrong at the bond rating agencies, and so they may fail to address misaligned incentives such as granting stock options to mid-level employees, which can promote positive ratings rather than honest ones.
The Securities and Exchange Commission reported that profit motives had undermined the integrity of ratings at Moody's and its main competitors, Fitch Ratings and Standard & Poor's, in July 2008, but the full extent of Moody's internal strife never has been publicly revealed.
Moody's, which rates McClatchy's debt and assigns it quite low value, disputes every allegation against it. ''Moody's has rigorous standards in place to protect the integrity of ratings from commercial considerations,'' Michael Adler, Moody's vice president for corporate communications, said in an e-mail response to McClatchy.
But insiders say that wasn't true before the financial meltdown.
''The story at Moody's doesn't start in 2007; it starts in 2000,'' said Mark Froeba, a Harvard-educated lawyer and senior vice president who joined Moody's structured finance group in 1997.
''This was a systematic and aggressive strategy to replace a culture that was very conservative, an accuracy-and-quality-oriented [culture], a getting-the-rating-right kind of culture, with a culture that was supposed to be 'business-friendly,' but was consistently less likely to assign a rating that was tougher than our competitors,'' Froeba said.
Critics 'downsized'
After Froeba and others raised concerns that the methodology Moody's was using to rate investment offerings allowed the firm's profit interests to trump honest ratings, he and nine other outspoken critics in his group were ''downsized'' in December 2007.
''As a matter of policy, Moody's does not comment on personnel matters, but no employee has ever been let go for trying to strengthen our compliance function,'' Adler said.
Moody's was spun off from Dun & Bradstreet in 2000, and the first company shares began trading on Oct. 31 that year at $12.57. Executives set out to erase a conservative corporate culture.
To promote competition, in the 1970s ratings agencies were allowed to switch from having investors pay for ratings to having the issuers of debt pay for them. That led the ratings agencies to compete for business by currying favor with investment banks that would pay handsomely for the ratings they wanted.
Wall Street paid as much as $1 million for some ratings, and ratings agency profits soared. This new revenue stream swamped earnings from ordinary ratings.
''In 2001, Moody's had revenues of $800.7 million; in 2005, they were up to $1.73 billion; and in 2006, $2.037 billion. The exploding profits were fees from packaging . . . and for granting the top-class AAA ratings, which were supposed to mean they were as safe as U.S. government securities,'' Lawrence McDonald said in his recent book, A Colossal Failure of Common Sense.
He's a former vice president at now defunct Lehman Brothers, one of the high-flying investment banks that helped create the global economic crisis.
From late 2006 through early last year, however, the housing market unraveled, poisoning first mortgage finance, then global finance. More than 60 percent of the bonds backed by mortgages have had their ratings downgraded.
''How on Earth could a bond issue be AAA one day and junk the next unless something spectacularly stupid has taken place? But maybe it was something spectacularly dishonest, like taking that colossal amount of fees in return for doing what Lehman and the rest wanted,'' McDonald wrote.
Ratings agencies thrive
Ratings agencies thrived on the profits that came from giving the investment banks what they wanted, and investors worldwide gorged themselves on bonds backed by U.S. car loans, credit-card debt, student loans and, especially, mortgages.
Before granting AAA ratings to bonds that pension funds, university endowments and other institutional investors trusted, the ratings agencies didn't bother to scrutinize the loans that were being pooled into the bonds. Instead, they relied on malleable mathematical models that proved worthless.
''This system will not get fixed until someone credible does the necessary due diligence,'' said John Coffee, a finance expert at Columbia University.
One Moody's executive who soared through the ranks during the boom years was Brian Clarkson, the guru of structured finance. He was promoted to company president just as the bottom fell out of the housing market.
Several former Moody's executives said he made subordinates fear they'd be fired if they didn't issue ratings that matched competitors' and helped preserve Moody's market share.
Froeba said his Moody's team manager would tell his team that he, the manager, would be fired if Moody's lost a single deal. ''If your manager is saying that at meetings, what is he trying to tell you?'' Froeba asked.
When Moody's went public in 2000, midlevel executives were given stock options. That gave them an incentive to consider not just the accuracy of their ratings, but also the effect they'd have on Moody's — and their own — bottom line.
Clarkson's net worth was tied up in Moody's market share. By the time he was pushed out in May 2008, his compensation approached $3 million a year.
''The CEO is from a structured finance background, most of the people in the leadership were from a structured finance background, and it was putting their people in the right places,'' said Eric Kolchinsky, a managing director in Moody's structured finance division from January to November 2007, when he was purged, he said, for questioning some of the ratings. ''If they were serious about compliance, they wouldn't have done that, because it isn't about having friends in the right places, but doing the right job.''
Adler, the Moody's spokesman, said that compensation for Moody's analysts and senior managers ''is not linked to the financial performance of their business unit.''
Clarkson couldn't be reached to comment.
WASHINGTON: As the housing market collapsed in late 2007, Moody's Investors Service, whose investment ratings were widely trusted, responded by purging analysts and executives who warned of trouble and promoting those who helped Wall Street plunge the country into its worst financial crisis since the Great Depression.
Get the full article here.
Comments
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Akron, OH
Posted 04:38 AM, 10/18/2009
Not surprised, considering the type of people who typically run Wall Street, etc. firms.
akron, oh
Posted 08:20 AM, 10/18/2009
All this means to me is that Akron's ratings are now probably worse han we've been led to believe.
Assuming this article is correct, I then have to ask why all these people aren't in jail. They apparently committed fraud.
Akron, OH
Posted 01:02 PM, 10/18/2009
The silver lining to this story is that there were executives who were willing to lose their job rather than stay silent about corrupt behavior. Always remember that there are good people, and evil only wins when the good people don't stand up.
