[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
OVERSIGHT OF THE CREDIT RATING
AGENCIES POST-DODD-FRANK
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
----------
JULY 27, 2011
----------
Printed for the use of the Committee on Financial Services
Serial No. 112-51
OVERSIGHT OF THE CREDIT RATING AGENCIES POST-DODD-FRANK
OVERSIGHT OF THE CREDIT RATING
AGENCIES POST-DODD-FRANK
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
JULY 27, 2011
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-51
----------
U.S. GOVERNMENT PRINTING OFFICE
67-946 PDF WASHINGTON : 2011
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee
Larry C. Lavender, Chief of Staff
Subcommittee on Oversight and Investigations
RANDY NEUGEBAUER, Texas, Chairman
MICHAEL G. FITZPATRICK, MICHAEL E. CAPUANO, Massachusetts,
Pennsylvania, Vice Chairman Ranking Member
PETER T. KING, New York STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota MAXINE WATERS, California
STEVAN PEARCE, New Mexico JOE BACA, California
BILL POSEY, Florida BRAD MILLER, North Carolina
NAN A. S. HAYWORTH, New York KEITH ELLISON, Minnesota
JAMES B. RENACCI, Ohio JAMES A. HIMES, Connecticut
FRANCISCO ``QUICO'' CANSECO, Texas JOHN C. CARNEY, Jr., Delaware
STEPHEN LEE FINCHER, Tennessee
C O N T E N T S
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Page
Hearing held on:
July 27, 2011................................................ 1
Appendix:
July 27, 2011................................................ 61
WITNESSES
Wednesday, July 27, 2011
Gellert, James H., Chairman and Chief Executive Officer, Rapid
Ratings International, Inc..................................... 33
Kroll, Jules B., Executive Chairman, Kroll Bond Rating Agency,
Inc............................................................ 35
Ramsay, John, Deputy Director, Division of Trading and Markets,
U.S. Securities and Exchange Commission........................ 6
Rowan, Michael, Global Managing Director, Commercial Group,
Moody's Investors Service...................................... 31
Sharma, Deven, President, Standard & Poor's...................... 29
Smith, Gregory W., General Counsel and Chief Operating Officer,
Colorado Public Employees' Retirement Association.............. 38
Van Der Weide, Mark E., Senior Associate Director, Division of
Banking Supervision and Regulation, Board of Governors of the
Federal Reserve System......................................... 8
White, Lawrence J., Professor of Economics, Stern School of
Business, New York University.................................. 36
Wilson, David K., Senior Deputy Comptroller, Bank Supervision
Policy, and Chief National Bank Examiner, Office of the
Comptroller of the Currency.................................... 10
APPENDIX
Prepared statements:
Neugebauer, Hon. Randy....................................... 62
Gellert, James H............................................. 64
Kroll, Jules B............................................... 89
Ramsay, John................................................. 95
Rowan, Michael............................................... 102
Sharma, Deven................................................ 118
Smith, Gregory W............................................. 129
Van Der Weide, Mark E........................................ 209
White, Lawrence J............................................ 216
Wilson, David K.............................................. 242
Additional Material Submitted for the Record
Neugebauer, Hon. Randy:
Written statement of the Federal Deposit Insurance
Corporation................................................ 259
Fitzpatrick, Hon. Michael:
Letter to Chairman Neugebauer from Hon. Timothy Geithner,
Secretary of the Treasury, with attachments................ 266
Stivers, Hon. Steve:
Letter from John Ramsay, FDIC, providing additional
information for the record................................. 320
OVERSIGHT OF THE CREDIT RATING
AGENCIES POST-DODD-FRANK
----------
Wednesday, July 27, 2011
U.S. House of Representatives,
Subcommittee on Oversight
and Investigations,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:02 a.m., in
room 2128, Rayburn House Office Building, Hon. Randy Neugebauer
[chairman of the subcommittee] presiding.
Members present: Representatives Neugebauer, Fitzpatrick,
Pearce, Hayworth, Renacci, Canseco; Capuano, Miller of North
Carolina, Himes, and Carney.
Ex officio present: Representative Bachus.
Also present: Representatives Garrett and Stivers.
Chairman Neugebauer. Good morning. This hearing will come
to order.
We will have opening statements, and I remind Members that
your opening statements will be made a part of the record. I am
going to ask unanimous consent today that we allow Mr. Garrett
to participate in the hearing. Also, without objection, written
testimony submitted by the FDIC will be made a part of the
record.
We will now have opening statements, and the Chair yields
himself 4 minutes.
Today's hearing is about the rating agencies. And I guess
that the topics will be fairly broad, and we will cover a lot
of ground. I think this is a very important time to have this
hearing.
If you look back to the financial crisis and the Dodd-Frank
Act and all of the things that followed, some people indicated
that they felt that the rating agencies had some culpability in
the credit crisis, that the ratings did not actually reflect
the risks that were being taken.
Subsequent to that, we passed Dodd-Frank, and a lot of
attention was given to the rating agencies in Dodd-Frank. Some
of those regulations have now come out, and some of them have
not come out.
One of the things was that there was deemed to be too much
dependence on the rating agencies in the markets, and
particularly in some of the financial institutions. And Dodd-
Frank asked that the references to those ratings be really
expunged and that the agencies, the regulators, would come up
with new criteria for measuring risk that was not necessarily
tied to the rating agencies.
One of the things we will want to hear from our regulators
today is where we are in that process.
The other thing that still is of concern to some folks is
the fact that there still continues to be a concentration in
just three of those agencies. Between Moody's, Standard &
Poor's, and Fitch, they have covered about 98 percent of the
ratings and 90 percent of the revenue, and some people are
concerned that access for other entities to become Nationally
Recognized Statistical Rating Organizations (NRSOs) is still
limited, particularly when you look at some of the regulation
that is coming out and making it more and more burdensome and
more difficult for other firms to come into that. And I think
we will hear something about that today.
Also of interest to me is that when we look at the fact
that some people say that we ended too-big-to-fail with Dodd-
Frank, some of us do not believe that actually ended too-big-
to-fail, but many of us somewhat believe that it probably
contributed to furthering too-big-to-fail.
When you look at the major financial institutions in this
country, a lot of people thought that they should be smaller
after Dodd-Frank. What we have seen is that many of these
institutions are actually larger.
And what we also now see within the rating industry is that
there is still a reward for being considered one of those
systemically risky financial institutions and, in fact, that
these institutions are getting somewhat of a bump or upticks
over other financial institutions, which may in fact have a
better baseline financial rating.
So these are some of the things that we are going to want
to look at today. My guess is that some of my colleagues will
want to discuss something that is relevant to these times and
that is the role of the rating agencies as it pertains to the
United States sovereign debt. And I suspect there will be some
questions along those lines as well.
But I look forward to a very robust hearing. This is a very
important part of our economy. A lot of people still put a lot
of credence into these ratings. Some people feel like they have
lost their credibility. And as we are moving forward, one of
the things that we feel is going to be extremely important is
restoring a little bit more certainty in the marketplace.
And so, with that, I will then recognize my good friend,
the ranking member, Mr. Capuano.
Mr. Capuano. Thank you, Mr. Chairman.
First of all, welcome to all our panelists.
I know that a lot of people today are going to want to talk
about the removal of references. Though I am interested in
that, I am more interested in other aspects.
It is well known by everybody, actually, including all the
testimony, the Majority memo on today, that faulty ratings
contributed significantly to the recent economic problems that
we have had. We all know that. It is accepted. There is really
no debate about that any further.
I am particularly interested in where we are now and how we
go forward. And I am particularly interested in how the
budgetary constraints might have impacted some of your agencies
relative to implementing some of Dodd-Frank and whether, even
in implementing Dodd-Frank, it has hurt other parts of your
activities.
I think that is a very important aspect to this. It doesn't
do any good to have the greatest regulations in the world if
you cannot enforce them or oversee them.
I am interested in the overall report as to whether the
credit rating agencies are doing their job, whether we should
be concerned any further about--at least currently, I know
things can change tomorrow, but as of the moment--whether they
have finally done what we had all hoped and wanted them to do.
And I, from where I sit, think they have done a better job.
They are more reliable, more independent, and have changed
their model significantly. But I would like to hear your
opinions as to whether or not that is a fair assessment.
I am also interested in your opinions as to how we are
doing with the bill that we passed. Like any bill, like
particularly a major bill, I have always known, we have always
known, that any major bill, no matter how good or bad you think
it is, needs to be tweaked as you go forward. What did we do
wrong? What can we do better? What should we be doing that we
didn't think of?
Because the truth is our economic situation right now, the
debt limit obviously is the crisis of the moment. Hopefully, we
will pass that in the next few weeks or so, but that doesn't
solve all our problems. I think everybody here knows that.
We have other problems. We have other things we have to
address. And we have other economic issues that are related to
the credit rating agencies. And if they do their job, I believe
our entire system will work better, and that is really what I
am interested in hearing today.
So with that, I will yield back.
Chairman Neugebauer. I thank the gentleman.
I now recognize the chairman of the full committee, Mr.
Bachus, for 3 minutes.
Chairman Bachus. I thank the chairman for convening this
hearing to examine the future of credit rating agencies post-
Dodd-Frank.
The credit rating agencies failed spectacularly in the
years leading up to the financial crisis. A government seal of
approval for credit rating agencies led to a mispricing of risk
and the subsequent collapse in market confidence.
House Republicans identified this as a significant problem
and proposed removing references to credit ratings in Federal
statutes. Unlike most of our proposals, which were rejected by
the then-Majority, this one was adopted and incorporated into
the final legislation with bipartisan support. I commend all
the members of the committee for that.
Section 939A of Dodd-Frank requires all Federal agencies to
review and replace references to credit ratings in their
regulations with alternative measures of creditworthiness. The
significance of Section 939A cannot be overstated. Because the
provision had overwhelming bipartisan support throughout the
regulatory reform debate, I fully expect the regulators to
implement it consistent with legislative intent.
This provision has been discussed and debated within this
committee and on the House Floor and the Senate Floor since
2009. If the regulators had concerns prior to Dodd-Frank's
enactment about their ability to develop suitable alternatives
to credit rating, I am unaware of them having articulated any
of those concerns to Members of Congress.
While Section 939A is an important step to de-emphasize
credit rating, the Dodd-Frank Act, in some cases, lacks
consistency in its approach to credit rating. Provisions such
as Section 939F, the so-called Franken Amendment, works against
the intent of Section 939A. The Franken Amendment reinforces
the significance of credit rating by requiring the government
to establish a system for the SEC to choose a rating agency to
evaluate an issuer's structural financial product.
Regulations adopted by the SEC under Dodd-Frank appear to
also contradict the goals of an earlier credit rating agency
reform law authored by our colleague from Pennsylvania, Mr.
Fitzpatrick. That was the Credit Rating Agency Reform Act,
which sought to reduce the barriers to entry for credit rating
agencies seeking the Nationally Recognized Statistical Rating
Organization designation (NRSRO).
However, the 517 pages of rules adopted by the SEC in May
to implement sections of Dodd-Frank erect new barriers to entry
for prospective NRSROs. SEC Commissioner Kathleen Casey stated
that these rules may be life-threatening to smaller credit
rating agencies.
Finally, Dodd-Frank removes the expert liability exemption
under the Securities Act for credit rating agencies. In
addition to causing a dislocation in the asset-backed security
market, a new liability standard further discourages new
entries to the rating agency arena. I am pleased that last week
this committee approved legislation authored by the gentleman
from Ohio, Mr. Stivers, to repeal this counterproductive
provision of Dodd-Frank.
Mr. Chairman, all this shows why today's hearing is very
important. I look forward to hearing from our witnesses.
Chairman Neugebauer. I thank the gentleman.
And now I would like to recognize the vice chairman of the
subcommittee, Mr. Fitzpatrick, who has done a lot of work in
this area and has been a great advocate for making sure that we
have more competition. And so with that, I recognize the
gentleman for 2 minutes.
Mr. Fitzpatrick. Thank you, Mr. Chairman. Thanks for your
leadership in convening this hearing. I know that we are all
really looking forward to the testimony coming of both panels.
Credit rating agencies have a role to play in our financial
system. The problem is that the system has not always worked,
especially for all of the users. In 2006, as the chairman
indicated, I wrote legislation, the Credit Rating Agency Reform
Act, designed to open the door to more participation and more
competition in your industry. It began a process that has led
to this day. However, in the interim, we had a catastrophic
failure in the system that actually hastened the reform.
I think it is striking that one of the few bipartisan
understandings to come out of Dodd-Frank was that reliance on
credit ratings have become too ingrained and too pervasive in
our statutes. However, Dodd-Frank instituted additional
provisions that seem to contradict our bipartisan agreement
and, in fact, now create additional barriers to competition in
the industry.
It is timely that we are having this discussion in the
midst of our debt negotiations here in the Nation's Capital.
The full faith and credit of the United States is on the line.
We are at a crossroads where we need to decide if we are going
to heed the economic warnings and get our fiscal house in order
or just continue to have the Federal Government make the easy
choices.
So I think today's hearing will contribute to that debate
as well, and I look forward to participating.
Thank you, Mr. Chairman.
Chairman Neugebauer. I thank the gentleman.
I now yield 1 minute to the gentleman from Texas, Mr.
Canseco.
Mr. Canseco. Thank you, Mr. Chairman.
The financial crisis of 2008 reinforced the fact that the
largest credit rating agencies carry a tremendous amount of
influence over our economy. Largely because of a government
stamp of approval, the ratings assigned to securities from
Nationally Recognized Statistical Rating Organizations were
used as regulatory benchmarks for determining appropriate
capital standards.
NRSRO's designation was also a cause of investor
complacency when these rating agencies began to rate complex
asset-backed securities and collateralize debt obligations,
even though they had no experience rating such instruments, and
as we now know, these instruments were not really understood by
anybody.
In order to help decrease the dependence on a few
organizations to have such an outsized influence in our
financial system, a bipartisan proposal was added to the Dodd-
Frank bill that required regulators to cease their reliance on
credit ratings and instead adopt their own standard of
creditworthiness. Unfortunately, some banking regulators have
not fully embraced this common-sense proposal, and I have great
concern over the impact of their decision.
I look forward to hearing from our witnesses today on this
very important matter.
Thank you.
Chairman Neugebauer. I thank the gentleman.
And now the gentleman from New Jersey, Mr. Garrett, for 1
minute.
Mr. Garrett. Thank you. And I thank the chairman for
holding this very important and timely hearing today.
The consideration of regulatory reform legislation that
Congress passed last year unfortunately was very partisan, and
the overreach that resulted from that partisan structure is now
needlessly restricting our economic growth and limiting job
creation.
However, as was just pointed out, one significant area of
bipartisanship did emerge through deliberation, that dealt with
credit rating agencies. There was broad agreement that
investors, because of the government's explicit requirement of
ratings, had become basically overreliant on the rating
agencies and failed to do their due diligence. And so by having
the government require these ratings, investors believed that
the ratings had a stamp of approval from the Federal
Government.
In order to refute this, Ranking Member Frank, Chairman
Bachus and I crafted language to remove all rating requirements
from the statutes and the regulations. So, I am pleased to see
that in some regards, the regulatory community has been moving
forward on implementing that.
I understand that changing from that old system to a new
system can be difficult for all involved, but I know with
bright minds, we have a regulatory community that can figure
out a way to make this system work in the future.
As we can see by the discussion going on this week
surrounding the debt debate, however, the rating agencies'
opinion still does carry quite a bit of weight. And while
ratings can play a role in evaluating the credit of a company,
security, or even a country, it should not be the sole
determinant.
In conclusion, we must continue to work to lessen
investors' reliance on these rating agencies and disconnect any
belief that the government somehow stands behind their
opinions.
And with that, I yield back.
Chairman Neugebauer. I thank the gentleman.
And now we will go to our panel. I remind the panelists
that your full written statements will be made a part of the
record.
Our first panel consists of: Mr. John Ramsay, Deputy
Director, Division of Trading and Markets, U.S. Securities and
Exchange Commission; Mr. Mark Van Der Weide, Senior Associate
Director, Division of Banking Supervision and Regulation,
Federal Reserve Board; and Mr. David Wilson, Senior Deputy
Comptroller and Chief National Bank Examiner, Office of the
Comptroller of the Currency.
Mr. Ramsay, you are recognized for 5 minutes.
STATEMENT OF JOHN RAMSAY, DEPUTY DIRECTOR, DIVISION OF TRADING
AND MARKETS, U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Ramsay. Chairman Neugebauer, Ranking Member Capuano,
and members of the subcommittee, my name is John Ramsay, and I
am a Deputy Director in the Division of Trading and Markets at
the Securities and Exchange Commission. Thank you for the
opportunity to testify on behalf of the Commission concerning
its oversight of credit rating agencies and the regulatory
treatment of ratings.
The Commission first gained regulatory authority over
rating agencies in 2006 with the passage of the Credit Rating
Agency Reform Act, which mandated that the Commission establish
a registration and oversight program for Nationally Recognized
Statistical Rating Organizations, or NRSROs.
Yet, it is important to note that the Commission is
prohibited from regulating the substance of credit ratings or
rating agency procedures or methodologies.
From 2007 to 2009, the Commission adopted rules under this
authority to address conflicts of interest, establish
recordkeeping and reporting requirements, and require rating
agencies to publish historical and performance data on the
ratings they issue.
Following the financial crisis, which highlighted problems
in the performance of credit rating agencies, the Dodd-Frank
Wall Street Reform and Consumer Protection Act mandated a
comprehensive additional set of rules in this area. In May of
this year, the Commission proposed rules under this new
authority.
In all of its efforts in this area, the Commission has
strived to achieve three general goals: to address conflicts of
interest and improve the integrity of rating processes and
methodologies; to provide more transparency so that investors
have more and better information about ratings and can better
compare the performance of rating agencies; and to promote
competition in the market for rating agency services.
While my written testimony details the Commission's
significant regulatory efforts to date, I would like to
highlight just a few of those actions.
Many of the existing rules are directed to the integrity of
the rating process. For example, the Commission's rules require
the rating agencies to have procedures to manage conflicts of
interest and that prohibit certain other conflicts.
The agencies are prohibited from structuring the same
products that they rate, and employees who participate in
determining credit ratings are not allowed to participate in
fee negotiations. Under the rules we recently proposed, these
requirements would be strengthened by prohibiting credit
analysts from being involved in any way in sales or marketing
activities.
In order to promote better transparency, the Commission's
rules require NRSROs to make various disclosures about rating
histories, methodologies, and performance statistics among
other items. Our recent proposals aim to strengthen these
requirements by increasing the amount of public data and
standardizing the way performance information is provided so as
to be more useful to investors.
In addition, each published rating would need to be
accompanied by information to make the ratings more
understandable, and the rating agencies would be required to
adopt procedures to clearly define each rating symbol and to
make sure that symbols are applied consistently.
The Commission also has sought to improve competition for
rating agency services. For example, our rules provide a
mechanism for a ratings agency that has not been hired to rate
a structured finance security to be able to access the
information it would need to rate the security on an
unsolicited basis.
In May of this year, the Commission issued a request for
public comment as part of the effort to complete a study
required by the Dodd-Frank Act addressing the process for
rating structured finance products and the conflicts of
interest that arise from the way the rating agencies are paid
for these ratings.
The study will focus specifically on the feasibility of
establishing a system in which a public or private utility or
self-regulatory organization would assign agencies to determine
ratings for these products.
The Commission is also seeking to eliminate references to
credit ratings in its rules, in order to reduce reliance on
credit ratings. As required by Dodd-Frank, already this year
the Commission has proposed to remove numerous rule references
to credit ratings and to substitute other standards of
creditworthiness where necessary.
Finally, the Dodd-Frank Act requires the Commission to
conduct examinations of each NRSRO at least annually and to
issue a report summarizing the findings. The staff is currently
in the process of completing the first cycle of these exams.
I would be pleased to answer any questions you may have.
[The prepared statement of Mr. Ramsay can be found on page
95 of the appendix.]
Chairman Neugebauer. Thank you.
Mr. Van Der Weide?
STATEMENT OF MARK E. VAN DER WEIDE, SENIOR ASSOCIATE DIRECTOR,
DIVISION OF BANKING SUPERVISION AND REGULATION, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Van Der Weide. Chairman Neugebauer, Ranking Member
Capuano, and members of the subcommittee, thank you for the
opportunity to discuss credit ratings and Section 939A of the
Dodd-Frank Act.
To help achieve the important goal of reducing governmental
and private sector reliance on credit ratings, Section 939A of
the Act requires all Federal agencies to remove references to
credit ratings from their regulations and replace them with
appropriate alternative standards of creditworthiness.
For many years before the introduction of credit ratings
into Federal regulations, investors had used credit ratings to
assist them in making investment decisions. Credit ratings
provided a uniform, market-driven third-party assessment of the
creditworthiness of countries, State and local governments, and
companies.
Federal agencies later incorporated credit ratings into
their regulatory frameworks in part because of these same
attributes.
The recent financial crisis, however, made plain serious
flaws with the methodologies and processes around the
determination of credit ratings, particularly ratings for
structured finance positions. These flaws contributed to the
issuance of credit ratings that severely underestimated the
credit risk of many mortgage-backed securities.
Investors for their part relied too heavily and
uncritically on these ratings for making their investment
decisions. And downward revaluations of many of these
securities by market participants between 2007 and 2009 and the
resulting loss of confidence in the accuracy of credit ratings
contributed meaningfully to the destabilizing dynamics of the
crisis.
Section 939A of the Dodd-Frank Act is one of a number of
provisions of the statute that are intended to address problems
with credit ratings and rating agencies.
The Board has identified 46 references to credit ratings in
its regulations. Most of these references are in the Board's
risk-based capital requirements for State member banks and bank
holding companies. And the Board's greatest challenge in
implementing Section 939A is completely removing those credit
ratings from our risk-based capital rules.
To protect the safety and soundness of individual banking
firms and financial stability more broadly, we are striving to
develop alternative standards of creditworthiness for use in
our capital rules that possess the virtues of credit ratings,
but not the vices.
There are several key characteristics of a good
creditworthiness standard. First, and most importantly, the
standard should be reliably risk sensitive. It should
effectively measure the relative credit risk of various types
of financial instruments.
Second, the standard should result in a consistent and
transparent application across different types of financial
instruments.
Third, the standard ideally should auto adjust on a timely
basis to reflect changes in the credit risk profile of
instruments and should auto adapt to cover new financial market
practices.
Finally, the standard should be relatively simple to
implement and should not increase regulatory burden for banking
firms, particularly small banks.
Obviously, credit ratings themselves do not meet all of
these criteria and developing good replacements for credit
ratings is a particularly difficult task.
Since the Dodd-Frank Act was signed into law last July, the
Board has been working with the OCC and the FDIC to carry out
the 939A mandate. In August of 2010, 1 month after the Act was
passed, the banking agencies issued an Advance Notice of
Proposed Rulemaking (ANPR) on alternative standards of
creditworthiness for use in our capital rules. In November of
last year, the Board hosted a roundtable discussion with the
other banking agencies, academics, and private sector
participants to solicit views on this issue.
Public commenters on our 939A efforts have expressed
concern about the statutory mandate, have suggested it could
lead to competitive distortions across the global banking
system and across the domestic banking landscape, and have
urged the agencies to develop alternatives that are risk
sensitive, consistent across banks, and easy to implement.
We continue to work closely with the other banking agencies
to develop our appropriate alternative standards. We are
considering a number of approaches, including approaches that
rely on market-based indicators such as bond spreads,
approaches that rely on balance sheet financial ratios, and
approaches that rely on internal assessments of credit risk by
banking firms.
Each of these approaches, like the use of credit ratings,
has strengths and weaknesses. The Board anticipates that it
will propose amendments to remove references to credit ratings
from our regulations in the near future.
The Board also has been active in the international efforts
by the Financial Stability Board and the Basel Committee to
encourage reduced dependence on credit ratings across the
global financial system.
Although the international financial regulatory community
is working to reduce reliance on credit ratings, the Basel
capital framework continues to incorporate credit ratings in
material ways. Accordingly, we will need to find ways to
synchronize our 939A changes with the global bank capital
accords.
The Board welcomes input from the public and from members
of the subcommittee on this important issue of public policy.
Thank you for the chance to describe the Board's efforts to
date to implement Section 939A. And I am happy to answer any
questions.
[The prepared statement of Mr. Van Der Weide can be found
on page 209 of the appendix.]
Chairman Neugebauer. Thank you.
Mr. Wilson?
STATEMENT OF DAVID K. WILSON, SENIOR DEPUTY COMPTROLLER, BANK
SUPERVISION POLICY, AND CHIEF NATIONAL BANK EXAMINER, OFFICE OF
THE COMPTROLLER OF THE CURRENCY
Mr. Wilson. Chairman Neugebauer, Ranking Member Capuano,
and members of the subcommittee, I appreciate the opportunity
to testify about the initiatives the OCC has undertaken and the
challenges that we are facing in our work to implement Section
939A of the Dodd-Frank Act.
Section 939A does require each Federal agency to review its
regulations that refer to and require the use of credit
ratings. And each agency must then modify its regulations to
remove any reference to, or requirement for reliance on credit
ratings to, and substitute alternative standards of
creditworthiness that the agency determines is appropriate.
Section 939A also requires each agency to transmit a report to
Congress, and the OCC will be submitting that report today.
OCC regulations affected by this provision include the
interagency risk-based capital regulations and also OCC-
specific regulations pertaining to national bank investment
securities activities, securities offerings, and international
banking activities.
The banking agencies' risk-based capital standards use
credit ratings to determine appropriate capital requirements
and assign risk weights to securitizations and exposures to
qualifying securities firms.
Credit ratings are also used to assign risk add-ons under
the agency's market risk rule and to determine the eligibility
of certain guarantors and collateral for credit risk mitigation
purposes.
Section 939A could also significantly affect future
implementation of other Basel Accord capital requirements in
the United States. These include the standardized approach for
credit risk, which relies extensively on credit ratings to
assign risk weights, as well as the 2009 revisions made by the
Basel Committee to enhance and strengthen international risk-
based capital standards.
The OCC's investment securities regulations use credit
ratings for determining credit quality, marketability, and
appropriate concentration levels of investment securities
purchased and held by national banks.
Credit ratings are also referenced and used in our
regulations governing securities offerings by national banks
and the types of assets Federal branches and agencies can hold
as a capital equivalency deposit.
The OCC has issued two Advance Notices of Proposed
Rulemaking to seek input on how to revise our regulations to
implement 939A. An interagency ANPR sought comment on several
approaches for developing creditworthiness standards for
agencies' risk-based capital rules, and these approaches varied
in complexity and risk sensitivity.
We also issued a similar ANPR on alternative
creditworthiness standards for our noncapital regulations.
The agencies, as Mark said, also hosted a roundtable
discussion attended by bankers, academics, asset managers,
credit rating staff, and others to discuss alternatives to
credit ratings. Commenters on the ANPRs and roundtable
participants generally expressed concerns with the removal of
credit ratings from our regulations and asserted that credit
ratings can be a valuable tool for assessing creditworthiness.
Many commenters believe that the simple approaches outlined
in the option, due to their lack of risk sensitivity, create
incentives for inappropriate risk arbitrage. However,
commenters were also concerned that the more complex and risk
sensitive an approach is, due to the depth and types of
analysis that would be required, pose a disproportionate burden
on small banks.
Commenters also expressed concern that certain alternatives
could create competitive inequities and inconsistencies with
the international capital standards established by the Basel
Committee.
These comments reflect the challenges that the OCC and the
other Federal banking agencies are facing as we work to
implement 939A. We believe that with appropriate operational
and due diligence requirements, credit ratings can be one
valuable factor to consider when evaluating the
creditworthiness of financial instruments.
In our view, an approach that precludes undo or exclusive
reliance on credit ratings rather than imposing an absolute
prohibition on their use would strike an appropriate balance
between the need to address the problems created by the
overreliance on credit ratings with the need to enact sound
regulations that can be consistently implemented.
Notwithstanding these challenges, we are continuing our
work to revise our regulations to be consistent with Section
939A. We are being careful and thorough in order to ensure that
the result is not a step backward in assuring that banks of all
sizes conduct their activities in a safe and sound manner and
that reflect sound credit judgment and adequate capital for the
risk they take.
Thank you.
[The prepared statement of Mr. Wilson can be found on page
242 of the appendix.]
Chairman Neugebauer. Thank you.
So we have heard your testimony. Section 939A basically
says that we are going to move away from the references to
rating agencies in our financial institutions as a part of
regulatory capital.
And, Mr. Ramsay, I think you said that--have you all
published a definition for your standards of creditworthiness?
Where are you all in that process?
Mr. Ramsay. Mr. Chairman, we have currently, I think,
proposed to remove references from 11 separate rules or sets of
rules--in some cases, nine different forms.
Actually, just yesterday the Commission adopted the removal
of ratings as a criterion for so-called short form or shelf
registration. So we are coming along in the process of adopting
some of our proposals.
It is tricky because each rule has to be looked at
individually. The right sort of alternative for
creditworthiness is not going to be the same in all cases. It
has to be sort of calibrated, if you will, to the purpose for
the particular rule.
Chairman Neugebauer. Thank you.
Mr. Van Der Weide, where is the Federal Reserve in this
process? Have you all developed a definition of
creditworthiness?
Mr. Van Der Weide. We are working on that. We issued a
first proposal on that last summer. We have been engaging over
the past year in extensive discussions with the OCC and the
FDIC on this topic.
Part of our particular challenge that is causing us to take
a little more time is the core regulation set that we have to
worry about is the bank capital rules. And the bank capital
rules, as I think we have learned in part through the financial
crisis, are extremely important to ensuring the safety and
soundness of banks and the financial stability of the United
States.
We have to be very careful about how we amend our capital
rules. We need to take our time and make sure it gets done
right. The capital rules are also an area where a fair amount
of risk sensitivity is required. It is not an on/off switch,
investment grade or not. So it requires a little bit more work
to make sure that we have a more granular system like that.
Other complexities that we are working on are it is an
interagency process. The bank capital rules are importantly
interagency. So there are a number of us working on it. It is
not one agency. That will result in a better product at the
end, but it will lengthen the processing time a little bit for
this effort.
And the final complication that we have is, the capital
rules are negotiated internationally at the Basel Committee, so
there is an international bank capital accord which we have
been implementing in the United States. And as you know, there
is some tension between the international capital accord, which
does contain references to ratings and what we are trying to do
under 939A. So we also need to synchronize our efforts with the
international accord.
We are working very hard on it. We don't have concrete
proposals to propose at this time, but we will have some in the
near future.
Chairman Neugebauer. Mr. Wilson?
Mr. Wilson. The capital rules are an interagency process,
so my answer is very similar to Mark's.
But the other thing in the capital rules, in addition to
what Mark mentioned, is we are trying to implement an accord
that has been done internationally. There is extensive reliance
on credit ratings and the standardized approach. There is
extensive reliance on securitizations.
But also importantly, some of them, like securitizations,
are very granular. So it is hard to come up with definitions
that provide that level of granularity to put risk weights into
buckets like the Basel accord did.
But in addition to that, as I have mentioned, we have OCC-
specific rules primarily in investment securities. That is more
of an on/off switch, and we can take an approach, and we have
proposed an approach similar to what the SEC is proposing and
just having a descriptive standard of creditworthiness.
Chairman Neugebauer. I appreciate the fact that you are
looking at an interagency approach to this. And, of course, I
think there needs to be some standardization. I think there is
a feeling here that this process is not moving extremely
swiftly.
One of the concerns that I have is that under FSOC, the
Treasury Secretary is supposed to provide some leadership to
this coordination among the regulators. And I would mention
that the Secretary was--we did ask Treasury to provide a
witness today, and this is the second hearing in a row that we
have had that the Treasury has elected not to send a
representative.
And so we think it is very important for the Treasury
Secretary to be very engaged in this disharmonization within
the regulatory framework, because we can't go and talk about
harmonization with Basel and these other countries if we don't
have our own plan. And so, I would encourage you to make sure
that we move along in that process and make sure that happens.
I would just close with this interesting concept and just a
quick question. If we are going to expunge that from our
capital rules and some of the other rules, what would be the
response if we just did away with the NRSRO designation?
Mr. Ramsay?
Mr. Ramsay. I think I should maybe use some background, and
indicate that the NRSRO designation has been used for quite
some time. It used to be used as part of an informal, no-action
letter process, which for many years is the way that agencies
were recognized.
Chairman Neugebauer. I am sorry to interrupt you here. My
time is, unfortunately, expiring. Could you just give me the
short answer? Would you support doing away with the NRSRO
designation?
Mr. Ramsay. I guess the short answer, Mr. Chairman, is that
I think there are arguments that could be made for and against,
but the Commission certainly hasn't taken a position on--
Chairman Neugebauer. Mr. Van Der Weide?
Mr. Van Der Weide. The Fed also does not have a position on
that question.
Chairman Neugebauer. Could you develop one?
Mr. Van Der Weide. I will take that back.
Chairman Neugebauer. Yes.
Mr. Wilson? I guess your answer is going to be the same?
Mr. Wilson. Yes.
Chairman Neugebauer. Thank you. And with that, my time has
expired.
The gentleman from North Carolina, Mr. Miller, is
recognized for 5 minutes.
Mr. Miller of North Carolina. Thank you, Mr. Chairman.
One of the lessons I took from the financial crisis is when
the folks in the financial sector say, ``Everything is under
control; there is nothing to worry about,'' but they have a
desperate look in their eyes, I worry, because I think maybe
they know something they are not telling.
What really happened in September of 2008 was described in
the press as interbank lending freezing up. And in fairness to
the press, it is going to be pretty hard to explain it any more
deeply than that.
But in a part of the shadow banking system that hardly any
American knows anything about, hardly anyone in Congress knows
anything about, and those who know something about it don't
know very much, was the repo market. And as much money was
moving around every night in the repo market as there was in
bank deposits.
Bear Stearns was getting $70 billion a night in repo market
lending, every night. What they were doing with that money was
making longer-term loans. Using very short-term borrowing for
longer-term loans is not a formula for financial stability. And
what happened was that there was an old-fashioned run, like
what you saw in, ``It's a Wonderful Life,'' that used to happen
to depository institutions before there was deposit insurance
in the repo market.
U.S. Treasuries seemed to be the principal collateral for
the repo market and for the derivatives market. If our debt is
downgraded, have any of you given any thought, do any of you
have any clue what effect that might have on the repo market,
on the derivatives market and the use of that debt as
collateral in those markets?
Mr. Wilson. Yes, it is something that we have considered.
It is one of many things as we try to look at what the impact
might be. The best guess is that there would be an adjustment
of the margin required. So you wouldn't be able to borrow as
much through the repo market. There would be more margin for
the given amount of collateral that you have.
We think that is manageable in the short-term because, for
example, going from AAA to AA, you still have a very high
quality security. And it is still considered one of the safest
instruments in the world, but who knows what will happen long
term.
Mr. Miller of North Carolina. I have gotten a letter from
my State's treasurer saying, ``Please, please, please, don't
allow Federal Government debt to be downgraded because North
Carolina's State debt will almost certainly be downgraded as
well if that happens.'' I understand the same is likely true of
all manner of other kinds of debt--Fannie's debt, Freddie's
debt, Federal Home Loan Bank debt, and on and on.
Do you have any sense of what the ripple effect will be in
other forms of debt if Treasuries are downgraded?
Mr. Wilson. Yes. The only sense is that will probably
happen. The extent of it, just like in 2008, what we saw, some
of our predictions and what might happen in some of these
markets were just blown away with what actually happened. So we
believe there will be an effect, but the size of the effect is
hard to measure.
Mr. Miller of North Carolina. Okay. And also--somebody
else? Did you--
Mr. Van Der Weide. If I could address a little bit your
previous question on the repo markets. The repo markets are not
what they were in 2006 and 2007. There has been a reduction in
the amount of short-term funding financing long-term assets
through the repo markets over the past few years.
There has also been a lot of work done, both at the private
sector level and on an interagency regulatory basis, to make
the infrastructure of the repo markets stronger.
There is also recognition going forward of the reality now
that the borrowers in the repo market are much more well-
capitalized than they were leading into the crisis.
And there is also a new regulatory framework that is coming
on line, the Basel Accord. The new capital requirements under
Basel, the new liquidity requirements that are under Basel, are
all designed to make that repo market safer and sounder and
more stable to deal with potential adverse effects.
Mr. Miller of North Carolina. Okay. Also, I understand a
great many funds require that all the debt they hold be AAA. Do
you have any idea of what effect may be on funds? Will they
have to dump Treasuries? What effect will that have on the
financial system?
Mr. Ramsay. I guess I should say that my understanding is
that, at least according to our rules, the rules don't require
a AAA rating generally for money market funds. They require
where funds hold government securities or securities that are
guaranteed by the full faith and credit, that is sufficient
now. Individual funds may have investment guidelines that would
require a AAA rating. And I think they are in the process of
looking at those guidelines and determining whether they should
make changes.
Mr. Miller of North Carolina. I guess one summary question,
since my time has technically expired, but the chairman has not
brought the gavel down yet, am I right to worry that this could
be really bad if our debt was downgraded?
Mr. Wilson. It is hard to measure, but I think you are
right to worry. It could happen. It could be a big thing.
Mr. Miller of North Carolina. Okay. My time has expired.
Chairman Neugebauer. I thank the gentleman.
And now the chairman of the full committee, Mr. Bachus, is
recognized for 5 minutes.
Chairman Bachus. I thank the chairman.
And the gentleman from North Carolina, I think, is right to
be concerned about a default. I think he would also be prudent
to worry about unsustainable spending. Although a default may
be a more immediate problem, the overwhelming problem is
structural long-term changes. And both of those ought to be
addressed, and until both of them are, there won't be a lasting
solution.
I have listened to your testimony, and I acknowledge that
939A is giving you some problems, particularly the bank
regulators, the OCC and the Federal Reserve. You have not moved
very quickly on implementing it.
If you read it, it asks you to replace the reliance on
credit rating agency as the sole basis with alternative systems
of creditworthiness, which could include credit rating. It
could include credit rating, but it would be an alternative
which would suggest other criteria.
If you notice the--you have mentioned your coordination
with our European brethren, our international coordination. The
European countries of the E.U. are making great efforts to end
their reliance or overreliance on credit rating. In fact, they
have followed, I think, our example.
And I noticed on July 11, 2011, European Commissioner
member Michael Barnier stated that the Commission's credit
rating legislation would address overreliance on credit
ratings. The Financial Times just this week said that Europe
intends to end its reliance on credit ratings. And I think that
means overreliance, not reliance.
Have you been in discussions with them as they are moving
towards implementing provisions, or are you aware and are you
coordinating your efforts with theirs?
Mr. Wilson. Yes, absolutely. And I want to be clear, I
don't think anybody disagrees that we shouldn't reduce reliance
on credit ratings. That is a Financial Stability Board
pronouncement. It is something we agree with, something that we
all think is a good thing.
But to address your earlier comment, if we can read 939A to
use a credit rating as one component in an overall credit
analysis with appropriate due diligence and appropriate
verification, that would make our job easier in order to
conform to the Basel Accord because--but even the enhancements
that were done in 2009 by the Basel Committee recognizes this
and put in additional due diligence and requirements before you
could rely on a credit rating.
Chairman Bachus. Yes, I think what one of the goals behind
it was that you heard investors, you heard particularly in
residential mortgage-backed securities, I think, that was the
spectacular failure. On municipal bonds, corporate debt,
municipal debt, I think the credit rating agencies did a much
better job.
I think that is part of your hesitancy, that, in fact, on
other asset-backed securities, they had a mixed record, but it
was of more value.
I think what we didn't want is people telling us that they
were required by the regulators to basically make purchases or
allocate their assets or their reserves based on that sole
criteria.
But I will say this: I did not hear any expressions from
either the OCC or the Federal Reserve during the entire debate.
I don't recall anyone coming to us and saying, ``This is a real
problem.'' So I would say going forward, I would encourage you
to have discussions with us.
This is not a holy grail, as we very much know up here. And
I will just ask you to work with us on this.
I have one final suggestion. I have 30 seconds left. I know
it is a complicated job, and it is easy to criticize, but you
are the professionals, and we did intend to give you
discretion, but we also intended to give you direction.
And one of those directions is Section 112, where we said
that as you cooperate, that the FSOC, which you are members of,
may be used as a coordinating body. And I don't know whether
you have done that or you are aware of Section 112, but I would
say, take a look at that in your efforts.
Thank you very much.
Chairman Neugebauer. I thank the chairman.
And now, Mr. Carney is recognized for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman. Thank you for having
this panel today. It is timely, given all the things that we
are looking at here with the debt ceiling.
It is also timely with respect to a hearing that we had in
the Financial Institutions Subcommittee last week about H.R.
1539, which as you may know, strikes 939G of Dodd-Frank, which
would have required a higher level of liability for the rating
agencies. And the effect, as my colleague from Ohio said, was
to dry up the asset-backed security market for a big employer
in his district, and that was the motivation behind his bill.
The SEC apparently had a regulation or has a regulation
that requires that ratings be part of the prospectus for such a
security. And I understand that they suspended that regulation
so that the market, I guess, would come back.
The former chairman, the ranking member, said that the
provision of Dodd-Frank would require the SEC to withdraw that
regulation to be consistent with the current law. Is that your
understanding, Mr. Ramsay? Or could you elaborate on this
situation?
Mr. Ramsay. Sure. I will try to briefly do so, although it
is a little bit of a complicated issue.
Mr. Carney. Which is why I asked the question.
Mr. Ramsay. We previously, actually, the Commission
proposed at one point or put out for comment the idea of
removing this special exemption, if you will, for rating
agencies from the higher liability standard. So I think we
recognize that there are arguments that could be made for or
against. The Commission never came to a consensus on that.
The Congress essentially made the decision for us. As you
noted, because the ABS market, because our rules require that
the rating be included in the prospectus, the result of
removing the exemption meant that rating agencies would have to
consent to have the rating information included in the
prospectus.
They refused to consent. As a result, there was the
potential that the registered ABS market would be shut down or
that there wouldn't be any deals being done. We thought that
that was a bad result for the markets and for investors, and so
we issued a no-action letter to allow that business to
continue. And that no-action letter was recently extended.
So that is where we are at this point.
Mr. Carney. How about the last part, the claim by Ranking
Member Frank that the SEC would be required to make its rules
and regulations consistent with Dodd-Frank and thereby, I
guess, withdraw that requirement?
Mr. Ramsay. We haven't done anything to alter 436G or what
was done in the statute. The only thing that we did was to
issue a no-action letter with respect to the ABS market.
Mr. Carney. Do you have a view or do other panelists have a
view on whether the rating agencies should be subject to that
expert standard? People do listen to the rating agencies. We
are seeing that right now.
When I was in State government, we listened. In fact, when
the rating agencies said, ``Jump,'' we said, ``How high?'' And
we would go--I was secretary of finance--we would go to the
legislature and say, ``You can't do that, because if you did
that, it could affect our rating.'' Now, we have the debate
over the debt ceiling and, of course, the big argument is, we
don't want to default. We don't want to downgrade.
And so people do listen. Some of the discussion and
argument is, do they rely on the ratings too much? But what
about the standard? The liability standard has a way of
disciplining what might be put in a rating and included in a
prospectus.
Mr. Wilson. We don't have a view on it. I think both of
those statements are correct.
Mr. Carney. Does anybody else have a view? And if you
don't, or you don't want to offer one, that is fine, too.
Let me ask this question, then. What does a different world
look like if we have too many people--I, frankly, think ratings
and the opinions that go with them are very meaningful and have
always been in the world that I live in--so what does a
different world look like where we don't rely so heavily on
ratings?
Going back to the chairman--he is not here--Mr. Bachus'
question, does anybody have a view of what that world looks
like?
Mr. Wilson. Back to Mr. Bachus' comments about where the
real problems were with the securitization structures. And the
view of the world is there will be some reliance on credit
ratings, but there should be additional due diligence. There
should be an understanding on the parts of the banks we
regulate and other investors on what is actually underlying
that securitization.
That is not a new view for the OCC. We had guidance in that
area. We reaffirmed it and strengthened it in 2009. Arguably,
we didn't enforce it as much as we should have, but I think
that the view is again back to this idea of reducing reliance
on credit ratings.
Mr. Carney. Thank you. I see my time has expired. I thank
the Chair for the additional seconds.
Chairman Neugebauer. I thank the gentleman.
And now, the vice chairman, Mr. Fitzpatrick, for 5 minutes.
Mr. Fitzpatrick. Thank you, Mr. Chairman.
Mr. Ramsay, I want to follow up on Chairman Neugebauer's
line of questions earlier having to do with the designation
process of the SEC for recognizing the Nationally Recognized
Statistical Rating Organizations. I think you testified that
for years the Commission had a policy of issuing a no-action
letter. Can you expand on that, what the process was and what
it currently is?
Mr. Ramsay. Sure. I think beginning in 1975, if I am not
mistaken, the Commission, when the first use of the term
``NRSRO'' was included in the Commission's rules, essentially
the Commission granted what we call no-action relief, which is
essentially a letter issued by the staff that says it would not
recommend enforcement action if a private market participant
operated in such a particular way.
So these letters were essentially ways of recognizing
individual rating agencies, and those ratings would then be
recognized in particular rules.
That process was criticized as being not very transparent,
I think probably rightfully so. And so as a result, in 2006,
the Congress created a structure that created a much more
transparent process for applicants to come in and register.
Since that authority was granted, we have registered 10
different entities. We have only turned down one. The only one
that we turned down was unable under the laws of its local
jurisdiction to be able to say that it could provide us with
the documents and examination authority that we would need.
So we have been trying to use the registration process and
the authority that we have been given to encourage competition,
but recognizing that we have to be able to make some baseline
findings that are required by the statute that the agencies
that come to us qualify.
Mr. Fitzpatrick. Is it your sense that the additional
market participants are increasing the quality of the
information, increasing the quality of what is out there for
investors, but also may be even decreasing the cost?
Mr. Ramsay. I would be hesitant about talking about quality
because, of course, as I mentioned, we are prohibited from
regulating the substance of ratings. I think we do believe that
the rating process that exists now is more--substantially
more--transparent, that the rating agencies are more
accountable now.
We think the proposed rules that we have put out there will
make that much more the case. And, hopefully, more competition
will exist as well.
So we recognize that the rules that we proposed will impose
some compliance costs. And those rules are still out for
comment. We have asked for comment about if there are ways that
our rules can be crafted so they don't impose so much in the
way of the costs.
We certainly think that more competition is a healthy
development.
Mr. Fitzpatrick. How about the opportunity for smaller
rating agencies to participate in the market? Are you guys
taking a look at the definition of what a small agency would
be?
Mr. Ramsay. We are. And, I think the rules are relatively
new. The authority is relatively new.
And so, we have had some people come in to us, and we have
been in discussions with them. There is not much of a precedent
or a track record there, so it is a little hard to figure out.
We are sort of going through that process for the first time.
Mr. Fitzpatrick. Sir, there was an Executive Order and a
memorandum from President Obama unequivocally calling for
regulations to be applied in the least burdensome manner in
order to reduce unnecessary regulatory obstacles to
competitiveness in the industry.
So, given that the three large NRSROs control over 80
percent of the credit rating market and have significantly
larger profit margins that allow them to sort of absorb the
higher compliance costs, do you believe your proposed rules
address the disproportionate impact of compliance on smaller
rating agencies?
Mr. Ramsay. Congressman, as I mentioned, I think, the rules
are still out for comment, and we have asked for comment. We
really do want to hear from people as to whether the costs are
excessive, if there are ways that we could scale them back. I
should be clear that the statute is fairly prescriptive in
terms of the things, the kind of rules that we are required to
adopt.
We have tried in our proposed rules as much as possible to
adopt what I call a ``policies-and-procedures approach,'' which
is that we require agencies to adopt policies and procedures to
achieve a specific objective rather than try to dictate the way
in which they have to achieve it.
And there are aspects of our rules by creating more
information that allow investors to be able to compare
performance of rating agencies that we hope over the long haul
will actually spur competition.
Mr. Fitzpatrick. Okay. Thank you.
Chairman Neugebauer. I thank the gentleman.
And now the ranking member, Mr. Capuano.
Mr. Capuano. Thanks, Mr. Chairman.
And thank you, gentlemen.
I just want to jump into a quick couple of things. As I
said at the beginning, the 939A stuff, though I think it is
good, is there anything in any rule anywhere that prohibits the
market from looking at a credit rating from anybody?
Mr. Wilson. No.
Mr. Capuano. So that you can't make them do it, but you
can't stop them from doing it either? Is that a fair statement?
Mr. Wilson. It has to be removed from the regulations. It
doesn't mean that the investor can't--
Mr. Capuano. That is what I am suggesting. The market is
going to call for a credit rating no matter what we do. I think
it is a good thing to get them out. I think it is a good thing
to do. But I don't want to pretend that is going to be the end
of all our troubles. The market is still going to be looking
for a credit rating.
Do you think that is a fair statement? Does anybody think
it is an unfair statement?
Mr. Van Der Weide. It seems fair.
Mr. Capuano. Thank you. I guess on the, what, the 939G, the
Section 11 section, again, it is not in the prospectus, but am
I wrong to think that most credit ratings are available to the
general public whether it is in the prospectus or not?
Mr. Ramsay?
Mr. Ramsay. I think generally the information does get into
the market one way or the other. We prefer to have the--I
should say this is a matter that is under review, so we have
to--the advantage of having the--
Mr. Capuano. Right now, as I understand it, credit rating
agencies are not allowing their ratings to go into the
prospectuses, because they are concerned about this rule, which
is fine. But that doesn't mean that I can't find their rating
as a private citizen in a thousand different places. Is that a
fair statement?
Mr. Ramsay. I believe that is a fair statement.
Mr. Capuano. So we are talking about a real technical
aspect where they don't do one thing and somehow prevent
themselves from being held liable under one section of the law.
That is all we are talking about.
Mr. Ramsay. Yes. I think there is nothing that--we can't
force rating agencies to consent under the scheme that we have.
And so, as a result, the failure to consent means that--
Mr. Capuano. But their ratings are still available to the
public. Is that a fair statement?
Mr. Ramsay. The ratings are still available to the public.
That is correct.
Mr. Capuano. So that by them simply not putting it into the
prospectus, it doesn't mean that somehow they are hiding it and
putting it in the bottom drawer. No one can see it.
It just means it is not in a technical piece of a document,
a technical document that is technically available. but yet, it
is available every place else, other than that document.
Mr. Ramsay. That is correct.
Mr. Capuano. And there is nothing in this regulation or any
other regulation that can supersede a law of the Congress. Is
that a correct statement?
Mr. Ramsay. I would say that is correct.
Mr. Capuano. So Congress has said to get rid of this. The
SEC has not done it yet. I would argue that it doesn't matter
what your regulations say. What matters is what Congress says,
whether people like it or not.
Congress has said it no longer is relevant, so, therefore,
do whatever you want. Section 11 doesn't apply. It is an
illegal regulation that the SEC has hung onto for no
particularly good reason. That is number one.
Number two, relative to Section 11, it doesn't relate to
the other liability that was put in place by Dodd-Frank that
says the credit rating agency that can be held liable for
knowingly or recklessly conducting their business. Is that a
fair statement?
Mr. Ramsay. I'm sorry?
Mr. Capuano. Fair enough. I assume none of you are lawyers.
Or are you all lawyers?
Mr. Ramsay. I am a lawyer. We may all be lawyers, yes.
Mr. Wilson. I am not.
Mr. Capuano. I am a lawyer, too. So, two good guys and one
so-so. So I am the only one who is going to defend you guys.
Don't worry, because as far as I see it, one liability in
Section 11 is a technical aspect. ``Knowingly and recklessly''
is still there for anybody to use. And nothing that anybody
does can stop that.
Now, I know it hasn't been used yet, but it is still there.
So let us not pretend that Section 11 is the only thing that is
out there protecting people from the credit rating agencies.
Mr. Ramsay. Yes, I agree, Congressman, 10-b5 liability is
there, and continues to be. And, in fact, the Dodd-Frank Act
sort of made the pleadings standards easier with respect to
rating agencies.
Mr. Capuano. Right. I know it hasn't been used yet. And
that is fair and well. I am not looking--
Mr. Ramsay. But that is obviously for the courts to sort
out.
Mr. Capuano. Absolutely. And I will be honest with you, I
hope it never gets used, because all I have ever wanted is for
credit rating agencies to do their jobs.
Now, I want to get back to my opening statement. As you
have been going through this, I would like to--this is an
opinion question, and you may or may not be comfortable
answering it.
Do you have an opinion as to whether credit rating agencies
in general are doing their job more efficiently, more
effectively, than they were prior to the crisis? That is a
straight-up question. It puts you on the spot. I am not trying
to, but what the heck, that is my job.
Go ahead, Mr. Wilson. You seem--
Mr. Wilson. Yes, as an opinion, there has obviously been
lots of energy devoted to the problems that we all saw,
including the rating agencies. In addition to that, there are
going to be a lot of additional requirements--
Mr. Capuano. Do you think they are doing a better job than
they were before?
Mr. Wilson. Yes.
Mr. Capuano. Mr. Van Der Weide?
Mr. Van Der Weide. I think they are doing a better job. I
think they and many of us have reacted to the lessons learned
by changing our ways and improving the way we estimate risks
and model risks. So I think they are doing better.
