Waxman Digs Into Moody's, S&P With Internal Docs

The ratings agencies explain themselves on Capitol Hill.

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In the latest chapter of its investigation into the financial crisis, the House Oversight and Government Reform Committee dragged the ratings agencies before lawmakers Wednesday.

And as usual, Rep. Henry Waxman's gang made sure to have plenty of internal documents on hand for questioning.

From Rep. Waxman's opening statement:

In their testimony today, the CEOs of Standard and Poor's, Moody's, and Fitch will tell us that "virtually no one...anticipated what is occurring." But the documents the Committee obtained tell a different story.

Ray McDaniel, the CEO of Moody's, will testify today that "we have witnessed events that many, including myself, would have thought unimaginable just two months ago." But that is not what he said in a confidential presentation he made to the board of directors in October 2007.

The title of the presentation is "Credit Policy issues at Moody's suggested by the subprime/liquidity crisis." In this presentation, Mr. McDaniel describes what he calls a "dilemma" and a "very tough problem" facing Moody's. According to Mr. McDaniel:

The real problem is not that the market ...underweight[s] ratings quality but rather that in some sectors, it actually penalizes quality.... It turns out that ratings quality has surprisingly few friends: issuers want high ratings; investors don't want ratings downgrades; short-sighted bankers labor short-sightedly to game the ratings agencies.

Mr. McDaniel then tells his board—and I quote—"Unchecked, competition on this basis can place the entire financial system at risk."

Mr. McDaniel describes to his board how Moody's has "erected safeguards to keep teams from too easily solving the market share problem by lowering standards." But then he says: "This does NOT solve the problem." In his presentation, the "not" is written in all capitals.

He then turns to a topic that he calls "Rating Erosion by Persuasion." According to Mr. McDaniel, "Analysts and MDs [managing directors] are continually 'pitched' by bankers, issuers, investors" and sometimes "we 'drink the kool-aid.' "

The entire presentation is fascinating and is well worth reading. But it's just one of a number of internal documents that the committee made public. Here's a sample: