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Replies to post #201603 on Fannie Mae-No Politics (FNMA)
MOODY’S: “IT WAS ALL ABOUT REVENUE”
Like other market participants, Moody’s Investors Service, one of the three dominant
rating agencies, was swept up in the frenzy of the structured products market. The
tranching structure of mortgage-backed securities and CDOs was standardized according to guidelines set by the agencies; without their models and their generous allotment of triple-A ratings, there would have been little investor interest and few
deals. Between 2002 and 2006, the volume of Moody’s business devoted to rating residential mortgage–backed securities more than doubled; the dollar value of that business increased from $62 million to $169 million; the number of staff rating these
deals doubled. But over the same period, while the volume of CDOs to be rated increased sevenfold, staffing increased only 24%. From 2003 to 2006, annual revenue
tied to CDOs grew from $12 million to $91 million.
When Moody’s Corporation went public in 2000, the investor Warren Buffett’s Berkshire Hathaway held 15% of the company. After share repurchases by Moody’s
Corporation, Berkshire Hathaway’s holdings of outstanding shares increased to over
20% by 2008. As of 2010, Berkshire Hathaway and three other investors owned a combined 50.5% of Moody’s. When asked whether he was satisfied with the internal controls at Moody’s, Buffett responded to the FCIC that he knew nothing about the
management of Moody’s. “I had no idea. I’d never been at Moody’s, I don’t know where
they are located.” Buffett said that he invested in the company because the rating
agency business was “a natural duopoly,” which gave it “incredible” pricing power and “the single-most important decision in evaluating a business is pricing power.”
Many former employees said that after the public listing, the company culture
changed—it went “from [a culture] resembling a university academic department to
one which values revenues at all costs,” according to Eric Kolchinsky, a former managing director. Employees also identified a new focus on market share directed by
former president of Moody’s Investors Service Brian Clarkson. Clarkson had joined
Moody’s in 1991 as a senior analyst in the residential mortgage group, and after successive promotions he became co-chief operating officer of the rating agency in 2004,
and then president in August 2007. Gary Witt, a former team managing director
covering U.S. derivatives, described the cultural transformation under Clarkson: “My
kind of working hypothesis was that [former chairman and CEO] John Rutherford
was thinking, ‘I want to remake the culture of this company to increase profitability
dramatically [after Moody’s became an independent corporation],’ and that he made
personnel decisions to make that happen, and he was successful in that regard. And
that was why Brian Clarkson’s rise was so meteoric: . . . he was the enforcer who could
change the culture to have more focus on market share.” The former managing director Jerome Fons, who was responsible for assembling an internal history of
Moody’s, agreed: “The main problem was . . . that the firm became so focused, particularly the structured area, on revenues, on market share, and the ambitions of Brian
Clarkson, that they willingly looked the other way, traded the firm’s reputation for
short-term profits.”
If an issuer didn’t like a Moody’s rating on a particular deal, it might get a better
rating from another ratings agency. The agencies were compensated only for rated
deals—in effect, only for the deals for which their ratings were accepted by the issuer.
So the pressure came from two directions: in-house insistence on increasing market
share and direct demands from the issuers and investment bankers, who pushed for
better ratings with fewer conditions.
Richard Michalek, a former Moody’s vice president and senior credit officer, testified to the FCIC, “The threat of losing business to a competitor, even if not realized,
absolutely tilted the balance away from an independent arbiter of risk towards a captive facilitator of risk transfer.” Witt agreed. When asked if the investment banks
frequently threatened to withdraw their business if they didn’t get their desired rating, Witt replied, “Oh God, are you kidding? All the time. I mean, that’s routine. I
mean, they would threaten you all of the time. . . . It’s like, ‘Well, next time, we’re just
going to go with Fitch and S&P.’” Clarkson affirmed that “it wouldn’t surprise me to
hear people say that” about issuer pressure on Moody’s employees.
Thomas Jefferson, declared, "If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks and corporations that will grow up around them, will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered."
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