Consistent with comments that Dave made earlier, the
crucial thing is that no matter how good we think they are
doing, we not overrely on them, not the government, not the
private sector. So I think that is the chief goal here.
Mr. Capuano. That is a very good statement.
Mr. Ramsay?
Mr. Ramsay. I do think it is fair to say that because the
regulations that are in place, they are more consistent in
terms of their methodologies. And certainly, the amount of
disclosure that is out there that investors can use is much
greater.
Mr. Capuano. Mr. Chairman, with your indulgence, one final
question.
Mr. Ramsay, if your agency was tasked with creating an
office of credit rating, would you have been able to do this if
you had been allowed to reprogram your money?
Mr. Ramsay. My understanding, Congressman, is that the
reprogramming authority that was required from the House has
not been granted. And so as a result, what we have done is take
resources from our other examination areas in order to complete
the annual examinations that we are required to do this year.
We have had to draw resources from the investment adviser,
from joint investment adviser broker dealer exams. And those
are exams we would like to do more of, so that has imposed some
strain on our resources.
Mr. Capuano. Thank you, Mr. Chairman.
Chairman Neugebauer. I thank the gentleman.
And now the gentleman from Texas, Mr. Canseco, for 5
minutes.
Mr. Canseco. Thank you, Mr. Chairman.
Mr. Wilson, your testimony describes difficulty in
identifying a workable replacement for credit ratings. Among
other authorities, Section 112 of Dodd-Frank empowers the
Financial Stability Oversight Council, FSOC, with the authority
to coordinate rulemaking and recommend regulatory principles to
FSOC members.
Have you requested assistance from the chairperson of the
Financial Stability Oversight Council, the FSOC, to use its
authority under this section to provide assistance in 939A
rulemaking?
Mr. Wilson. To my knowledge, we have not in 939A.
Mr. Canseco. Okay.
Mr. Van Der Weide?
Mr. Van Der Weide. No, we have not. I think we have
concluded that the core coordination that is needed in this
process is between the banking agencies, because we have a lot
of common regulations, most importantly the capital rules. So
it is critical that the banking agencies coordinate. We are
coordinating fairly intimately, are meeting very frequently
with our working groups to develop alternatives.
We have also consulted with the SEC and the CFTC and the
other agencies. I can't call it a coordination process, but we
have consulted with them. So there is a lot of coordination and
consulting going on. But we have not asked the FSOC to get
involved.
Mr. Canseco. Mr. Ramsay?
Mr. Ramsay. I am not aware that the FSOC in particular has
been involved in this issue. As Mark said, I think the agencies
themselves have been talking to each other a fair amount.
Mr. Canseco. Okay. Thank you.
Mr. Wilson, the SEC has made significant progress in
removing references to ratings and even began the process when
this seemed a likely legislative possibility in 2009. Why is
the SEC able to move forward while you are here only talking
about the challenges? Are you going to fulfill your statutory
duties?
Mr. Wilson. Yes, we will have to. I will say that we talked
before in our testimony about how there are a couple of
challenges related to the capital rules that are different than
a lot of the other rules, and that would include OCC-specific
rules that are more similar to many of the SEC rules, where it
is more of an on/off switch or maybe a two-bucket approach
where it is either investment grade or it is not. And that is
easier to address in a definitional way.
But when you have capital rules, for example, our current
advanced approach securitization rule that has, like, 12
buckets, it is really hard to distinguish risk between those
buckets without something fairly granular like a credit rating.
So that is part of the difficulty that we have to find a
solution for.
Mr. Canseco. Thank you.
Mr. Ramsay, in your opinion, how does making it easier to
sue Moody's and S&P allow investors to better assess their own
risks and reduce their reliance on ratings?
Mr. Ramsay. Congressman, I guess I wouldn't want to proffer
an opinion on what you specifically suggested. I think that the
potential liability is something that exists for all actors in
the markets. Section 11 liability is one sort of step up from
10b liability. And as I said, I think there are policy
arguments as to whether rating agencies should be treated like
accountants for those purposes. The Commission hadn't sort of
reached a result on that.
But 10b-5 liability is available for a variety of actors,
and that is basically for the courts to sort out, not for the
SEC.
Mr. Canseco. Do you think, Mr. Ramsay, that this cloud of
liability improves the accuracy of the credit rating agencies?
Mr. Ramsay. I guess I am not sure what the connection might
be. I am not sure of any research on that. And so, I wouldn't
want to proffer an opinion on what the connection might
actually be.
Mr. Canseco. Would you agree with me that the prospect of
liability or exposure is a damp rag over the accuracy of a
credit rating agency?
Mr. Ramsay. I am not, as I said; I don't think I am in a
position or qualified to offer an opinion on what the
relationship between the level of liability and sort of the
ultimate quality of the ratings might be.
Mr. Canseco. Thank you, Mr. Ramsay.
Mr. Wilson, one last question. Do you believe it is good
public policy for the government to mandate the use of credit
ratings by privately owned companies, then use those ratings as
the basis for capital requirements?
Mr. Wilson. It is one of those where it is the best option
we have. And I think that is what the Basel Committee came to.
So it is a hard answer. But until we can find a better option,
I think that is at least what the Basel Committee decided.
Mr. Canseco. Do you have an opinion, other than the Basel
requirement?
Mr. Wilson. Yes. I think it is difficult because I don't
have another option that is better.
Mr. Canseco. Okay.
Mr. Wilson. If you want to be risk sensitive.
Mr. Canseco. Thank you very much.
I yield back.
Chairman Neugebauer. I thank the gentleman.
And now the gentleman from New Mexico, Mr. Pearce, for 5
minutes.
Mr. Pearce. Thank you, Mr. Chairman.
Mr. Wilson, right as Mr. Miller was closing, he asked if it
was right to worry about a potential downgrade, and your
comment was something like that it could happen. Is that right?
Mr. Pearce. The worry is that it could happen.
Mr. Wilson. We have done a lot of work on this and talked
with a lot of folks, and it is as you know very difficult to
assess the impact--
Mr. Pearce. But you said the problem is that it could
happen?
Mr. Wilson. That is correct.
Mr. Pearce. --and if it doesn't happen, then, whew, it is
okay.
Mr. Wilson. Yes, absolutely.
Mr. Pearce. Okay. I am going to pursue that and drill down
just a little bit on that, if you don't mind.
Mr. Van Der Weide, on page 2, you described things that
caused the ratings to be bad--untested models, flawed
assumptions, limited, unverified data about underlying asset
pools, default frequencies, potential conflicts.
And then on page 3, you say these flaws contributed to
issuance of credit ratings that severely underestimate the
credit risk of the--anyway, they underestimate the risk.
And so my question is, is it possible for us to
underestimate the risk with regard to the Federal Government?
Mr. Van Der Weide. I think there is a fair amount of
uncertainty.
Mr. Pearce. So even if we don't default on August the 2nd,
are there uncertainties still lying out there?
Mr. Van Der Weide. There certainly are uncertainties. And
part of our job as bank regulators, the Fed, the OCC--
Mr. Pearce. Who is in charge of making sure that those bond
ratings, those rating agencies adequately correct the problems
on the previous page? Who is responsible to make sure that
doesn't happen again?
Mr. Van Der Weide. It is a complicated question. Our
specific responsibility--
Mr. Pearce. Basically, if it is complicated, that means
nobody is responsible.
Mr. Van Der Weide. I'm sorry?
Mr. Pearce. Nobody is responsible. Any time I hear the
words, ``it is complicated'' in Washington, it means nobody is
responsible.
Mr. Van Der Weide. There are different agencies that are
responsible for part of the solution.
Mr. Pearce. And if we are all responsible, none of us are
responsible. I already know that. I have six brothers and
sisters. If we could ever make it a big deal, it was not a
small deal. It wasn't us.
Mr. Van Der Weide. Yes, sir. But the banking agencies are
responsible for doing their part to remove the references from
our regulations, and we are working on that.
Mr. Pearce. Okay. So as we look then, I was going through a
fascinating process yesterday looking at a failed bank. And it
was really a solid-looking bank, solid, solid, solid, and they
went in, and they realized they had not adequately judged the
asset pool, not looked at things. And so all of a sudden, it
skyrocketed in risk, because the rating agencies suddenly
became aware of that.
Then Mr. Miller made these very precise comments, and I
know that they are accurate, about the repo accounts and Bear
Stearns. And they were doing things that were risky. And you
have said that we have cured that risk.
So my question, Mr. Wilson, is would it worry you that the
asset pool of the U.S. Government repaying our debt is actually
being printed by the guy sitting next to you, a deal called
quantitative easing? Chairman Bernanke came in the day before,
or a few days before, and said he is fully ready to do it
again, Quantitative Easing 3.
You mention on page 2 of your testimony that you all do
alternative creditworthiness standards. Now, I know they
haven't been downgraded and they may not be downgraded on
August the 2nd. But, you saw the falseness of Bear Stearns
doing what they were doing, the repos. The oversight agencies
have seen the falseness of what was going on in banks.
Is anyone daring to speak--are you internally developing
alternative creditworthiness standards for the U.S. Government?
Mr. Wilson. We are not.
Mr. Pearce. That is fine enough. But we are all
participating in a little process here. We are going to print
money and make sure that we can pay the bills, and we are going
to make sure we pass that legislation so that we don't default,
because that is a huge deal, and we can't stand that.
I think in truth the creditworthiness of the U.S.
Government has never been adequately looked at and is not being
adequately looked at now. So if we pass August the 2nd, I think
we still have a system that is very badly out of kilter, and we
are printing money to make it work, and we are going to act
like we can just continue to whistle while we work. And
somewhere somebody ought to get some truth in the system.
I yield back, Mr. Chairman.
Chairman Neugebauer. I thank the gentleman.
And now, I recognize Ms. Hayworth for 5 minutes.
Dr. Hayworth. Thank you, Mr. Chairman.
And, gentlemen, thank you for being here.
The E.U. Commissioner in charge of financial reform is
Michel Barnier. And I am going to quote something that he said:
``The CRA ratings are too embedded in our legislation, and I
intend to reduce as much as possible the references made to
those ratings in our prudential rules. That is my first
priority today.'' This was last week.
``I can already tell you that the first of these measures
to limit overreliance will be integrated into the upcoming
modification of the capital requirements directive--otherwise
known as CRD 4--and which is the effective translation of Basel
III into E.U. law. I will make these proposals on the 20th of
July. To limit overreliance we will be strengthening the
requirement for banks to carry out their own analysis of risk
and not rely on external ratings in an automatic and mechanical
way.''
And, as I understand it, our current statutory requirements
are to--on our side, as well--to limit the weight of CRA
ratings in these capital requirements.
Given that, of course, you rely on the statutory authority
from our Congress and you work with our European counterparts
to create the compliance with Basel III, what is your plan to
advance--do you have a plan to advance the goal of not
automatically and mechanically having CRA ratings be a part of
how you evaluate bank capital?
Any of you? Thank you.
Mr. Van Der Weide. We do.
I think it is important to note that there is an evolving,
perhaps evolved, global consensus on this particular issue at
this point. I think all the major jurisdictions are moving
towards removing reliance by government and private sector
reliance on credit ratings and removing them from the bank
capital requirements.
We are in extensive discussions with our international
counterparts, both through the Financial Stability Board and
the Basel Committee about what the right way to do that is.
The focus of attention, I think, in the short term is where
the rating agencies screwed up the worst, and that is in the
structured finance area. So we are having active discussions in
international fora about what the right way is to reduce
international capital rules reliance on rating agencies. I
think we are making some good progress on that.
And we are also spending a lot of time--the OCC, the Fed,
the FDIC--working through the different alternatives for
removing those ratings from the U.S. implementation, the U.S.
form of the global capital rules--
Mr. Wilson. I just would echo almost everything Mark said.
We all agree that this rote mechanical reliance on credit
ratings was not the right way to go. There is global consensus
on that. We are all looking for good ideas to reduce reliance.
I think, again, the question is reducing reliance or just
absolutely banning reliance on it, so--
Dr. Hayworth. Thank you. Thank you both.
It certainly sounds as though, of course, there is--
speaking as a consumer of information and as an investor in my
own life, it is challenging. I trust that you are working on
what we can offer to assure our consumers of financial products
that there is, in fact, a way in which we can reliably use
parameters to judge the quality of capital at our institutions.
One appeal, obviously, of having credit rating agencies is
that if it works right, then you have a standard. But the
problem seems to have been that, unfortunately, that standard
was not one on which we could rely as scientifically as we
thought.
Is that an accurate impression?
Mr. Van Der Weide. Yes, I think that is pretty accurate.
I think one of the core principles that we have in the
interagency working group that has been looking at this issue
is to try to find a replacement for credit ratings that is
transparent and consistent across different banks, across
different financial instruments.
We think that is useful to the markets, useful to the
banking system, useful to the regulatory agency, so
transparency is one of the hallmarks that we are striving for.
Dr. Hayworth. Thank you all.
And I yield back my time, Mr. Chairman. Thank you.
Chairman Neugebauer. I thank you.
Mr. Stivers is recognized for 5 minutes.
Mr. Stivers. Thank you, Mr. Chairman.
I am Steve Stivers. I represent Columbus, Ohio, and the
surrounding areas. In my district, we have a big Honda plant
that makes about a half million cars a year and employs about
4,400 people, and uses asset-backed bonds to finance the
building and financing of cars. And so, I have some questions
for Mr. Ramsay.
The first question I have, the gentleman from Massachusetts
earlier sort of embedded in a question, assumed that the
ratings are not in prospectuses anymore of asset-backed bonds,
but, in fact, they are indeed still in the prospectuses. And
the SEC is still requiring that, aren't they, Mr. Ramsay?
Mr. Ramsay. Our rules currently still, as I understand it,
require ratings in prospectuses. But that is a topic that is
out for public discussion and comment.
Mr. Stivers. Great. And the status of that--is there a
pending proposed rule out there? These are yes-or-no questions,
if you could. It's really easy.
Mr. Ramsay. Yes.
Mr. Stivers. So it is a proposed rule, or is it in draft
form?
Mr. Ramsay. I believe there is a proposed rule.
Mr. Stivers. Okay. And it would remove the ratings. Because
I have not seen the proposed rule--I have heard there is a
discussion draft, but I have not seen a proposed rule.
Mr. Ramsay. I believe the Commission yesterday put out a
proposed rule to remove, at least for shelf registration ABS,
the requirement for ratings.
Mr. Stivers. Great, thank you.
And the next question I have goes to sort of how these
things happen. So is the credit rating agency involved in
preparing a prospectus, reviewing a prospectus, or is the
credit rating agency just taken and inserted by attorneys and
accountants in the prospectus?
Mr. Ramsay. Congressman, you are getting out of my depth in
terms of the way that those things are prepared. I think the
rating agencies have--I am not aware that they are involved
heavily in the preparation of the prospectus itself--
Mr. Stivers. That is my understanding, as well. And I guess
that just goes to the point that the prospectus is not their
document.
And so let us talk for a second about what you know about
Section 932, 933 of Dodd-Frank. The gentleman from Delaware
alluded to this, as well. Is there not indeed still liability
for the credit rating agencies under those sections, even if
939G were to go away?
Mr. Ramsay. In general terms, Congressman, yes, there are
two potential routes for liability. One is Section 11, which is
the, sort of, higher standard of liability that exists for
accountants and certain other experts. And then there also is,
sort of, general anti-fraud liability under Section 10-b.
Mr. Stivers. And even before Dodd-Frank, weren't the credit
rating agencies sued before that new clause of liability was
inserted?
Mr. Ramsay. They have been from time to time--
Mr. Stivers. And successfully sued in cases.
Mr. Ramsay. I am not aware exactly what the court precedent
is. I am not aware that there is any one pattern of decisions
on this.
Mr. Stivers. But it has not been universally unaccepted.
That is the point. We didn't even need the new liability in
section 932 and 933 of Dodd-Frank. Nobody is proposing that to
go away. But certainly the 939 provision, I think, is of
concern to a lot of us, because it has frozen up the asset-
backed market. The market is depending on an indefinite no-
action letter from the SEC.
I am excited to hear that yesterday you proposed a new
rule. I will have to go check that out, but I had not seen it.
I had heard there was a discussion draft, but I hadn't seen it,
so I will certainly go look for it today.
Thank you. I yield back.
Mr. Carney. Will the gentleman yield?
Mr. Stivers. Sure.
Mr. Carney. Yes, thank you to the gentleman from Ohio.
I would just like clarification from Mr. Ramsay. You said--
I thought I heard you say that your requirement that the rating
be in the prospectus is still enforced. Is that what you said?
Mr. Ramsay. My understanding, Congressman, is that for
asset-backed deals generally there is still a requirement that
the rating information be included. There is a no-action letter
that is out that is sort of--
Mr. Carney. So the no-action letter, and you just mentioned
that a minute ago, frankly, means that the ratings, as I
understand it, are not being included in the prospectuses but
they are being included in the selling documents. Is that your
understanding?
Mr. Ramsay. That is my understanding.
Mr. Carney. I just wanted to clarify that for the record.
Mr. Stivers. That is not my understanding, I will tell you.
I believe that they are being included. And, frankly, the no-
action letter applies to the 939G provisions of holding people
liable as experts. Is that not correct, Mr. Ramsay?
Mr. Ramsay. Congressman, at this point perhaps I should
have my friends in the Division of Corporation Finance get back
to you with that before I--
Mr. Stivers. I am pretty sure that--I have talked to them.
I could be wrong, but I am pretty sure that is right.
Thank you.
I yield back, Mr. Chairman.
Chairman Neugebauer. Thank you.
I think that is all of the questions from both sides. We
want to thank this panel. And with that, we will dismiss this
panel and call up the second panel.
I would like to welcome our second panel here: Mr. Deven
Sharma, president of Standard & Poor's; Michael Rowan, global
managing director, Commercial Group, Moody's Investors; Mr.
James Gellert, CEO of Rapid Ratings; Mr. Jules Kroll, chairman
and CEO, Kroll Bond Rating Agency; Mr. Lawrence J. White,
Robert Kavesh professor or economics, Stern School of Business
at New York University; and Mr. Gregory Smith, chief operating
officer and general counsel, Colorado Public Employees
Retirement Association.
I would remind you that your written statements will be
made a part of the record, and you will each be recognized for
5 minutes.
Mr. Sharma?
STATEMENT OF DEVEN SHARMA, PRESIDENT, STANDARD & POOR'S
Mr. Sharma. Thank you, Chairman Neugebauer, Ranking Member
Capuano, and members of the subcommittee. Good morning.
My name is Deven Sharma, and I am the president of Standard
& Poor's and have served in that capacity since September 2007.
I am pleased to appear before you today.
Much has changed with regard to credit ratings and credit
rating agencies over the past several years, both in terms of
how we go about our work and the regulatory framework in which
we operate. For our part, we at Standard & Poor's have
undertaken a variety of initiatives in recent years designed to
further our fundamental mission of providing the market with
high-quality independent benchmarks about the creditworthiness
of debt securities.
These initiatives include measures designed to strengthen
the governance and control framework and has the analytics and
criteria we use to rate issues and issuers and clearly
communicate the rationale behind our actions and better
identify and report on key areas of risk in order to further
transparency in the markets.
These initiatives reflect the great lengths and significant
efforts we have made to enhance the way we go about serving
investors, regulators, and the capital markets. Put simply,
with these added checks and balances and enhanced analytics,
our organization today operates very differently than it did
even just a few years ago.
These changes include investing significantly in our
compliance and quality operations, including significant staff
additions; establishing an independent criteria review and
approval process; supplementing existing controls against
potential conflicts of interest, including implementing look-
back reviews and an analyst rotation program; and adopting
enhanced ratings definitions and updating of criteria across
major asset classes to map it to those definitions.
This has enhanced ratings comparability across asset
classes and across geographic regions. It has also led us, on
balance, to look for stronger credit characteristics for
securities seeking higher ratings, enhancing disclosure in the
ratings reports of applicable factors and variables, applicable
criteria and the assumptions underlying their analysis, and
finally, increasing analytical training of our analysts,
including a new analytical certification program.
A more comprehensive list of these initiatives can be found
in my written submission, as well as on our Web site,
www.standardandpoors.com.
Of course, the regulatory landscape of credit ratings has
also undergone major change. Through legislation and related
rulemaking, regulatory measures have reinforced and
strengthened the integrity of the ratings process through
increased oversight, greater transparency and accountability,
and improved analyst training.
Specifically, the passage of the Credit Rating Agency
Reform Act in 2006, together with a rigorous set of governing
rules adopted by the SEC, established the first comprehensive
regulatory scheme governing credit rating agencies.
NRSROs are now required to make extensive disclosures of
procedures and methodologies for determining ratings,
performance measures, and statistics for credit ratings,
policies for addressing and managing potential conflicts of
interest.
The CRA Act also empowered the SEC to conduct detailed and
lengthy examinations of rating agencies' practices and
procedures and lowered barriers to entry for other credit
rating agencies to register with the SEC. Indeed, several new
ratings agencies have been registered in recent years,
including those that employ the investor-paid business model
and the rating agencies that use different analytical
approaches in deriving ratings. S&P believes increased
diversity of approaches and views benefits the markets with
more information.
Dodd-Frank represented another significant event in the
evolving landscape for rating agencies. One notable aspect of
Dodd-Frank is its requirement that Federal agencies review the
use of credit ratings in rules and regulations and remove
references to ratings from several areas of Federal law. S&P
has long supported addressing undue reliance on ratings by the
market through elimination of legal mandates in the use of
ratings.
Standard & Poor's welcomes many of the regulatory changes
and enhancements that have been put in place in recent years.
We also firmly believe that perhaps the most important value of
ratings is the independence and forward-looking view they
express about future creditworthiness.
For the markets to have confidence in those ratings, they
must ultimately represent the independent view of rating
agencies. That means, of course, that they should be free of
commercial considerations, and S&P is fully committed to that
principle. But it also means that they must be free of
regulatory or governmental influence as to their analytical
substance.
As Dodd-Frank rulemaking progresses, we believe it is
critical that new regulations preserve the ability of NRSROs to
make their own analytical decisions without fear that those
decisions will be later second-guessed, if the future does not
turn out to be as anticipated or that in publishing a potential
controversial view, they will expose themselves to regulatory
retaliation.
Pressures of that sort could only undermine the significant
progress we believe has been made over the years by rating
agencies and regulators alike to provide the market with
transparent, quality, and generally independent views about the
creditworthiness of issuers and their securities.
I thank you for the opportunity to participate in the
hearing, and I would be happy to answer any questions you may
have. Thank you.
[The prepared statement of Mr. Sharma can be found on page
118 of the appendix.]
Chairman Neugebauer. Thank you.
Mr. Rowan?
STATEMENT OF MICHAEL ROWAN, GLOBAL MANAGING DIRECTOR,
COMMERCIAL GROUP, MOODY'S INVESTORS SERVICE
Mr. Rowan. Good morning, Mr. Chairman, and members of the
subcommittee. My name is Michael Rowan, and I am the global
managing director of the Commercial Group at Moody's Investors
Service.
On behalf of my colleagues, I would like to thank you for
the opportunity to participate in today's hearing and to speak
to you about Moody's, the role credit rating agencies can play
in the markets, our competitive landscape, and the impact of
Dodd-Frank on the credit rating agency industry so far.
In providing you with our perspective on these questions, I
would like to outline two principles that have guided us over
the years.
First, Moody's believes that the legislative initiatives
that periodically review and update the regulatory regime under
which market participants operate are both necessary and
healthy. They can increase market confidence that rules are
fair and the playing field is level. They also encourage best
practices among and across industries.
Second, we think that markets thrive when the regulatory
landscape allows for and encourages numerous differing views
while permitting market participants to choose opinion
providers based on quality.
It is equally important that contrarian opinions not only
be tolerated, but encouraged.
For these reasons, Moody's has been a strong advocate of
competition in our industry, so long as that competition occurs
on the basis of quality.
Moody's has developed our reputation over a long period of
time. We are, however, also well aware of the loss of
confidence in the credit rating industry, largely driven by the
performance of the U.S. residential mortgage-backed securities
sector and related collateralized debt obligations.
Over the past several years, Moody's has adopted and will
continue to adopt a number of measures to regain confidence of
our ratings in that sector.
The actions and initiatives that we have pursued in the
recent past can be categorized into five broad areas:
strengthening the analytic integrity of credit ratings;
enhancing consistency across ratings groups; improving
transparency of credit ratings and the ratings process;
increasing resources in key areas; and bolstering measures to
mitigate conflicts of interest.
One initiative that I wish to underscore is the creation of
the department which I head, Moody's Global Commercial Group.
Our mandate builds on prior measures through which Moody's had
first prohibited rating analysts from discussing fees with
issuers and then extended that prohibition to their managers.
Last year, we took those efforts one step further and
created the Commercial Group to strengthen separation between
our credit rating and credit policy functions on the one hand
and our commercial functions on the other. My position in
particular was established to bring the commercial functions
under common leadership.
The Commercial Group is responsible for business strategy
and planning, new business origination, and managing the
relationships with issuers for the rating agency. The employees
of the Commercial Group have no involvement in determining or
monitoring credit ratings or developing or approving rating
methodologies.
Equally as important, Moody's analytic employees are not
involved in the commercial activities of the company, which
adds another layer of protection against the potential of
conflict.
In addition to our own internal efforts, Moody's supports
regulatory reform and believes that effective regulation of
credit rating agencies is positive for our industry and the
broader market.
For example, the Credit Rating Agency Reform Act of 2006
and Title 9 of the Dodd-Frank Act call upon nationally
recognized statistical rating organizations to be transparent
about their rating opinions and methodologies and to
effectively address conflicts of interest.
Dodd-Frank also introduced measures to enhance credit
rating agencies' accountability and reduce the regulatory use
of credit ratings.
In particular, Moody's has long supported removing
references to credit ratings in regulation. We believe that
mechanical triggers, regardless of whether they are ratings
based on market signals or another type of measure, can
inadvertently harm markets by amplifying rather than dampening
the risks in the system.
Finally, over the past year, the Securities and Exchange
Commission has been proposing rules and seeking comments for
studies related to the credit rating agency industry, as
mandated by the Dodd-Frank Act.
Moody's has submitted comments on these proposed rules and
studies and will continue to provide our views throughout the
SEC's public comment process. We anticipate that the new rules
will spur various changes in Moody's processes and operations,
as well as lead to the codification and deepening of some of
Moody's existing practices.
While we anticipate that the evolving regulatory landscape
will lead to further change, our objective remains what it has
been for the past 100 years: to provide the highest quality
credit opinions, research and analysis.
Thank you, again, for inviting me to testify on this
important matter. And I look forward to answering your
questions.
[The prepared statement of Mr. Rowan can be found on page
102 of the appendix.]
Chairman Neugebauer. I thank the gentleman.
Mr. Gellert?
STATEMENT OF JAMES H. GELLERT, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, RAPID RATINGS INTERNATIONAL, INC.
Mr. Gellert. Thank you. On behalf of Rapid Ratings'
employees and shareholders, I would like to thank Chairman
Neugebauer, Ranking Member Capuano, and the members of the
subcommittee for asking me to join you today. My name is James
Gellert, and I am the chairman and chief executive officer of
Rapid Ratings.
As we arrive at the 1-year anniversary of Dodd-Frank, we
face essentially the same or worse ratings landscape as 1 year
ago. S&P, Moody's, and Fitch have undiminished influence,
competitors that are NRSROs have even more challenges and
costs, and non-NRSRO rating agencies are even less likely to
apply to be one.
Rapid Ratings is neither an NRSRO nor a traditional rating
agency. We are a subscriber-paid firm. We utilize a proprietary
software-based system to rate the financial health of thousands
of public and private companies and financial institutions from
70 countries. We re-rate all U.S. filers quarterly. We use only
financial statements, no market inputs, no analysts, and have
no contact with issuers, bankers or their advisers.
In a recent third-party academic paper, we are identified
as being 2.9 years earlier than Moody's in downgrading to below
investment grade companies that ultimately fail. We represent
innovation and competition in ratings.
Dodd-Frank has positive and negative initiatives, but
ultimately it penalizes the wrong players, creates
disincentives for new players to enter the business, and misses
opportunities to truly change the ratings industry.
The biggest positive initiative is the removal of NRSRO
references from Federal regulations. Many have covered that,
and I think will, so I will skip that for the moment and refer
you to my written testimony on that subject.
The negative developments can largely be grouped as
increased reporting, oversight, board construction,
administrative and compliance duties.
I do not disagree with prudent governance and compliance,
but I am discouraged by the immense costs associated with
complying. Many of these rules were implemented to address the
conflicts of interest and behavioral issues of the big three,
and ironically those companies are the only ones that can
easily afford to comply.
Increased liability dominated the reform debate throughout
2009 and into the enacting of Dodd-Frank. It is perhaps the
most politically charged and roundly understood concept for
reform by the public at large.
It may be fair to levy stricter liability standards on
those agencies that contributed directly to the crisis, but
Dodd-Frank changed the relevant language from NRSRO to credit
rating agency at the last minute. This change was the only
material instance where non-NRSROs were captured by this new
statute. I wonder why. I suspect to prevent NRSROs from
unregistering. If so, this is quite a statement about how the
drafters felt Dodd-Frank would go over with the big three
rating agencies.
I suggest that CRAs that have never been NRSROs should be
given safe harbor from these liability provisions. Section 932
of Dodd-Frank covers the disclosure of ratings methodologies in
the attempt to measure ratings accuracy. The SEC's
implementation regulations, which are out for comment, propose
so much disclosure of underlying methodology that they put at
risk the intellectual property of a firm like Rapid Ratings
that is innovation-driven. This is overkill.
On accuracy, without question, more accurate ratings are
good for the market. However, regulatory enforcement of a
prescription of accuracy--of accurate ratings--is not. Markets
drive innovation, not regulations.
If a standard for ratings accuracy is prescribed by
regulation, over time agencies will engineer ratings to the
standard by which they are being measured. This means fewer
diversified opinions, not more. Homogenizing ratings only
correlates risk-taking and increases systemic risk.
A major shortcoming of Dodd-Frank is it does nothing to
expand NRSROs' access to data used by other NRSROs in the
ratings process. Firms can now access due diligence data on
some forms of structured products, but not nearly enough.
Collateralized loan obligations are the perfect example, as
detailed in my testimony.
Next week, I will propose in a comment letter to the SEC a
simple yet potentially wide-reaching initiative to assist in
the improvement of this industry. All NRSROs should be required
to file an affirmative statement with the SEC that they confirm
or change each previously issued and outstanding rating on a
quarterly basis.
This initiative would force firms to think more carefully
about their initial ratings and ensure they stand by their
product, promote some confidence in the ratings process among
users, make asset managers more responsible for understanding
more frequent ratings changes instead of arbitraging stale
ratings, and ensure that the SEC has more performance data.
Effective reform will only come with the following: not
stifling competition through compliance costs; removing
references from regulations to decrease dependence on NRSROs;
promoting innovation and avoiding the homogenization of
ratings; and increasing the flow of data critical to providing
new ratings into the market.
Why take a young, hungry competitor in the rating space and
subject it to all manner of change, increased scrutiny, costs,
liabilities, uncertainties and a playing field that changes and
then changes again? Until there are benefits that outweigh the
costs, we will build our business outside the NRSRO network.
Thank you.
[The prepared statement of Mr. Gellert can be found on page
64 of the appendix.]
Chairman Neugebauer. Thank you.
Mr. Kroll?
STATEMENT OF JULES B. KROLL, EXECUTIVE CHAIRMAN, KROLL BOND
RATING AGENCY, INC.
Mr. Kroll. Thank you for the opportunity of speaking with
you this morning, Chairman Neugebauer, Mr. Capuano, and other
Members of Congress.
My statement is a very personal statement. I built my
previous company starting 40 years ago focused on the concept
of due diligence, and focusing on the concept of fighting
corruption in the corporate world and ultimately in the
government world.
It was all about bringing professionalism to an industry
which was not held in very high repute in those days, called
the private detective industry. So unlike James, I can't take
on the attributes of the young, hungry competitor, so consider
me an old, hungry competitor.
Thank you, Larry.
A couple of things I would like to say personally. I had
sold my company. I was in pretty good shape. My wife was
complaining I was hanging around the house a little too much.
And I began to look at things where I might apply my experience
and the experience of my colleagues to an important public
policy issue, as we had with corruption and payoffs and
kickbacks in the 1970s, 1980s, and 1990s.
I had always marveled at the racket that these big rating
agencies had. It was beautiful. Charge whatever you want. Take
no responsibility. Hide behind the First Amendment. Make a lot
of money. It looked like a good business model to me. So I
began to study it and to see whether our skills and our history
and our knowledge could be applied here.
Now, this is a personal statement from me. My view is the
whole concept that you hide behind the First Amendment and
accept no accountability for your work is irresponsible, and it
is scandalous. I have yet to hear people say at the big three
that they are sorry. They have said they underestimated the
depth of the housing crisis in America. Who do you think
contributed to it?
I don't want to whine about that. I want to tell you what I
am doing about it and the traction that we are getting, but
some of the obstacles we face. So I don't know about the rest
of you, but when I read a novel, I cheat. I go to the end. I
want to see is the hero or the heroine still alive. So I won't
hold you in suspense in my remaining 2 minutes and 34 seconds.
We became an NRSRO because we felt when it came to public
pension funds and it came to corporate pension funds and
university endowments and other foundations, there was no
official status to your rulings unless you were an NRSRO. So as
long as there is an NRSRO, we had to become one.
So we bought the tiniest one there was. It was a little
company doing $1 million a year. We developed a marvelous
business model. We managed to spend more money on lawyers and
compliance in the last year than that little company had
revenue. Now, my wife has informed me this is not a good
business strategy, but it is an essential one, because we
needed a better foundation to build on.
So here are my asks. Number one, let us go back to the
Fitzgerald bill and its attempt to encourage competition. And
there were a few little firms that came in. One of them, we
bought. Another one, Egan-Jones, is still in business. And then
there is Realpoint that was acquired by Morningstar.
Those are the three smaller ones. And by the way, there is
nothing that James has said that I don't completely endorse.
Whether an NRSRO or not an NRSRO, he has gotten it right.
So number one, we have to look at the 500 pages of
regulations that the SEC promulgated in response to Dodd-Frank,
no less on my birthday, May 18th, and I was meeting with them
on May 19th. They have made an effort to comply. They have
tried in each and every way to be in sync with the legislation
from Dodd-Frank.
But when you are making rules for, in effect, an oligopoly,
with massive numbers of people who are working in every
discipline and opining on which countries should be downgraded
or not downgraded, that is a different species. The mice can't
run and compete with the elephants, if we have the burdens and
the expense that are laid on because of this.
And I have some sympathy for the big three, but frankly not
much, given the amount they make. These are among the most
profitable companies in America. It is time for them to
reinvest in the quality of what they do.
Our business is totally focused on where the problem was.
We are totally focused in the structured finance area. And we
are building it silo by silo, and we are making headway. So my
ask is lighten up on the burdens from a regulatory point of
view and let us just get on the field and compete face to face
on the accuracy and the quality of our ratings and let us not
hide behind the First Amendment. Let us be accountable for our
work.
Thank you.
[The prepared statement of Mr. Kroll can be found on page
89 of the appendix.]
Chairman Neugebauer. Thank you, Mr. Kroll.
Mr. White?
STATEMENT OF LAWRENCE J. WHITE, PROFESSOR OF ECONOMICS, STERN
SCHOOL OF BUSINESS, NEW YORK UNIVERSITY
Mr. White. Chairman Neugebauer, Ranking Member Capuano, and
members of the subcommittee, my name is Lawrence J. White. I am
a professor or economics at the NYU Stern School of Business. I
represent solely myself at this hearing. Thank you for the
opportunity to testify today on this important topic.
The three large U.S.-based credit rating agencies--Moody's,
Standard & Poor's and Fitch--and their excessively optimistic
ratings of subprime residential mortgage-backed securities in
the middle years of the past decade played a central role in
the financial debacle of the past 2 years.
Given this context and history, it is understandable that
there would be strong political sentiment, as expressed in
Section 932 of the Dodd-Frank Act, for more extensive
regulation of the credit rating agencies in hopes of
forestalling future debacles.
The advocates of such regulation want figuratively, perhaps
literally, to grab the rating agencies by the lapels, shake
them, and shout, ``Do a better job.''
This urge for greater regulation is understandable and
well-intentioned, but it is misguided and potentially quite
harmful. The heightened regulation of the rating agencies is
likely to discourage entry, rigidify a specified set of
structures and procedures, and discourage innovation in new
ways of gathering and assessing information, new technologies,
new methodologies, and new models, possibly including new
business models, and may well not achieve the goal of inducing
better ratings from the agencies.
Ironically, these provisions will also likely create a
protective barrier around the larger credit rating agencies and
are thus likely to make them even more central to and important
for the bond markets of the future.
Why would we want to do that?
You just heard from Mr. Gellert and Mr. Kroll about all the
problems that Section 932 creates, especially for the smaller
agencies.
There is a better route. That route is also embodied in the
Dodd-Frank Act. It is sections 939 and 939A. These are the
sections that remove statutory ratings--references to ratings--
and that instruct Federal agencies to review and modify their
regulations so as ``to remove any reference to or requirement
of reliance on credit ratings and to substitute in such
regulations such standards of creditworthiness as
appropriate.''
Doing so would really open up this bond information
industry in a way that it has really not been open since the
1930s.
Unfortunately, financial regulators, especially the bank
regulators, have been slow to implement these provisions. You
heard from them earlier today. They have been slow, especially
the bank regulators.
On one level, this slowness, this reluctance is
understandable. Regulatory reliance on an existing set of
rating agencies is easy. It is a check-the-box kind of
approach. It is easy for the regulator. It is easy for the
regulated.
But at another level, this is not rocket science we are
talking about. The approach of the regulators ought to follow
the same approach that bank regulators already use--they
currently use--for assessing the safety and soundness of the
other kinds of loans that are in bank portfolios.
That approach basically says, ``Place the burden directly
on the bank or other financial institution to demonstrate and
justify the safety and soundness of their bond portfolios.''
That is essential. That safety must--and the regulatory
approach to that safety must--remain.
The financial institutions can do this either by doing
their own research and analysis themselves in-house, or they
can rely on third-party sources of creditworthiness
information. Third-party sources might encompass the existing
incumbent NRSROs or other sources of creditworthiness
information--and there are other sources: There are the smaller
non-NRSROs. Mr. Gellert represents one of them. There are
creditworthiness fixed-income analysts at securities firms. And
in a more open environment, these analysts might be encouraged
to hang out their own shingles and start doing more independent
analysis on their own.
Of course, regulators have to check on the competence of
the financial institutions in doing that research or in
employing the services of those creditworthiness advisers, but
it can be done.
So Section 939 and 939A are the direction to go. When they
are fully implemented, then there wouldn't be any need for the
NRSRO system, to address a question you raised earlier, Mr.
Chairman.
And if we can somehow avoid the dangers of Section 932--
ideally, if it were my choice, I would repeal 932 in a
heartbeat--then the bond information market, and that is really
what we are talking about, would be opened to innovation and
entry in ways that have not been possible since the 1930s.
My written statement expands on these ideas. Thank you,
again, for the opportunity to testify this morning. I would be
happy to answer questions from the committee.
[The prepared statement of Dr. White can be found on page
216 of the appendix.]
Chairman Neugebauer. Thank you, Mr. White.
Mr. Smith, you are recognized for 5 minutes.
STATEMENT OF GREGORY W. SMITH, GENERAL COUNSEL AND CHIEF
OPERATING OFFICER, COLORADO PUBLIC EMPLOYEES' RETIREMENT
ASSOCIATION
Mr. Smith. Thank you. Mr. Chairman, Ranking Member Capuano,
and members of the subcommittee, thank you for having me. Good
afternoon. I am Greg Smith, general counsel and COO of the
Colorado Public Employees Retirement Association (PERA). I am
also a member of the board of directors of the Council of
Institutional Investors.
I appreciate the opportunity to speak to you today. My
testimony is going to emphasize three points: first, the
systemic risk being created by the premature removal of credit
ratings from all regulations from the perspective of an
investor; second, the SEC's role in oversight of credit rating
agencies and what it takes to accomplish that goal; and,
finally, the critical nature of the provisions making credit
rating agencies accountable, as are others, for their products
that they sell.
Colorado PERA is a pension fund with more than $40 billion
in assets. And, as general counsel and COO, I am responsible
for protecting the retirement security of more than 475,000
participants and beneficiaries in that system.
In that capacity and as a board member of the council, I
have had the opportunity to study the issues surrounding the
credit ratings industry and the ways in which ratings agencies'
actions impact institutional investors and pension funds.
At the outset, it is important to note that neither prior
to the financial crisis nor subsequent to the passage of Dodd-
Frank has Colorado PERA ever relied on rating as a sole source
of buy-sell decisions. Rather, ratings are used as a part of a
mosaic of information we consider during the investment
process. That is the way all responsible institutional
investors have done it and continue to do it.
Our investment process involves risk budgeting, an effort
to ensure that investment managers are generating appropriate
returns within a specified range of risk. A consistent and
reliable risk measure is critical to institutional investors in
order to manage those risk budgets. In addition, ratings are an
important factor in our decision to participate in short-term
credit facilities, such as cash accounts and money market
funds.
We fully agree with the conclusions of the Financial Crisis
Inquiry Commission and many others that, ``the failures of
credit rating agencies were an essential cog in the wheel of
financial destruction.''
In light of those failures and the credit rating agency
provisions of Dodd-Frank that followed, Colorado PERA has begun
a process of consulting with internal fund managers and outside
experts in order to identify appropriate alternative measures
of risk.
We are hopeful that, once identified, such measures can
also help to define in our investment management agreements the
level of risk to be taken on by our individual portfolio
managers. The process, however, as we have heard from the OCC
as well as the Fed today, is a challenging one. And to date,
identifying cost efficient measures that could comprise a
robust, objective evaluation of credit risk remains elusive.
In the meantime and to the extent that credit rating
agencies continue to act as gatekeepers for the financial
markets, we strongly believe that rating agencies should have
an appropriate level of government oversight and accountability
to investors at least as rigorous as auditors, investment
banks, and other financial gatekeepers.
Providing an appropriate level of government oversight for
credit rating agencies requires sufficient funding of the SEC
so that they can implement and enforce the provisions of Dodd-
Frank that begin to address credit rating agency conflicts of
interest, lack of transparency, and other deficiencies.
As you are aware, SEC funding does not increase the Federal
deficit, because its budget is fully offset by fees imposed on
financial entities engaged in SEC-regulated securities
transactions.
Depriving the SEC of necessary funding as a supposed
punishment for past failures is counterproductive and contrary
to the needs of investors. Providing an appropriate level of
accountability to investors requires that credit rating
agencies be subject to liability to investors for poor
performance and poorly managed conflicts.
As you might expect, we were disappointed by the Committee
on Financial Services' vote last week in support of House
Resolution 1539. As you are aware, that bill would amend Dodd-
Frank to provide those NRSROs that directly contributed to the
multitrillion global financial crisis a shield from
accountability to investors.
We note that a similar shield from liability is not
provided under the Federal securities laws to any other
financial gatekeepers.
Colorado PERA and the council stand ready to work with this
subcommittee, the SEC, and other interested parties to better
ensure that the credit rating agencies post-Dodd-Frank will, to
the extent possible, more effectively and efficiently serve the
needs of investors and all participants in the U.S. financial
system.
That concludes my prepared remarks. I look forward to your
questions. Thank you.
[The prepared statement of Mr. Smith can be found on page
129 of the appendix.]
Chairman Neugebauer. I thank the panel.
And we will start with questions. I will recognize myself
first for 5 minutes.
I want to put up a chart. I know it is hard to read, and so
that chart is being passed out, and we will make sure the
panelists get one as well.
Basically, where I am going with this is that one of the
things I feel like Dodd-Frank does is it makes the big get
bigger and it is not--what we have heard is testimony here that
even in the rating agency space--but also what I think Dodd-
Frank has also done and what is going on in the rating agency
is they are kind of complicit in the fact that we are helping
the big financial institutions actually stay bigger and
actually giving many of those an unfair advantage.
And so what you have here is a chart that basically shows
the ratings of four banks, and so there is a kind of a before
the uplift and after. And basically, what you see are two
banks, SunTrust and TrustMark, that actually have a before
uptick ratings of A3, and then we have Bank of America and
Citigroup has a Baa2 rating, in using ratings of bank financial
strength, C, and the two other banks, C-minus.
But when you look at the upticks that they are getting, for
example, Bank of America is getting a 5-point uptick. And so,
it takes it up to Aa3 and Citigroup gets an uptick 4 to A1.
And so the concern here is, and what I am hearing over and
over again, is that we haven't cured this too-big-to-fail
perception out there among the rating agencies, and that, in
fact, the rating agencies today are giving these systemically
important financial institutions advantage over other financial
institutions that may, in fact, from a core standpoint be more,
obviously, from your own ratings, maybe be a better financial
risk on a standalone basis.
So my question is, where are we in this process of removing
this too-big-to-fail advantage for these large financial
institutions?
Mr. Sharma, I will start with you.
Mr. Sharma. Thank you, Mr. Chairman. In the spirit of our
objectives of transparency and clarity, we have recently also
clarified how we are going to rate banks in the future.
And we start with looking at the stand-alone credit risk
assessment of a bank on a number of factors that include
business position, risk exposure, funding, and liquidity.
But then after we do the stand-alone credit risk
assessment, we do look at what external support it may be
provided by a holding company or by a parent institution or by
government support. And in that context, we have created a very
simple framework that looks at different governments based on
their policies and regulations and history as to whether they
are supportive or supportive-uncertain or interventionist.
And then we look at different institutions as to how
important they are for the economy, the size, the
concentration, the interconnection across the different market
participants. And based on that, we determine how much support
we believe the government may provide to these institutions
when there is a crisis or a situation.
So in that context, we do believe, given the situation, we
are recognizing the Dodd-Frank Act has a very clear aim to
bring stability and raise the capital of the banks and the fact
that the banks should not be provided any support.
But our role is to provide the investor with a forward-
looking view. And in that context, our analysts have said, were
a similar situation to exist, we think, based on the history,
based on the size of the banks and the connectivity, that there
may be attempts at changing the policies to support the banks
in the future.
Chairman Neugebauer. But based--attached to the handout
there--based on a statement that was recently issued by your
company, you questioned whether the too-big-to-fail issue has
actually been settled.
Mr. Sharma. Mr. Chairman, that is my co-panelist's company,
Moody's, but we have also recently published research that
highlights the fact that we recognize the Dodd-Frank Act and
the aim of the Dodd-Frank Act to sort of take this too-big-to-
fail support away.
But we recognize on some of the connectiveness, the high
concentration of the large banks, the importance to the
sovereigns, that in a similar situation, policymakers may end
up looking at changes to the law to give support to the
institution in the future.
Chairman Neugebauer. And just for the record, the
statement, though, that is up there is a statement from--
Moody's is--these are ratings from--the table is from Moody's,
but the statement is from Standard & Poor's?
Mr. Sharma. Yes, and that is what I said. We have recently
published a similar--
Chairman Neugebauer. Yes. Just quickly, Mr. Rowan, your
response, because your company does the very same thing.
Mr. Rowan. Yes, Mr. Chairman.
Chairman Neugebauer. Won't you push your--yes, thank you.
Mr. Rowan. Sorry about that. Mr. Chairman, as the head of
the commercial group, I am completely removed from the rating
analysis, rating committees and the formation of the
methodologies, so I am not the person who can speak
authoritatively on the question and point that you are asking.
Chairman Neugebauer. At least let me ask you a question. Do
you think it give financial institutions an unfair advantage
that they get anywhere from two to four upticks for being
considered a risky financial institution? Do you think that
gives them an unfair advantage in the marketplace?
Mr. Rowan. Mr. Chairman, as I said, I am not involved in
the methodology, and I am aware that the methodology
incorporates the--
Chairman Neugebauer. I am not talking about methodology. I
am talking about common sense here. Do you think it is an
unfair advantage for an entity to get upticks just because the
Federal Government has not sent a clear signal whether it will
bail that entity out or not? Yes or no?
Mr. Rowan. Mr. Chairman, I am not the right person who can
give you a yes-or-no answer, but I can arrange to have the
right people speak with you and your staff, if that would be
helpful.
Chairman Neugebauer. So you don't have an opinion on that?
Mr. Rowan. As a representative of Moody's, sir, that is not
my specific area of expertise. I wouldn't want to mislead you.
Chairman Neugebauer. Okay.
Ranking Member Capuano, for 5 minutes.
Mr. Capuano. Thank you, Mr. Chairman.
Mr. Sharma, just to clarify, under your understanding of
current law, current law alone, you don't think we have made
any changes? I know what you said is, based on what you think
we might do, that is what you think. But based on current law,
do you think that too-big-to-fail still exists?
Mr. Sharma. The current law clearly states that, and it is
very clear about that, that it--
Mr. Capuano. Clearly states what?
Mr. Sharma. That it will not provide any--
Mr. Capuano. That we will not. So it does not provide.
Therefore, your opinion is based on your opinion that we might
act.
As a matter of fact, obviously, I won't read the
transcript, but I wrote it down, I think, pretty clearly, that
your opinion is based on the fact that you think we maybe will
attempt to change the policies, which means the current policy
to support. So when your opinion is based on your fact that you
think, in your professional opinion, which you are entitled to,
that we would change our current policies to react to a new
situation?
Mr. Sharma. Yes, that is exactly what our analysts have
said.
Mr. Capuano. That is fair.
Mr. Sharma. That is their future view of how things may
happen.
Mr. Capuano. That is a very fair statement. I just wanted
to be clear about that. You don't think that we do it now. You
think that we would react to it. And as long as it is a
statement of your opinion of what we would have to do, we would
have to change current law and our current activities in order
to do this again--
Mr. Sharma. Correct.
Mr. Capuano. --which, of course, we could change law to do
anything we wanted.
Mr. Sharma. Sure.
Mr. Capuano. That is the whole idea of why Congress exists,
to change laws.
I appreciate that, Mr. Sharma. I just want to make that
clear. It is your opinion of what we might do in the future.
And, Mr. Rowan, I know you are not the perfect person to
answer this. It is my understanding that Moody's has officially
said that they think that too-big-to-fail has been ended. Is
that a fair reading of what--not yours; I am not asking for
your opinion. I recognize you said you are not the guy here,
but I would hope that you would know what Moody's has said as a
general statement.
Mr. Rowan. Mr. Congressman, I am not sure that is Moody's
official statement. I can arrange to have the individuals who
are responsible for that--
Mr. Capuano. That is fair enough.
Mr. Rowan. --but I can't answer your question.
Mr. Capuano. I think that you should arrange to have them
put their official documents on the record, because it is my
understanding that Moody's has said so. I am not going to hold
you to it, and maybe I am wrong. I guess I am rolling the dice
here, but I have been led to believe that Moody's has said
that, and, therefore, I would like Moody's to go on the record
one way or the other what you think about too-big-to-fail,
because I have been led to believe they do.
Shifting to another thing, Mr. Kroll, I wanted to push a
little bit. You had earlier said that you would agree with Mr.
Gellert on everything, yet your comment on the First Amendment
indicated that you may not agree, and I am not so sure.
As I understand it, the reason that we had to change some
of the laws to take away or to limit the First Amendment
defense of the credit rating agencies, we put in ``knowingly or
recklessly,'' which is now under the law, under the Dodd-Frank
law, the new standard as to credit rating agencies.
It has nothing to do with the First Amendment. The First
Amendment is what has been used up until now to prevent them
from having any liability whatsoever.
Do you disagree with that, first of all, understanding?
And, second of all, do you think that we should get rid of
the new standard of extending liability to rating agencies
under a ``knowingly or recklessly'' standard?
Mr. Kroll. I am not sure what your question is.
Mr. Capuano. The question is, you said that--I want to make
sure I understood it. I am under the impression you said we
should get rid of the First Amendment defense?
Mr. Kroll. No. What I said was the rating agencies should
be accountable like lawyers, like auditors--
Mr. Capuano. I agree.
Mr. Kroll. --like investment bankers--
Mr. Capuano. But the courts--
Mr. Kroll. --and not hide behind the First Amendment and
not be accountable.
Mr. Capuano. But the courts up until now have stated that
the First Amendment protects them.
Mr. Kroll. Yes.
Mr. Capuano. So, therefore, the only way around it is to
provide a different standard, and the different standard in
Dodd-Frank is to say that they are now subject to a ``knowingly
or recklessly'' standard, therefore opening the door. It does
exactly what, I think, you suggest we should do.
Mr. Kroll. I think it is doing surgery instead of with a
laser, doing surgery with a meat cleaver. I believe that the
attempt to rectify the behavior can be done very simply and
create the same standard, the same standard for rating agencies
as every other professional in the financial marketplaces. That
would solve the problem.
Mr. Capuano. I would suggest that you talk to your lawyers,
because I am pretty sure it is the same standard, ``knowingly
or recklessly,'' that applies to everybody else. And if your
lawyers, or anyone else, have a suggestion of how we could have
done it surgically to get rid of--
Mr. Kroll. I am a lawyer.
Mr. Capuano. And how could we have circumvented a
longstanding series of court decisions that has said that they
are protected by the First Amendment?
Mr. Kroll. If you look at the recent ruling of the 2nd
Circuit--
Mr. Capuano. And I have.
