Translated material
Time to sort out the ratings
SEC head: “We have every reason to open an investigation”
The US Securities and Markets Commission (SEC) will determine the degree of guilt of rating agencies in the US mortgage crisis , which resulted in a global liquidity shortage. The commission is already studying the activities of the three largest agencies, and in early June it will propose a new set of rules for such companies.“We have sent letters to Moody's, Standard & Poor's and Fitch asking them to clarify certain aspects of their methodology,” Eric Sirri, head of the SEC's trading and markets division, was quoted as saying by Reuters. “We asked them to explain the policy and procedure for identifying errors in the valuation of structured banking products and to inform us about such errors over the past four years, as well as the measures that were taken to eliminate such problems.”
Moody's shares fell sharply last week when reports of misleading ratings surfaced. 44 European Constant Proportional Debt Obligations (CPDOs) totaling $4 billion were mistakenly given the highest rating of AAA due to a glitch in the computer model code. Agency officials said they hired the law firm Sullivan & Cromwell to investigate the cause of a coding error in a computer model that was assigning ratings based on scores four points higher than needed. SEC head Christopher Cox reported earlier that the commission had already begun an investigation into Moody's activities.
Ratings agencies have long been criticized for failing to warn several large corporations about the crisis. In particular, problems were not found in companies such as Enron and WorldCom, whose bankruptcy followed the publication of incorrect results.
At the end of January, the leaders of Europe's four leading countries met for a mini-summit to call on financial institutions and rating agencies to increase transparency and create an "early warning" system to prevent crises. Rating agencies and major audit firms have been advised of the need to assist investors as much as possible in assessing potential market risks. “Rating agencies must explain to investors in more detail the essence of complex financial products,” British Prime Minister Gordon Brown said at the time, warning that if the agencies refuse the proposed reforms, enforcement action will be taken against them.
Moody's was the first to respond to the call for increased transparency. In early February, it announced the introduction of a new rating system that will distinguish between bonds associated with subprime distressed mortgages, government securities, and corporate bonds. It also considered labeling securities to help investors distinguish CDOs (collateralized debt obligations) and other complex instruments from corporate and government bonds. As is known, CDOs have often been used to securitize pools of subprime mortgages.
Speaking yesterday at the annual conference of the International Organization of Securities Commissions in Paris, Christopher Cox said that "problems in the rating agency industry have been around for a long time and need to be addressed." He said there were similarities between ratings agencies' decision to give some mortgage assets a rating that would encourage investment in them and earlier decisions to give high ratings to assets that later turned out to be worthless. "We have every reason to launch an investigation," he said, adding that on June 11 the SEC will propose a new set of rules for rating agencies.
In addition, Mr. Cox confirmed that a plan is currently being developed to provide greater SEC oversight of the five largest US investment banks. So far, the SEC is monitoring Goldman Sachs Group, Morgan Stanley, Lehman Brothers, Merrill Lynch & Co Inc and Bear Stearns, which is on the verge of bankruptcy.