WASHINGTON — A key House of Representatives committee is set to vote soon on legislation that would overhaul financial regulation and produce greater transparency for investors, but as it's now written it fails to address many of the credit-rating agency missteps that helped fuel the global financial crisis.
The House Financial Services Committee was scheduled to approve the Accountability and Transparency in Rating Agencies Act on Wednesday, but on Tuesday it postponed the vote for a week. The measure would require greater transparency from the three major bond-rating agencies — Moody's Investors Service, Standard & Poor's and Fitch Ratings — about the methods they use in rating bonds.
The legislation is designed to strengthen the bond-rating agencies' compliance offices, which failed to alert investors that complex securities backed by U.S. mortgages were of poor quality, even though they'd received top investment-grade ratings.
A McClatchy investigation published Sunday, which quoted whistleblowers inside Moody's, found that Moody's gave high ratings to securities that it knew were of poor quality because it didn't want to lose business to competitors.
Despite widespread evidence of weakened lending standards from 2005 to 2007 and an unsustainable run-up in home prices, especially in hot markets such as California and Florida, the ratings agencies continued to provide top investment-grade ratings to mortgage-backed securities. When the bottom fell out of the housing market in late 2007, especially for sub-prime mortgages given to the least creditworthy borrowers, the triple-A ratings for mortgage-backed securities were downgraded rapidly to junk. Investors were left holding the bag.
Moody's stock, which peaked above $72, is now off by almost $50 from that high.
As part of a broad regulatory overhaul proposed by the Obama administration, House and Senate banking panels are trying to fix what went wrong, especially at the ratings agencies, whose blessing on a bond or security tells investors that it's trustworthy.
The draft legislation proposed by Rep. Paul Kanjorski, D-Pa., goes farther than Obama's recommendations, but it doesn't address some of the ratings agencies' most egregious abuses.
"I think that it's well-intentioned, but I'm afraid it will have little practical effort," said Eric Kolchinsky, who was a managing director in Moody's structured finance division from January to November 2007, when he was purged, he said, for questioning ratings methodology. (Moody's denied that.)
"It does little to alter the fundamental flaws of the rating agencies' role in financial markets," Kolchinsky said of the bill.
Most abuse came in the agencies' structured finance divisions, which assisted Wall Street in packaging pools of mortgages into securities whose supporting income stream came from U.S. homeowners' payments on their mortgages.
Kanjorski, the chairman of the House Financial Services Subcommittee on Capital Markets, would create a separate rating system for complex securities rated by structured finance divisions. It also would minimize the conflicts of interest that stem from the bond-rating agencies' practice of advising on the makeup of these securities and then receiving handsome payments for rating them.