Credit Rating Exec: "We Sold Our Souls to the Devil"

Internal documents show that while rating firms publicly defended their practices, executives privately wondered when the house of cards would fall.

Nick Baumann
Mother Jones

For years, credit rating agencies—the referees of Wall Street—insisted they were an impartial source of information, despite their financial reliance on the companies they rated. Then came the market meltdown—and a chorus of accusations that firms had artificially inflated their risk ratings to please their clients and gain a competitive edge. And now there's plenty of evidence to suggest the "referees" were unduly influenced by the players.

According to internal documents released at a congressional hearing Tuesday, while rating agencies strenuously defended their independence publicly, some of their top executives acknowledged privately that they faced fundamental conflicts. As one executive at Moody's, a major credit rating agency, put it following an internal discussion on the implosion of the subprime mortgage market, "These errors make us look either incompetent at credit analysis, or like we sold our soul to the devil for revenue." The documents lend credibility to charges by Wall Street executives that the rating agencies deserve part of the blame for the current financial crisis. "The story of the credit rating agencies is a story of colossal failure," said Henry Waxman (D-Calif.), the chairman of the House Committee on Oversight and Government Reform, which is holding a series of hearings to investigate the causes of the market meltdown. (Mother Jones also covered hearings on Lehman Brothers and AIG.)

The central problem that confronted the rating agencies, according to witness testimony and internal documents, was a fundamental conflict of interest, one that is inherent to the business model that many agencies adopted in the 1970s. At the time, they moved from charging investors for ratings information to charging companies to rate their products. Since issuers, not investors, are now the major profit center for the "big three" rating firms (Moody's, Fitch, and Standard & Poor's), the rating firms have an incentive to deliver good ratings for the issuers, whether or not the financial products in question actually deserve them.

Raymond McDaniel, the CEO of Moody's, explained the problem in a confidential presentation to his board of directors in October 2007. Under the heading "conflicts of interest," he wrote, "the market…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."

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