Mr. Kroll. --which was very favorable to the rating
agencies, very favorable--
Mr. Capuano. But not based on the ``knowingly or
recklessly'' standard. It was a completely different approach,
which I actually thought was a stupid approach.
Mr. Kroll. Okay. If you are saying ``knowingly and
recklessly,'' that is a separate issue. If you are talking
about having an absolution from general behavior and liability,
that is what I am focusing on. I think under reckless behavior,
anybody could be found liable, if that could be proven.
Mr. Capuano. I would be interested to hear what your
standard would be, because ``knowingly or recklessly''--if you
are a lawyer, you know this--has been a longstanding standard
that has applied to virtually everybody. It is actually a
relatively--it is a very common standard.
The First Amendment defense--I thought it was a very unique
defense brought before the courts many years ago. It is
surprising that the courts upheld it. And I would be interested
to pursue with you or your lawyers at a later time any other
way to do it, because I am not stuck on ``knowingly or
recklessly'' here. I just couldn't find one any other way.
Mr. Kroll. It is really simple. There are standards that
bankers, auditors, lawyers, and other people in the financial
process system are susceptible to and they are liable for.
There should be--the rating agencies wield enormous power.
We see it every day. They are deciding on which countries
should be upgraded or downgraded, including our own country.
They are doing all sorts of things, and they are doing it in
effect, without any legal responsibility.
Mr. Capuano. They have responsibility now. And ``knowingly
or recklessly'' is the standard that is applied to virtually
everybody else. And if there is another standard, I would like
to know what it is.
Mr. Kroll. If you want me to keep going on this, I will.
Mr. Capuano. Just tell me what standard it should be.
Mr. Kroll. I just told you. The standard should be the
level of liability that every other professional has in the
securities process.
Mr. Capuano. As a lawyer, you know that is not a legal
answer. That is a generic answer. What is the standard that
other people have? And the answer for me is that it is
``knowingly or recklessly.''
Mr. Kroll. Staying with this point, for example, if you
have an investment banker or an auditor or a lawyer who acts
negligently, they are going to be liable, if you can prove that
is the case.
Mr. Capuano. Under the ``knowingly or recklessly''
standard?
Mr. Kroll. If that is the case with a rating agency, good
luck.
Mr. Capuano. That is the new standard. I do wish you good
luck. Thank you.
Chairman Neugebauer. I thank the gentleman.
Now the vice chairman, Mr. Fitzpatrick.
Mr. Fitzpatrick. Thank you, Mr. Chairman.
I want to thank all the witnesses for their testimony. This
is very helpful.
Mr. Rowan, the question I have for you relates to--in the
written testimony of Mr. Gellert, he has proposed an initiative
that would apply to all NRSROs that would require them to file
an attestation on a quarterly basis, essentially reconfirming
the ratings and opinions previously issued.
He is doing that. I guess he believes it would provide
confidence to the public that the rating agencies are standing
by the ratings and their opinions.
Is Moody's prepared to file quarterly attestations? And
would Moody's stand by the ratings on an ongoing basis going
forward?
Mr. Rowan. Congressman, Moody's on a regular basis reviews
and maintains its credit opinions. Our willingness or capacity
to sign an attestation on a quarterly basis is something that I
can't answer for you today. But I do know that we regularly
review and monitor our ratings on all of the instruments that
we have ratings on.
Mr. Fitzpatrick. Mr. Rowan, how long have you been with
Moody's?
Mr. Rowan. For about 15 years.
Mr. Fitzpatrick. Fifteen years. So certainly, you remember
6 or 7 years, ago Enron and WorldCom went bankrupt. Moody's had
rated both of those entities as investment grade 5 days before
their filings for bankruptcy.
Had Moody's been standing by its ratings and filing
quarterly updates, investors would have had better information
about what was coming down the pike, would they have not?
Mr. Rowan. I believe that Moody's had continuously reviewed
and monitored those ratings, and that as information becomes
available, it is incorporated into the rating. And those
ratings and the issues surrounding those events are fairly well
documented, Congressman. I don't know whether or not a
quarterly attestation would have changed those ratings.
Mr. Fitzpatrick. Mr. Gellert?
Mr. Gellert. Thank you, Congressman.
Rapid Ratings had Enron as a below investment grade credit
in the mid 1990s. Re-rating things on a quarterly basis gives
an accurate perspective of the credit quality as it changes.
Companies do not maintain one single credit quality--or
securities don't maintain one single credit quality for decades
at a time.
And one of the fundamental tenets of the traditional
ratings process from the big three is the concept of rating
through the cycle. Rating through the cycle is essentially
putting a rating on a security and having it be good for some
period of time that is undefined and indefinite.
The concept is that it is fine until we say otherwise. And
the problem is, that has been proven to be incorrect over and
over again.
Mr. Kroll. Congressman, my former company ran Enron in
bankruptcy for 4 years, and we studied every single fraudulent
act in that company, going back historically because of all the
legal liabilities.
James has a good idea. What we are doing with structured
products is something Moody's and Standard & Poor's failed to
do, which was a key part of this crisis. They stopped doing
something called surveillance in the structured products area.
What does that mean? It means for years--for years--when we
thought they were watching the ship, they weren't. They were
not conducting surveillance.
Now James' idea is worth thinking about, because it forces
you to do that. We have committed to investors that we are
going to provide surveillance every month, whether we get paid
for it or not, through the life of the bond.
I think rating agencies need to be held accountable and put
on the record. That is a very interesting way to do it.
Chairman Neugebauer. I thank the gentleman.
Mr. Carney, you are recognized for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman.
I really just have two basic questions.
And one goes to something, Mr. Sharma, that you said in
your remarks, referring to look-back reviews. And looking
through your testimony, that is part of the action you have
taken to ensure integrity and independence.
Could you tell me a little bit about what that means in
that context? And then I would like to ask it in another
context as well.
Mr. Sharma. Congressman, as part of our number of actions
that we had announced in early 2008 to make changes in the
business, to improve our governance and checks and balances,
including our analytical independence, one of the things we
looked at was looking at people who would leave our
organization to go to an issuer, and to then examine all the
ratings that they may have been involved with, but when they
were at our organization and conducting the ratings for an
issuer with whom--
Mr. Carney. So it is a look-back at personnel and where
they move and--
Mr. Sharma. And the ratings that they had performed.
Mr. Carney. Right, right, right.
Mr. Sharma. And now, that has become a part of the
regulation. And we had adopted that, and we had announced that
we would adopt that in 2008.
Mr. Carney. So if you go the next section, ``Actions taken
to strengthen analytics,'' it doesn't use the term ``look-back
reviews.'' But do you do look-back reviews?
You talk about creating an independent model validation
group, which in some ways could be validating models that were
used. Did you look back at some of the structured products that
you had rated that fell apart, rated AAA and they turned out to
be less than that, let us just say?
Mr. Sharma. Congressman, like many other participants, we
have also reflected on and learned from many lessons of this.
But just as a context also, clearly, there were many lessons we
learned out of the U.S. residential mortgage-backed securities.
Mr. Carney. What would you mention as the most important of
those lessons?
Mr. Sharma. Part of it was sort of looking at our analytics
and making sure some of our ratings are completely comparable,
looking at the stress scenarios that we apply to them, and
enhancing surveillance. We have always conducted surveillance,
and we have enhanced them. We have strengthened our
surveillance programs.
Mr. Carney. When you say ``surveillance,'' what do you
mean?
Mr. Sharma. It is when the rating is--once it is new--
rating is issued on new issuance, then we continue to monitor
it. We get monthly reports on the servicers. We review it. We
look at it. What we have now done is we have gone one level
below. We are looking at the underlying collateral, etc., that
makes up a structured security.
So we have really expanded and enhanced our surveillance.
But the surveillance program was always in place, that we would
look at this on a quarterly basis--
Mr. Carney. So you discovered through the surveillance
process that you had rated securities that didn't perform at
AAA securities?
Mr. Sharma. We learned why the ratings sort of behaved the
way they did, what were some of the things to learn and
observe. Another aspect was information quality. We have now--
not only have we done that, we are looking at the rating of
different information that we receive based on the credibility
of the source of the information. And so, we have started to
apply that framework against it and it is also being introduced
as part of the regulation.
Mr. Carney. So changing gears a little bit as my time runs
out, what does it mean to you--and I will ask the others as
well--to stand behind your rating?
Mr. Sharma. First of all, we are accountable. We are
accountable to the regulators to make sure that what we do
follows our process, policies, regulations as appropriate.
Secondly, we are accountable through market scrutiny. And
at the end of the day, it is our credibility and our reputation
of our ratings. And the fact of the matter is, there are
independent reports--for example, IMF recently came out and
looked at the sovereign credit ratings and our performance in
those sovereign ratings, and how it has performed over time.
Mr. Carney. So Mr. Rowan, yourself--
I apologize for interrupting, but my time is running out.
How about Moody's?
Mr. Rowan. Mr. Congressman, the concept of credibility that
Mr. Sharma just mentioned is an integral part of the business
of a rating agency. And putting the brand and franchise behind
the rating is important, and the users of ratings look to
Moody's longstanding track record of credibility and
consistency of performance of our ratings in many areas outside
of residential mortgage-backed securities.
Mr. Carney. So we had a big discussion earlier, and you
were all here, about 939G in the liability section. What is
your view of that provision?
Mr. Rowan. Congressman, I am not a lawyer.
Mr. Carney. Okay. So we will go Mr. Sharma, then, if you
can't answer.
Mr. Sharma. Congressman, do you mean 436G or--
Mr. Carney. Section 939G, as I understand it, is the
section that imposes the provision for a stricter liability
standard.
Mr. Sharma. Oh. Sorry. Yes.
As I mentioned, we are accountable, and we recognize that
Dodd-Frank Act changes the pleading standard, which is actually
unique to rating agencies, unlike any other market
participants, that the pleading standard has now been changed
on us.
But otherwise, we are sued. We are sued. And cases have
been filed on us and on other laws that are on the books.
Mr. Carney. So does anybody--Mr. Smith, I think I heard you
articulate a different view of that?
Mr. Smith. We believe that in our review of the credit
rating agency line in case law, the ranking member is correct
that the standard that has been imposed by Dodd-Frank is
exactly the standard that is imposed on every other participant
in the financial markets--certainly, the lawyers, the
accountants--a knowing and reckless standard.
It is not a negligence standard. It is a knowing and
reckless standard, and it is one that makes them realize that
what they have done is wrong or that they were so reckless in
their disregard for whether it was wrong that they should be
held accountable for it.
I think that is the correct standard, and it is a standard
that applies across-the-board.
Mr. Carney. Thank you, Mr. Smith.
And I thank the Chair for the extra time.
Chairman Neugebauer. I thank the gentleman.
And now the chairman of the Capital Markets Subcommittee,
the gentleman from New Jersey, Mr. Garrett.
Mr. Garrett. I thank you. And I thank the panel.
So the panel probably heard the earlier panel, some of the
questions with regard to the larger issue that is affecting
this country right now, and that is the debt limit. And so,
there are certain questions there.
I will start with Mr. Sharma. Could you comment on the
evaluation of the potential for a downgrade on the President's
position or his solution to the problem as whether we will
still get a downgrade?
Mr. Sharma. Congressman, the way our sovereign analysts
look at it is they look at five variables to sort of assess the
creditworthiness of this commercial debt of a sovereign. They
look at the fiscal aspect. They look at the monetary. They look
at the economic strength of the country, as well as look at the
liquidity and funding, and then, of course, the political
institutions that formulate the policy and--
Mr. Garrett. And so one of those five--I only have so much
time. I realize the five-point analysis, and one of those
points of the analysis is what structural changes that the
Congress is going to pass. So were you able to look at what the
President has presented and be able to give an evaluation on
that, whether that is sufficient?
Mr. Sharma. What we have said is our analysts have said
that there has to be a credible plan to reduce the debt burden,
as well as reduce the deficit levels.
Mr. Garrett. I understand. So I serve on the Budget
Committee, and there is now that infamous statement from CBO
where they said, ``We do not evaluate speeches.''
Is there something that you were able to evaluate with
regard to the Administration as to whether their plan is
credible? Do they have a plan that you are able to look at?
Mr. Sharma. Congressman, there have been a number of plans
that have been announced by the Administration--
Mr. Garrett. Have you been able to look at them?
Mr. Sharma. --and we think some of the plans to reduce debt
levels could bring the U.S. debt burden, as well as the deficit
levels, in the range of a threshold for a AAA rating. And so we
have analyzed it, but we are waiting to see what the final
proposal is for a sovereign analyst to really analyze it more
thoroughly and then to opine on it.
Mr. Garrett. So the story is--at least one of the stories
out there is, with regard to the Reid plan, that it would be a
better plan to ensure that we would not get a downgrade
according to some of the rating agencies. Is that story true,
that it is one that would aid better or is one that is
satisfactory?
And I say that partially with regard to your own analysis
of July 14th that says what we really need to have here in
order to avoid a downgrade is a $4 trillion structural change.
As far as I know, the Reid plan does not reach that level. So
would that be satisfactory?
Mr. Sharma. Congressman, I think we were misquoted. We do
not comment on any specific plan or the political choices or
policy choices being made. We are just commenting on what is
the level of debt burden, what is the level of deficit that
must meet the threshold to retain its AAA.
Mr. Garrett. Okay.
Mr. Sharma. And since there was a $4 trillion number put
forward by a number of Congressmen, as well as by the
Administration, our analyst was just commenting on those
proposals, that that would bring the threshold within the range
of what a AAA-rated sovereign debt would require.
Mr. Garrett. So watching my time, first, is something under
that then potential still be able to maintain a AAA rating?
Mr. Sharma. Congressman, I would leave that to our analysts
to determine that. And it is a decision that is made by the
ratings committee and by our sovereign analyst. We have
criteria on sovereigns that we have published. We have
thresholds that are out in the public domain.
Mr. Garrett. I know the original plans, the so-called grand
plan was in the $4 trillion size. The Reid plan is
substantially under that, $1.5 trillion or so under that. So
you have not made any other pronouncements since the July 14th
letter analysis saying that whereas $4 trillion would be
satisfactory, we have seen these other potential plans out
there, and they would or not--you have not produced any other
documents in that regard. Is that correct?
Mr. Sharma. No, Congressman, we have not. We are waiting
for the plans to come.
Mr. Garrett. Does Moody's want to chime in on this?
Mr. Rowan. Congressman, I am not a rating analyst. But
Moody's has placed the rating for the U.S. Government under
review for possible downgrade--
Mr. Garrett. Yes.
Mr. Rowan. --looking at two dimensions: one, the short-term
risk of a disruption; and two, the longer-term issue of the
level of debt in relation to the overall economy.
Mr. Garrett. Right. And I know you are not the analyst
there, so do the plans that we have seen either from the White
House, which are--I haven't seen anything on paper--or from
Reid, which is more specific, which come under the $4 trillion
level, do they satisfy those criteria?
Mr. Rowan. To my knowledge, Moody's has not published
anything in regard to specific policy issues or the specific
parameters that the rating committee will consider for the
review action.
Mr. Garrett. Okay.
Mr. Kroll, do you want to chime in?
Mr. Kroll. I don't think rating agencies have the
wherewithal, the intellectual range, the experience to be doing
ratings on--
Mr. Garrett. Sovereigns?
Mr. Kroll. --100 countries around the world. I question
whether this is the job of a private sector entity to be
looking at the United States Government or, frankly, any other
government and reaching decisions on their levels of
creditworthiness.
And what we have seen throughout history is a constant
activity of being a day late and a dollar short and running
around in front of the parade.
So is this new news? What makes these organizations--we are
not qualified to do this. We are too small. But I question
conceptually whether private enterprise should be in this
business for pay.
Mr. Garrett. I thank you.
I think my time is up.
Chairman Neugebauer. I thank the gentleman.
And now the gentleman from Texas, Mr. Canseco, for 5
minutes.
Mr. Canseco. Thank you, Mr. Chairman.
Mr. Sharma, do you believe that the amount of debt held by
the United States poses a systemic risk to our economy?
Mr. Sharma. Our sovereign analysts in the publication have
highlighted that the debt burdens and the growth rate of the
debt burdens is something that does need to be addressed for us
to continue to assess the creditworthiness of the sovereign
commercial debt at AAA levels.
Mr. Canseco. In the political discourse that we are seeing
today, do you think that it is the job of a credit agency to
get involved in trying to make a decision one way or the other
on a political basis? Do you think that is interference on the
part of the credit rating agencies to be stepping in at this
stage and making an assessment?
Mr. Sharma. Congressman, sovereign debt is a large asset
class that many investors around the world invest in. And our
role is to really provide an independent view and a future
forward-looking view for the investors as to what the risk
levels are for those assets that they invest in.
And that is what we are doing today. We are really for the
benefit of investors giving them a perspective and a point of
view that says what do we believe, whether the risks are rising
for any sovereign, whether it is here or Europe or anywhere
else. We are doing the same that we do in any other part of the
world, that we are speaking to the risk that the investors
invest in.
And this is a large asset class that investors invest in,
and they are the ones who determine what to pay for those
risks.
Mr. Canseco. Do you honestly believe that the United States
could default on its debt?
Mr. Sharma. Our analysts don't believe they would. And by
the way, changing a rating doesn't mean it would default. AAA,
all it means is that it is a low probability, a very low
probability of a default. That is all it means. And if you
change a rating, it means that the risk levels have gone up. It
doesn't mean it is going to default. If you believe that, they
would change it to a default status.
Mr. Canseco. Thank you.
Mr. Gellert, is there information to which Moody's and S&P
have access that your firm cannot access?
Mr. Gellert. A significant amount, actually. And in
addition, there is a lot of information that they have that
even NRSROs like Kroll Bond Ratings can't access. I think it is
17(g)(5) that is the rule that created last year, or in late
2009, an ability for--in structured products for data that is
being used by a paid-for rating to be shared and accessed by
another NRSRO for an unsolicited rating.
