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Congressmen Warn Credit Raters Against Repeating History on CDOs

The top executives of Standard & Poor’s, Moody’s Investors Service and Fitch Ratings were warned by three members of Congress against granting inflated grades to the same type of securities that helped trigger the credit seizure.

“It has been well documented that your institutions contributed to the financial crisis by underestimating the extraordinary risk inherent in CDOs,” Vermont’s Peter Welch, Luis Gutierrez of Illinois and Keith Ellison of Minnesota, wrote in the June 18 letter.

“It’s vitally important that you get it right this time around,” according to the letter from the three Democrats, which cited a June 5 story in the Wall Street Journal on how synthetic collateralized debt obligations were being assembled for investors. Bloomberg News reported in March that the securities were making a comeback.

Synthetic CDOs, derivatives that pool credit-default swaps to make magnified bets on corporate debt, enabled securitization to expand even as the home-loan market dried up six years ago before the market seizure, the Financial Crisis Inquiry Committee wrote in a 2011 report.

Analysts at the three ratings firms were pressured to give their stamp of approval to complex investments to win lucrative business from Wall Street banks, the U.S. Senate Permanent Subcommittee on Investigations said in an April 2011 report. CDOs that packaged home-loan securities and were given top AAA ratings by S&P wiped out investors in a matter of months, the Justice Department said in a Feb. 4 lawsuit against the firm.

‘Numerous Changes’

“S&P has taken to heart the lessons learned from the financial crisis,” Ed Sweeney, a spokesman for the world’s largest credit rater, said today in an e-mail, “Based on what we learned, we changed the way we rate almost every type of security that was affected.”

Michael Adler, a Moody’s spokesman, said in an e-mail that the company reviews the credit quality of transactions it is asked to rate and doesn’t allow “commercial considerations” to influence the process.

“Fitch has made numerous changes to strengthen its business since 2008, and we have not rated any synthetic CDOs since the crisis,” spokesman Daniel Noonan, said in an e-mail.

The letter was sent to Douglas L. Peterson, president of S&P; Raymond McDaniel, the president and chief executive officer of Moody’s; and Paul Taylor, president and CEO of Fitch.

To contact the reporter on this story: Matt Robinson in New York at Mrobinson55@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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