Credit rating executives say they were pressured to give good ratings

Executives from credit-rating firms Moody’s Investors Service and Standard & Poor’s presented additional evidence Friday that management pressure to maintain their market share eroded the quality of investment-grade ratings and amplified the nation’s financial crisis.

Testifying before the Senate Permanent Subcommittee on Investigations, former executives who were closely involved in giving investment-grade ratings to complex financial instruments backed by shaky U.S. mortgages described how they were pressured to give Wall Street what it wanted.

A McClatchy Newspapers investigation in October documented how top managers from the structured finance division, which rated the complex deals, were moved into the top executive suites at Moody’s and in effect took over the company.

Called to appear before the panel, Richard Michalek, a former Moody’s vice president and senior credit officer, described the ratings process as a “must say yes” atmosphere for deals that could bring more than $1 million in fees.


Frank Raiter, a former managing director at S&P and head of the group that rated pools of residential mortgages, told the panel that analysts routinely sought direction from top management about the shaky deals they were being asked to rate.

“I retired because I got tired of the frustration,” he said.

The panel’s chairman, Sen. Carl Levin (D-Mich.), read e-mails from inside the rating companies about deals that never should have been rated, much less received an investment-grade rating.

“These e-mails are just devastating to the kind of culture that is going on here,” Levin said.


Most striking was testimony from Eric Kolchinsky, a Moody’s managing director who in 2007 was in charge of the division that rated the complex deals called collateralized debt obligations. CDOs are securities backed by pools of U.S. mortgages that have been packaged together into bonds and sold to investors.

Kolchinsky recounted how in the first two quarters of 2007, his group generated more than $200 million in revenue for Moody’s by giving complex deals investment-grade ratings — which told investors that they were relatively safe bets. In the late summer of 2007, however, Kolchinsky was informed by superiors that bonds issued a year earlier were about to be severely downgraded.

That should have required a new methodology for ratings on deals that were still pending, but when he tried to do that, he was told not to. It amounted to securities fraud, in his opinion.

“My manager declined to do anything about the potential fraud, so I raised the issue to a more senior manager,” Kolchinsky testified. He said that the complaint resulted in a change to methodology.


“I believe this action saved Moody’s from committing securities fraud. Because of the culture, I knew what I did would possibly jeopardize my role at Moody’s.”

He was right. A month later, he was sent a nasty e-mail asking why his market share slipped from 98% to 94% in the third quarter. The e-mail came, he said, just days after Moody’s had downgraded more than $33 billion in bonds backed by subprime mortgage loans. Less than two months after challenging the integrity of the ratings, Kolchinsky was removed from his post and given a lower-paying job elsewhere in the company with far less responsibility. Later, he was pushed out altogether.

Under questioning from Levin, Kolchinsky acknowledged that he and his staff rated the complex Goldman Sachs deal that this month became the subject of fraud charges brought against Goldman by the Securities and Exchange Commission.

The SEC alleges that Goldman failed to disclose to investors that hedge fund mogul John Paulson helped pick the mortgages in the deal with an eye toward betting that they’d fail. Kolchinsky said this information was never shared with Moody’s.


“I did not know and … I am fairly certain my staff did not know either,” he said.

Asked by Levin whether that would have affected the rating the deal received, Kolchinsky said yes.

“From my perspective it is something I would have wanted to know. It is more of a qualitative, not quantitative, assessment. It changes the incentives of the structure,” Kolchinsky said. “It just changes the whole dynamic of the structure.”

Hall writes for McClatchy.