As a non-NRSRO, we don't have access to any of that. As an
NRSRO, what Mr. Kroll would not necessarily have is access to
things like the underlying data that goes into a collateralized
loan obligation (CLO) security. CLOs are very, very closed.
They are not covered in the asset-backed securities that are
really covered under 17(g)(5). And in fact, the SEC doesn't
have purview over the loans themselves, the underlying
collateral for those types of securities.
So there is a whole world of information that none of us
have access to that really would open up the space to
competition, as well as providing the investor community
information that they directly could use, if that information
was available to them.
Mr. Canseco. Thank you.
Mr. Kroll, would your answer be the same or different?
Mr. Kroll. As an NRSRO, which is one of the reasons we
became an NRSRO, we do have access to most of the information.
So, for example, we have just in the last 30 days rated 3, and
in 2 weeks it will be 5, commercial mortgage-backed deals. We
are privy to the same information that the oligopoly gets, if
they are on those deals.
Mr. Canseco. Okay.
Mr. Gellert, were you disappointed or pleased with the
provisions of Dodd-Frank related to credit rating agencies?
Mr. Gellert. I think by and large, I was disappointed with
them. I think the idea behind Dodd-Frank, in my understanding,
was to, vis-a-vis rating agencies, was to create transparency,
create accountability, increase competition.
In fact, I think what happened was a lot of punitive,
directed initiatives towards the big three with unintended
consequences that hurt the variety of us who would consider
being NRSROs or even those firms that are NRSROs.
Ultimately, innovation and competition in this space is
what is going to evolve it, and I don't think Dodd-Frank as a
whole really helps contribute to that mission.
Mr. Canseco. As a non-NRSRO player in an entrenched field,
what is the biggest challenge your firm faces?
Mr. Gellert. I think there is still a certain amount of or
a decent number of institutional investors that are paying
attention to the NRSROs before they will pay attention to a
non-NRSRO, in part because of the infrastructure in the
regulatory environment that continues, although it may be
evolving, but continues to support them.
For us, we don't mind the hard work. We are in this for the
long term and we are in this to grow our business. And doing
the hard work and explaining our ratings to a variety of
potential and current users is very much a part of what we do,
but we are trying.
This example of the quarterly ratings affirmation, we
believe even as a non-NRSRO, we are leading the field in best
practices in certain areas and will continue to try to do that.
So we are prepared to compete, but obviously it becomes harder
with certain folks, given the entrenchment.
Mr. Canseco. Thank you.
I see that I am out of time, Mr. Chairman, so thanks very
much.
Chairman Neugebauer. In consultation with the ranking
member, we are going to provide members another round of
questions. And so, I will start that.
Mr. Sharma, in the last 6 or 7 months, have you had
conversations with Secretary Geithner about the ratings of U.S.
sovereign debt?
Mr. Sharma. Mr. Chairman, like we do for all entities that
issue debt, we meet with the management, in this case the
Treasury is the management for us, and so our sovereign teams
have had ongoing dialogue. And we do this with not only with
the sovereign governments around the world. We do that with
companies. We meet them regularly and sometimes hourly when
they have new updates to information.
So our sovereign team has been meeting and discussing and
dialoguing with the Treasury, as well as other parts of the
Administration and some Members of Congress to just better
understand what the situation is, what policies are being
formulated, how credible would those plans be in that to be put
into place. So they have been having a regular ongoing dialogue
in the spirit of getting better understanding.
Chairman Neugebauer. So let me re-state my question. Have
you and Secretary Geithner had a conversation about the rating
of U.S. sovereign debt?
Mr. Sharma. No, Mr. Chairman. I have not had any direct
conversation with Secretary Geithner.
Chairman Neugebauer. Yes, and so what about--I know this
sovereign debt thing is not just a U.S. issue right now, but it
is a global issue, particularly in the European Union and the
European Central Bank. Have those entities been having ongoing
dialogue on how you might be rating their debt in the same
respect?
Mr. Sharma. Congressman, first of all, our sovereign
analysts meet with the central banks, with finance ministries,
Treasuries and other policymakers around the world on a regular
basis. We rate about 126 countries, and we have over 100
analysts in sovereign. So they are really meeting with all the
people around the world all the time.
And from time to time, yes, I do in my role meet with
central banks as well as finance ministry and Treasuries around
the world to just exchange views, but not on their ratings per
se.
Chairman Neugebauer. And so, here is the question. What
about countries that can monetize their own debt, like the
United States and some other countries? Would a country that
can print money get a higher credit rating than a country that
doesn't have that ability available to it?
Mr. Sharma. Yes. In our criteria, we explicitly say that
countries that can have their own currency, and in this case
U.S. is a global reserve currency, so it does get a lift. I am
not exactly sure how much lift, but yes, they do get a lift.
Chairman Neugebauer. Yes. It would be interesting, I think,
for me at least and maybe some of my Members to know what the
lift is for countries that can print money.
Mr. Sharma. Sure. I think we may have published it, and we
will make efforts to get it to you.
Chairman Neugebauer. Another question here is when you are
looking at the potential--what a rating is is the potential or
what you think the risk of default is. What percentage of a
country's government expenditures attributed to interest would
begin to cause you to enhance the potential for default?
In other words, some countries, their interest is 5
percent, 10 percent. Some countries are 25 percent interest. At
some point in time, it is squeezing out the amount of
government expenditures and forcing either additional taxes
or--but would the interest carry be a factor that you would--
Mr. Sharma. It is. And cost of debt servicing is an
important factor, as is the total debt level, as is the
deficit, as is the economic growth prospects, because they all
influence the trajectory of the growth of the debt levels for
the country.
So clearly, we have thresholds for each rating category
against many indicators that we look at. At this point in time,
I don't know explicitly what that threshold is for a AAA for
the debt servicing, but we can look at our published documents
to see if it is in there and then can send it to you.
Chairman Neugebauer. Last point, in a country that the debt
levels are increasing, in other words, the interest carry is
increasing at a faster level than the GDP, the growth in the
economy, what is the pathway for that country?
Mr. Sharma. It all is a function of that, plus it is a
function of--the total debt level is a function of the debt
deficit. It is a function of the economic growth, and then, of
course, of what steps are going to be taken to address all
these things. So you can change the trajectory by using a
number of other variables.
And then, as you mentioned, the dollar as a global reserve
currency also brings some benefits also to the
creditworthiness.
Chairman Neugebauer. Would you say this is a fair
assumption that the comments you made recently about U.S. debt
was not whether we were going to default or not, but whether we
were going to actually address the massive deficits that this
country is running?
Mr. Sharma. Mr. Chairman, that is it exactly. The more
important issue is really the long-term growth rate of the debt
as it is driven by the debt burden, as well as the deficit.
That is the more important issue at hand. And to your point,
that is the more important issue.
Chairman Neugebauer. I thank you. My time has expired.
Ranking Member Capuano?
Mr. Capuano. Thanks, Mr. Chairman.
Mr. Chairman, I just want to point out that I have the
Bloomberg News report on the 2nd Circuit opinion. It deals with
underwriters. Apparently, Moody's and Standard & Poor's and
others were sued as underwriters.
I can't imagine why they would sue you as underwriters. No
one, other than probably this plaintiff, would have considered
you to be underwriters. You are in the business of making
thoughtful, professional opinions, not underwriting.
I guess the plaintiffs made no other legal claim. So I am
glad you won the case because I wouldn't want to get into this
mess. But that has nothing to do with other cases that may
come.
Mr. Smith, I wanted to pursue another area. And I am not
sure whether Colorado PERA is considered in the class as a muni
type of bond. Are you in that category?
Mr. Smith. As far as an issuer?
Mr. Capuano. Yes.
Mr. Smith. No, sir.
Mr. Capuano. No, so you don't get tax-exempt status?
Mr. Smith. No, we do not issue bonds. We are a pension fund
that acquires assets, pays benefits, but we are not a part of
the State. We are an arm of the State, but we are not a part of
the State for purposes of issuing debt.
Mr. Capuano. Okay. I appreciate that. I wanted to ask
because I want to find--look, guys, I have been chasing the
credit rating agencies for years, before this problem.
And it really had to do with because I am a former mayor,
and I was kind of giving you a little bit of taste of what I
got from my 9 years as mayor. I didn't like it.
As Mr. Carney said earlier, when you guys came in the door,
I had to jump through hoops that were ridiculous to get ratings
that were below what I deserved.
And then, when I got here, I realized that I did get
ratings below what I deserved, because my risk of default,
which is really the only basis for which I thought anybody
worked, was significantly in a different standard.
Dodd-Frank was supposed to address some of these things,
and I guess I would like to pursue as to whether it has.
In the last couple of years--I have the numbers before me,
but they are up until 2008; I have not updated them--but prior
to 2008, the historic ratings of all rating categories, all of
them, AAA down to noninvestment grade, munis by Moody's
standards were 97 percent times less likely to default than
corporate bonds, yet were rated lower. By S&P's standard, they
were 45 times less likely to default, yet rated lower.
Have you changed your ways? Are you now rating municipal
and other governmental agencies as if they were corporations,
again, based on one thing and only one thing, which is the risk
of default?
Mr. Sharma?
Mr. Sharma. We have always had one scale, a consistent
scale, that we have tried to adopt across all our asset
classes. And, as a result, you will see we have been--our
municipal ratings are generally higher than the corporates, of
course, and other types of institutions, financial
institutions.
And we have now even made vigorous attempts to really make
our ratings very comparable, whether it is munis or corporates
or whether it is financial institutions, whether it is in the
United States or it is in Europe.
So we are striving toward getting comparability of our
ratings across all asset classes, across all geographies.
Mr. Capuano. So, the reason I ask, because in 2008--again,
not updated, but I know it has changed a little bit, but my
guess is--let me ask a basic question, are you aware that munis
have defaulted at any higher rate than corporate bonds?
Mr. Sharma. I don't have that data exactly, but, as I
mentioned, we are aiming to get comparability of our ratings
across all asset classes and geographies.
Mr. Capuano. That would mean, basically, that you would now
start rating what was once rated in 2008 as maybe a BA or BB,
up to a AAA. They had approximately the same default rate as a
AAA corporate bond.
And I would argue that since default rates are really the
only thing that matters in the final analysis, because, again,
am I wrong to think that the only thing that matters is the
likelihood of getting repaid?
And if that is the only thing that matters, you should,
based on historic data, absent individual items, that munis
should be rated--BBA munis should be rated AAA. So are you
telling me you have addressed that issue and that now that all
munis are addressed comparable to corporates?
Mr. Sharma. We are working toward it. We are recalibrating.
We have, in fact, recalibrated our criteria across many areas,
including structured finance, sovereigns, governments, and we
have been also recalibrating our criteria on municipals, with
the aim and objective to sort of have comparability of ratings
and across all our sectors, across all asset classes and
geographies, but this is forward-looking--
Mr. Capuano. Mr. Rowan, has Moody's made some progress on
this as well?
Mr. Rowan. Yes, Mr. Congressman, I am aware that since
2008, Moody's has recalibrated, formally recalibrated, all of
the U.S. public finance ratings to move them on to a scale that
is comparable to corporate ratings, financial institutions--
Mr. Capuano. Based on historic default rates?
Mr. Rowan. There was a research piece and a lot of analysis
around that recalibration that I can make sure is provided to
you and your staff.
Mr. Capuano. My staff will be in touch with both of you to
try to catch up on some of the data.
Mr. Gellert, do you do governmental issues? I don't know
whether you do or not.
Mr. Gellert. We do not. But I would point out, and I am not
sure the data that you are referring to, but I will point out,
of course, a lot of the municipal issuants were insured, so you
definitely have a skewing of default stats and statistics and
ratings--
Mr. Capuano. Actually, these are based on noninsured.
Mr. Gellert. Okay, fine.
Mr. Capuano. And that was my basic argument, that I
believed then that munis were being chased into insurance that
they didn't need.
Mr. Gellert. I was just clarifying.
Mr. Capuano. Mr. Kroll, do you do munis?
Mr. Kroll. Yes.
Mr. Capuano. Do you--
Mr. Kroll. We are releasing a--
Mr. Capuano. Oh, your microphone, please.
Mr. Kroll. We are releasing--yes, we do munis. We are just
starting. We will release a study in September, taking the 200
most liquid muni issues. Many involve States. Some involve
cities. And we are looking at the actual financials, so we will
not be using dated information, and sometimes a year, year and
a half dated, to come up with our ratings of those. So stay
tuned for September.
Mr. Capuano. I am looking forward to it.
Thank you all very much. I appreciate it.
Chairman Neugebauer. I thank the gentleman.
And, now, the vice chairman, Mr. Fitzpatrick.
Mr. Fitzpatrick. Mr. Sharma, I want to follow up on the
line of questions of the chairman earlier.
In a letter sent to this subcommittee dated June the 13th,
Secretary Geithner acknowledged that he, along with Deputy
Secretary Wolin, OMB Director Lew, and a representative of the
Vice President's office, met with S&P personnel on April 13th,
an actual meeting.
Are you aware of what was discussed at that meeting?
Mr. Sharma. Congressman, no, I am not. I know our team, as
mentioned, regularly meets with them as part of the process on
trying to get a better understanding, and they met with the
Treasury. I wasn't even aware that they met with the members
that you just said, but I know they had a meeting. They met
with them.
I am not privy to people they meet, once they are in the
ratings process.
Mr. Fitzpatrick. According to documents obtained by this
committee, 2 days after that meeting, on April 15th, David
Beers reached out to Under Secretary Goldstein to let Treasury
know the rating committee's outcome.
Do you know what was discussed on that call?
Mr. Sharma. No, Congressman, I don't. Normally, the process
would be once the ratings committee makes a decision, we write
up the decision. We also inform the issuer of the rating
action, if there is a change or if there is an affirmation. And
if there is any publication that we are going to do, we do
share it with them also.
Mr. Fitzpatrick. So you would have informed the issuer
before the public would find out what the--
Mr. Sharma. We let them know that we would be taking a
rating action, yes.
Mr. Fitzpatrick. Shortly after that call, Mary Miller of
Treasury reached out to David Beers of S&P for a draft press
release on the outlook change. This was 3 days before the
actual press release occurred.
What would be the purpose of sharing a draft press release
with the issuer?
Mr. Sharma. It is to give the issuer a chance. If there are
any factual errors or anything else in the press release, then
there is an opportunity to correct that, so that we want to
give the public a completely error-free information. And so,
that is the opportunity for them.
Mr. Fitzpatrick. And that is standard practice?
Mr. Sharma. That is standard operating procedure, yes.
Mr. Fitzpatrick. Do you know whether or not the Department
made any substantive changes to the press release?
Mr. Sharma. Congressman, I don't know that.
Mr. Fitzpatrick. The next day, which was 2 days before the
actual press release, another Treasury official reached out to
John Chambers and asked if there is a communications director
that Treasury's press people can connect with. And it appears
that a call actually did take place.
Do you know what happened on that call, what might have
been discussed?
Mr. Sharma. I don't know specifically, but generally, there
is--they may have wanted to coordinate as to when we will be
releasing our information so they can plan their own releases
of information that they may have intended to do so.
And that is a normal process that even a corporation that
we rate, where if we are going to announce a rating action,
which they believe is material, then they may want to
coordinate with their own communications group as to what they
may want to say to the public along the timelines of when we
will say.
Mr. Fitzpatrick. But you don't know what occurred on the
telephone call?
Mr. Sharma. No, I don't.
Mr. Fitzpatrick. And you don't know whether or not Treasury
asked for any substantive changes to the draft press release in
the days before it was issued?
Mr. Sharma. As I said, the purpose of sharing the draft
release is only if there is a factual error. Once a rating
committee decision is made, we proceed along those lines.
Mr. Fitzpatrick. And you believe that is an appropriate
process?
Mr. Sharma. We believe that is an appropriate process,
because it allows elimination of any errors that may occur by
mistake or by any other reason. But once the rating action is
done, we follow the process, and we follow it very rigorously
within our organization.
Mr. Fitzpatrick. Mr. Chairman, I would just ask that the
Secretary's letter dated June 13th and the attachments be made
a part of the hearing record.
Chairman Neugebauer. Without objection, it is so ordered.
Mr. Capuano. Mr. Chairman, if the gentleman would yield for
a minute?
Mr. Fitzpatrick. Yes.
Mr. Capuano. Thank you.
Mr. Sharma, again, I want to be clear. As I said, as a
former mayor, I got phone calls from your agency before you
came out with a rating. It is common throughout everything you
do. Is that a fair statement?
Mr. Sharma. Just to be--
Mr. Capuano. Every rating you do, you give the individual
being rated an opportunity to correct factual disagreements?
Mr. Sharma. Yes.
Mr. Capuano. Mr. Rowan, does your company do the same
thing?
Mr. Rowan. Our company has the same policy, Congressman,
for the same purpose, to ensure that there isn't a material
misstatement of fact or inadvertent disclosure.
Mr. Capuano. I know you do, because Moody's called me, too.
Mr. Gellert, again, you are a little different, in that you
don't do public stuff, but do you do something similar?
Mr. Gellert. We have absolutely no contact with issuers at
all.
Mr. Capuano. Because you don't make public statements of
any kind, then?
Mr. Gellert. That is correct.
Mr. Capuano. That is what I thought.
Mr. Kroll, on your public aspects?
Mr. Kroll. On the issuer-paid side of our business, because
we also have a subscription business--
Mr. Capuano. Yes.
Mr. Kroll. --on the issuer-paid, which has done our first
five transactions, we do the same thing. But it is only about
correcting any factual error that we may have.
Mr. Capuano. So it is a standard practice in the industry?
Mr. Kroll. Correct.
Mr. Capuano. Thank you.
Chairman Neugebauer. I want to thank this panel. This has
been a very good hearing. And we appreciate your time and your
thoughtful testimony.
The Chair notes that some members may have additional
questions for this panel which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for members to submit written questions to these
witnesses and to place their responses in the record.
If there is no further business, this hearing is adjourned.
[Whereupon, at 1:02 p.m., the hearing was adjourned.]
A P P E N D I X
July 27, 2011
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