Ratings Firms Scrutinized for Role in Credit Mess

In Depth

The Mortgage Market: What Happened? An explanation of how the housing boom led to risky mortgages.


Credit Ratings Agencies and the Mortgage Monster: A discussion of how ratings firms helped create the current mortgage crisis.

People walk in front of the New York Stock Exchange.

People walk in front of the New York Stock Exchange on a recent morning. Mario Tama/Getty Images hide caption

itoggle caption Mario Tama/Getty Images

Treasury Secretary Henry Paulson is trying to reassure investors that the U.S. will "work through" the problems of a turbulent credit market "just fine." But in a CNBC interview Tuesday, Paulson cautioned that there's no "quick solution."

That point was underscored by more worrisome data on home foreclosures: Foreclosure filings nearly doubled in July from the same time a year ago, according to the research firm RealtyTrac.

Senate Banking Committee Chairman Christopher Dodd (D-CT) held a private meeting Monday with Paulson and Federal Reserve Chairman Ben Bernanke. Dodd, who is running for president, complained afterwards about adjustable-rate mortgages that start with low monthly payments but quickly ratchet up.

"We may have as many as a million to 3 million people who could lose their homes — not because they lost their jobs, not because the economy collapsed, but because they got bad deals on mortgages," Dodd said.

Dodd encouraged people who are facing foreclosure to call a national hot line (888-995-HOPE) run by NeighborWorks America, a nonprofit group. The group offers financial counseling to homeowners and tries to renegotiate more favorable mortgage terms.

Helping Homeowners Renegotiate Loans

"What we often shoot for in that negotiation is a fixed rate and stretching the term back out to 30 years," said Gabe del Rio, vice president of lending with the group's San Diego affiliate. "That essentially provides a refinance product without going through a refinance."

That's important because in areas where home prices have fallen, distressed owners may not qualify for traditional refinancing of their mortgages.

The Neighborhood Assistance Corporation of America is also offering 30-year mortgages with low fixed rates to borrowers who've been victims of predatory lenders. The nonprofit group has access to $10 billion worth of loans, including $1 billion set aside for people at risk of foreclosure.

"That is a drop in a huge bucket," said CEO Bruce Marks. "The problem is, it's the only drop right now. So our goal is not just to provide people with the opportunity to refinance, but to force the major lenders to restructure their loans to make it affordable."

Dodd said the government-sponsored agencies Fannie Mae and Freddie Mac could encourage more favorable loans to distressed borrowers, if the Bush administration would relax restrictions on them. Paulson dismissed that idea, but said the administration is studying other ways to help troubled borrowers.

Eyeing the Practices of Ratings Agencies

Dodd also said the government needs to look at some underlying problems with the market, including the role of credit rating agencies. Until recently, Moody's, Standard and Poor's, and other agencies gave top ratings to securities backed by home mortgages — even those that turned out to be at high risk of default.

"These ratings were way, way off," Dodd said. "And obviously, there's an inherent problem if the agencies are being paid by the very people they're rating. You have some legitimate underlying questions of how reliable those ratings can be."

Rating agencies are paid by the Wall Street firms that bundle mortgages into securities for sale. The rating agencies coached Wall Street on just how many risky mortgages they could pack in, said finance professor Joseph Mason of Drexel University.

"The builders of the securities wanted to push the envelope. And I would say that the credit rating agencies, in order to maintain business in this highly lucrative and fast-growing area, went along with the game," Mason said.

Those credit ratings turned out to be overly optimistic. And when more and more homeowners started defaulting on their mortgages, investors were caught off guard, setting the stage for the current credit backlash.

Mason said that while many investors rely on credit ratings, there are few objective standards. A mortgage-backed security might boast the same high rating as a corporate bond, even though it carries up to 10 times the default risk. When rating agencies have that much leeway, it's little wonder they can be swayed by the people paying their fees, Mason said.

"Regulators don't seem to want to acknowledge that they've handed over this broad authority to the credit rating agencies. Now the credit rating agencies have responded to being handed that broad authority by selling it," Mason said.

Standard and Poor's declined to comment on the criticism. Moody's didn't return a call for comment. In recent weeks, rating agencies have been steadily downgrading securities backed by high-risk mortgages — a move critics say is too little, too late.

Accredited Home Lenders Struggles to Survive

Accredited Home Lenders Holding Co. became the latest banker caught in the turbulence of a shaky subprime mortgage industry that is rattling financial markets around the globe.

