Glimmer of hope with S&P’s ‘other’ ratings announcement

Nobody missed the big rating agency story earlier this month: Standard and Poor’s downgraded its rating of U.S. debt for the first time in history.

But S&P also surprised the financial community with another announcement that didn’t get much press outside specialized journals. This announcement, believe it or not, may have been a positive development and a sign that rating agencies may finally be acknowledging the mistakes they made that helped cause the financial meltdown.

On the day before its federal debt downgrade, in a totally separate action, S&P announced that it would not rate the notes in a $1.5 billion offering of Commercial Mortgage Backed Securities already placed with investors by Goldman Sachs and Citigroup.

CMBS are the commercial real estate equivalent of the Residential Mortgage Backed Securities (RMBS) that were at the heart of the recent financial meltdown. S&P’s announcement, which it said was necessary because it had discovered “potentially conflicting methods” in its ratings processes, was a bombshell on Wall Street. Citibank and Goldman Sachs were forced to withdraw the transaction.

My initial reaction was to wonder how many homes and jobs would have been saved if, instead of waiting until July of 2007 to begin downgrading RMBS, the rating agencies had properly rated hundreds of billions of dollars of RMBS they rated AAA from 2004 until 2007.

But I saw at least a glimmer of hope. Maybe the rating agencies are finally beginning to do the job we always thought they were supposed to do.

Reports have been circulating for some time that the Dodd-Frank legislation was having little impact on how Wall Street and the rating agencies did business in mortgage-backed securities.

Up until the S&P announcement — in effect a last-minute downgrade — it was clear that issuers of mortgage-backed securities had not stopped the practice of shopping the rating agencies to give them AAA ratings on their CMBS.

I learned all about this during hearings of the U.S. Senate Permanent Subcommittee on Investigations in April 2010. The ratings agencies were and still are paid by the companies whose products they rate. Between 2004 and 2007, those companies often let the agencies know that if they didn’t cooperate with high ratings, they would lose business.

Executives of ratings agencies who protested were often told by management that their bonuses depended on their market share, so do not lose business.

In a hearing held in February of this year, when I was chair of the Congressional Oversight Panel on the Troubled Asset Relief Program (TARP), we learned that there was potential for real problems in the commercial real estate market if the economy did not turn around. This was borne out when U.S. commercial mortgage delinquency rates reached an all time high of 9.88 percent in July.

Ratings of CMBS should reflect market conditions, not the financial interests of debt issuers.

After S&P’s non-rating of the Citibank-Goldman Sachs CMBS offering, the agency was the target of withering attacks from issuers, along with threats that the agency could lose business in the CMBS market. On Aug. 5, S&P announced that it is renewing the rating of CMBS deals.

Back to business as usual? I hope not.

How can the investing public have any confidence in the rating agencies if market share, profits and executive compensation drive their ratings of securities?

Under Dodd-Frank, the Securities and Exchange Commission was told to establish a new oversight office to monitor the rating agencies. One year later, that office is still not up and running.

Much of the delay has been caused by the high volume of other rules required of the SEC in the bill. But establishing an effective office has also been complicated by very heavy Wall Street lobbying against it, as well as by the chair of the House Financial Services Subcommittee, who is trying to reduce the SEC budget.

Meanwhile, we are dependent on ratings agencies whose credibility suffered a body blow in the recent financial meltdown.

What S&P did with the Citibank-Goldman Sachs CMBS transaction was a positive sign.

Let’s hope it wasn’t an aberration, and the rating agencies begin to stand up to debt issuers even before help from the SEC arrives.

Originally published 14 Aug 2011 on