Who Will Take Responsibility For Crisis?

Companies like Standard & Poor's and Moody's were responsible for giving the seal of approval to questionable investments in the subprime mortgage market. Now the people who made those decisions will be grilled by Congress.

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ALEX COHEN, host:

From NPR News, it's Day to Day. On Capitol Hill today, Congress heard from former credit-rating executives. Companies like Moody's and Standard & Poor's are supposed to downgrade investments that aren't up to par, but credit agencies give stellar ratings to securities backed by subprime mortgages even when the housing market was showing signs of serious trouble. Now Congress wants to know why. Marketplace's Janet Babin is here. Janet, what did these executives have to say about what these credit rating agencies did?

JANET BABIN: Well, in general, Alex, they blamed their former employers for selling their independence to the highest bidder and following profits instead of truly rating these financial products we were talking about. A lot of subprime mortgages were bundled up and sold as securities all over the world, in all kinds of financial instruments, like CDOs - you might have heard of them, credit default obligations. There are many others. Now, when investors were deciding whether or not to buy these securities, they relied on the credit ratings to help them judge how sound an investment was. And many of these instruments were rated triple A, the highest rating a financial instrument can get from an agency, and that happened just a short time before investors found out that they were actually, nearly worthless.

COHEN: Did any of these executives specify how credit agencies should change their business models?

BABIN: Well, the problem, according to many at the hearing, is the investor-pays model. This is the model the agencies use where the issuers of the financial instruments being rated pay for the rating service, not the people buying the bond or security at question, and that's a conflict of interest. Former Securities and Exchange Commissioner Joseph Grundfest explains it in terms of restaurants and restaurant reviewers.

Professor JOSEPH GRUNDFEST (Law and Business, Stanford Law School; Former Commissioner, Securities and Exchange Commission): It's as though you've got all the restaurant reviewers being paid by the restaurant owners. No matter how good the reviewers are, you then have some concern that they always have an incentive to please the people who are actually paying the rent.

BABIN: Now, Jerome Fonz is a former executive at Moody's Corporation, and he told the committee today that the business model should be reversed in favor of the buyers.

Mr. JEROME FONZ (Former Executive, Moody's Corporation): Bond ratings must serve the potential buyer of the bond and no one else. The rating must be correct today, in the sense that it fully reflects the views of the analyst or rating committee.

COHEN: Janet, what about fraud? Did anyone bring up the possibility that maybe these agencies knowingly misled bond holders and sellers?

BABIN: Alex, that's not the type of thing, of course, that's going to be decided at a panel like this, whether there is or isn't fraud going on, but absolutely it's an important question to be asked, and it did come up at the hearings. Several law makers brought it up and asked that question. The House panel had internal company documents from one company. They were actually instant messages between two employees that showed at least some company executives knew very well what was going on. And these agencies made a lot of profits on these bad ratings, and lawmakers, I think, are going to want to try and get to the bottom of whether there was fraud here.

COHEN: Janet Babin of public radio's daily business show, Marketplace.

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