The San Diego-based company said Wednesday it will have to shut down most of its business to survive. It plans to slash its work force of 2,600 to just 1,000 people and close 65 branches.

Accredited said it will immediately stop accepting applications for home loans in the U.S., though it will honor the those it has already committed to finance, saying that shutting down most of its business was necessary to navigate the turbulence in the mortgage industry.

The company issued $15.77 billion in home loans last year.

It will close its retail business, which issues home loans directly to consumers, and scale back much of its wholesale lending division, which issues mortgages through brokers.

More Bankruptcy Protection Filings

Accredited's troubles followed the apparent demise of several other lenders, including First Magnus Financial Corp., which filed late Tuesday for bankruptcy protection — less than a week after suspending its operations.

First Magnus, based in Tucson, Arizona, had total assets estimated at more than $942 million and liabilities of nearly $813 million, according to the bankruptcy filing.

"After carefully considering our options, a Chapter 11 filing provides First Magnus with the ability to realize the highest value of our assets for our creditors," First Magnus President and CEO G.S. Jaggi said in a news release.

It stopped taking mortgage loan applications and fired 99 percent of its 6,000 employees on Thursday.

The company originated home loans and then sold bundled loans into the secondary loan market. Among its debts, it owes $5 million to the National Bank of Arizona and $2.8 million to WNS North America, a business process outsourcing firm headquartered in Mumbai, India.

First Magnus also still owes employees about $13 million from the last pay period, spokesman Gary Baraff said. It made that amount its No. 1 request in the bankruptcy filing.

"Nobody in the company has been paid, including the CEO," according to Baraff.

He said everyone at First Magnus is still reeling from the shock of the company's downfall. "The company went out of business overnight," Baraff said. "Three weeks ago we were at the apex of the company's history. Everything was falling into place for us, and we had remarkable momentum across the country. It was shocking to everyone that essentially the secondary market collapsed."

Just last week the leading lender Countrywide Mortgage said it had borrowed $11.5 billion from a group of 40 banks to fund loans, a move that shows just how deep the lending crisis has become.

Stung by decaying credit quality, mortgage lenders across the industry have struggled to raise cash. Subprime loans are made to borrowers with shaky credit histories or those who cannot always document their incomes.

In a bid to calm jittery financial markets, Treasury Secretary Henry Paulson on Tuesday said the U.S. will safely get through the crisis that has sent world financial markets reeling.

"We are going to work through this problem just fine," Paulson said. He urged patience as investors reassess their appetite for risk, saying there isn't a "quick solution" to the matter. "These things take a while to play out," the secretary said.

Paulson commented as the Federal Reserve, trying to further stabilize the markets, pumped another $3.75 billion into the financial system Tuesday. It was the latest in a series of cash injections that have topped more than $100 billion since last week.

In another development, Senate Banking Committee Chairman Christopher Dodd urged Federal Reserve Chairman Ben Bernanke to use "all the tools available" so that a spreading credit crisis doesn't undermine the national economy.

Dodd, a Connecticut Democrat, is seeking his party's presidential nomination.

Consumers Fight Back

Consumer advocates on Tuesday called for a moratorium on home foreclosures, warning that California is facing a tidal wave of foreclosures over the next year as more homeowners are hit with payment increases brought on by subprime loans and risky mortgages.

"The curve is really starting to go up," said Alan Fisher, executive director of the California Reinvestment Coalition, a collection of nonprofit organizations and public agencies that advocate for the poor and minorities.

"We're seeing just the beginning of a problem," he added, testifying before the Senate Banking, Finance and Insurance Committee.

The Mortgage Bankers Association estimates that more than 46,000 California homes were in foreclosure in March, and another 76,732 mortgage loans were seriously delinquent.

Witnesses warned the committee that the numbers would grow over the final months of this year and in 2008 as more homeowners face higher payments because of adjustable rate mortgages.

"California is clearly ground zero for this problem nationwide," said Paul Leonard, director of the California office of the Center for Responsible Lending, a nonprofit group that advocates for homeowners.

From NPR reports and The Associated Press

Comments

 

Please keep your community civil. All comments must follow the NPR.org Community rules and terms of use, and will be moderated prior to posting. NPR reserves the right to use the comments we receive, in whole or in part, and to use the commenter's name and location, in any medium. See also the Terms of Use, Privacy Policy and Community FAQ.