Banks bullied agencies into giving them AAA ratings

Credit ratings agencies are under fire on both sides of the Atlantic, as a former Moody's director told a US inquiry he was bullied into giving sub-prime mortgage derivatives gold-plated ratings while the European Union announced plans to set up a credit ratings watchdog.

Yesterday's star turn at the US Congressional Financial Crisis Inquiry Commission was the billionaire financier Warren Buffett (above), who owns 17 per cent of Moody's credit ratings agency. The Sage of Omaha, as the famously canny Buffett is known, was forced to attend the hearing by a subpoena.

The commission's Democratic chairman, Phil Angelides, pointed out that, statistically speaking, flipping a coin would have been five times more accurate in making an investment decision than trusting Moody's ratings of sub-prime backed securities before the credit crunch.

Of the securities given the highest AAA-rating in 2006 by Moody's, 89 per cent were downgraded to junk status a year later.

But Buffet said it was not the ratings agencies' fault for failing to foresee the credit crunch, which was caused by an investment bubble in sub-prime mortgage derivatives. "I'd say they made a mistake that 300 million other Americans made," he said.

Asked why he personally did not see the bubble coming, Buffett explained he hadn't seen the dotcom bust coming either. Referring to another famous bubble from the 17th century, he said: "I never understood why tulips were worth what they were in the Netherlands."

But it was a former managing director of Moody's who stole the show by suggesting employees were bullied by Wall Street banks into handing out AAA ratings. Eric Kolchinsky suggested to the inquiry that it was the credit ratings sector's business model, whereby banks pay an agency to rate its products, that was at fault.

He said he was forced to give AAA ratings to mortgage-backed securities because his compensation package was based on increasing Moody's market share. "The focus on market share inevitably lead to an inability to say 'no' to transactions. It was well understood that if one rating agency said no, then the banker could easily take their business to another,"
he said.

The testimony is likely to lead to new regulation of the credit ratings sector in the US. Meanwhile the EU yesterday laid out its own regulatory plans, saying it would set up a ratings watchdog with the power to impose fines and withdraw licences.

EU Financial Services Commissioner Michel Barnier said: "The changes to rules on credit rating agencies will mean better supervision and increased transparency in this crucial sector."

There have also been calls for new ratings agencies to be set up, as there are currently only three: Standard & Poor, Moody's and Fitch. They are all American.

President of the European Commission Jose Manuel Barroso asked yesterday: "Is it normal to have only three relevant actors on such a sensitive issues where there is a great possibility of conflict of interest? Is it normal that all of them come from the same country?"

However, Stefan Kolek, a strategist at UniCredit SpA in Munich, told Business Week that the new rules miss the point: "It doesn't address the need to reform the rating agencies' business model." ·