A depressing piece in yesterday’s El País reports that Raymond McDaniel, CEO of the disgraced ratings agency Moody’s, who presided over the company’s devastating involvement in the financial crisis, took home $9.2 million in 2010, a 69% rise on the previous year. The justification for this? Apparently Mr McDaniel has “helped restore confidence in Moody’s ratings by improving knowledge of the role and function of ratings.”
The restoration of confidence was undeniably needed. After all, Mr McDaniels’s company it was that gave triple-A ratings to thousands of the sub-prime mortgage loans whose deterioration triggered the global recession. Triple-A, it should be noted, means a bond has less than a 1 in 10,000 chance of defaulting – in Moody’s’ estimation, as Michael Lewis points out in The Big Short, the sub-prime loans were as safe as US Treasury bonds (83 per cent of the triple-A ratings his firm gave to mortgage bonds in 2006 were subsequently degraded). McDaniels’s company, too, was still awarding triple-A ratings to Bear Stearns, Lehman Brothers and AIG shortly before – in part because they believed the ratings and invested heavily in sub-prime bonds – they all went bust and almost brought the whole financial system down with them. Mr McDaniels, as Lewis reports, told an investor in 2007: ‘I truly believe our ratings will be accurate.’
A restoration of confidence is also needed in light of the congressional Financial Crisis Inquiry Commission’s damning verdict on the ratings industry, published in January. The rating agencies, the Commission concluded, ‘abysmally failed in their central mission to provide quality ratings on securities for the benefit of investors…The rating agencies placed market share and profit considerations above the quality and integrity of their ratings.’ The Commission selected Moody’s as its case study for bad practice in the industry.
The sheer ineptness of the companies is documented in embarrassing detail in The Big Short. In one of many examples of their incompetence, Lewis shows how they rated floating-rate mortgages, whereby borrowers would spend two years on a low, “teaser” rate before the rate rose sharply for the rest of the term, more highly than steadier fixed-rate loans. The ratings remained the same even when the interest payable on the loans soared: ‘The rating agencies simply assumed that the borrower would be just as likely to make his payments when the interest rate on the loan was 12 per cent as when it was 8 per cent.’
That floating-rate loans received higher ratings meant that more people were able to take them out – the proportion of US sub-prime mortgages with floating rates rose from 40 to 80 per cent in the five years to 2007. Buoyed by the lively trade in mortgage securities, lenders persuaded tens of thousands of people who could not afford it to saddle themselves with these loans. As Lewis notes, ‘sub-prime borrowers tended to be one broken refrigerator away from default – few, if any, should be running the risk of their interest rate spiking up,’ but Moody’s couldn’t get the loan ratings out of the door quickly enough: the agency went from spending six weeks assessing the credit-rating of a single security to issuing thirty new triple-A ratings on mortgage bonds every day (the Commission called the company a “Triple-A factory”).
But it was not just stupidity that threatened the system; it was also a complete – and sometimes suspicious – lack of transparency. Another passage from The Big Short relates what happened when two investors, Danny and Vinny, went to meet a woman from Moody’s to ask how she went about rating sub-prime bonds:
The woman from Moody’s was surprisingly frank. She told [the investors] that even though she was responsible for evaluating subprime mortgage bonds, she wasn’t allowed by her bosses simply to downgrade the ones she thought deserved to be downgraded. She submitted a list of the bonds she wished to downgrade to her superiors and received back a list of what she was permitted to downgrade. “She said she’d submit a list of a hundred bonds and get back a list with twenty-five bonds on it, with no explanation of why,” said Danny.
“Here’s what I don’t understand,” said Vinny, hand on chin. “You have two bonds that seem identical. How is one of them Triple-A and the other one not?”
“I’m not the one who makes those decisions,” said the woman from Moody’s, but she was clearly uneasy.
“Here’s another thing I don’t understand,” said Vinny. “How could you rate any portion of a bond made up exclusively of subprime mortgages Triple-A?”
“That’s a very good question.”
It’s a question the ratings agencies prefer to duck. Ray McDaniel, of course, is not alone in benefiting from the mess he helped cause – most of the heads of the investment banks that conned or bullied the agencies into upgrading sub-prime ratings (Moody’s complied not just because it didn’t understand the complex bond packages but because of the threat that the banks would go to its rival, S&P, if the rating wasn’t high enough to sell the securities on to pension funds and insurance firms), or that bet on the dodgy bonds themselves, are still in their jobs, and still raking in obscene bonuses.
Those banks are again making profits, thanks to being bailed out by the US taxpayers they had already shafted once. Moody’s net annual profit, on the other hand – despite the alleged restoration of confidence in the company – was 10% lower in 2010 than it was in 2005 when McDaniels took the helm. During that time, according to El País, the salaries of top staff have doubled. Why there hasn’t been a revolt against these people (not least from the shareholders who are so obviously being taken for a ride) is a mystery, but as with the Middle Eastern dictators they resemble, who are finally being punished after years of pillaging their countries, the day of judgement is surely only deferred.