[Senate Hearing 110-982]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 110-982


   TURMOIL IN U.S. CREDIT MARKETS: THE ROLE OF CREDIT RATING AGENCIES

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   ON

 ISSUES INVOLVING THE RATING OF STRUCTURED FINANCE INSTRUMENTS BY THE 
  NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATIONS (NRSROS), AS 
      WELL AS RECENT INITIATIVES THAT THE NRSROS HAVE ADOPTED AND 
 RECOMMENDATIONS FOR LEGISLATIVE, REGULATORY AND VOLUNTARY CHANGES TO 
                   IMPROVE THE CREDIT RATING PROCESS


                               __________

                        TUESDAY, APRIL 22, 2008

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate /
                            senate05sh.html


                  U.S. GOVERNMENT PRINTING OFFICE
50-399                    WASHINGTON : 2010
-----------------------------------------------------------------------
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







            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware           CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey          JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii              MIKE CRAPO, Idaho
SHERROD BROWN, Ohio                  ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania        MEL MARTINEZ, Florida
JON TESTER, Montana                  BOB CORKER, Tennessee

                      Shawn Maher, Staff Director
        William D. Duhnke, Republican Staff Director and Counsel

                       Dean V. Shahinian, Counsel
           Roger M. Hollingsworth, Professional Staff Member
                Didem Nisanci, Professional Staff Member
               David Stoopler, Professional Staff Member
                 Jayme Roth, Professional Staff Member
                Brian Filipowich, Legislative Assistant
                  Megan Bartley, Legislative Assistant
                 Jason Rosenberg, Legislative Assistant

                    Mark Osterle, Republican Counsel
                    Andrew Olmem, Republican Counsel
         Tewana Wilkerson, Republican Professional Staff Member
          Courtney Geduldig, Republican Legislative Assistant

                       Dawn Ratliff, Chief Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor










                            C O N T E N T S

                              ----------                              

                        TUESDAY, APRIL 22, 2008

                                                                   Page

Opening statement of Chairman Dodd...............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     3
    Senator Menendez.............................................     4
    Senator Reed.................................................     6
    Senator Allard...............................................     6
    Senator Schumer..............................................     7
    Senator Tester...............................................     8

                               WITNESSES

Christopher Cox, Chairman, Securities and Exchange Commission....    10
    Prepared statement...........................................    61
    Response to written questions of:
        Chairman Dodd............................................   141
        Senator Shelby...........................................   142
        Senator Menendez.........................................   146
        Senator Bunning..........................................   149
John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia 
  University Law School..........................................    34
    Prepared statement...........................................    69
    Response to written questions of:
        Senator Shelby...........................................   150
Vickie A. Tillman, Executive Vice President for Credit Market 
  Services, Standard & Poor's....................................    37
    Prepared statement...........................................    89
    Response to written questions of:
        Chairman Dodd............................................   152
        Senator Shelby...........................................   155
        Senator Menendez.........................................   161
Claire Robinson, Senior Managing Director, Moody's Investors 
  Service........................................................    39
    Prepared statement...........................................   106
    Response to written questions of:
        Chairman Dodd............................................   186
        Senator Shelby...........................................   196
        Senator Menendez.........................................   210
Stephen W. Joynt, President and Chief Executive Officer, Fitch 
  Ratings........................................................    41
    Prepared statement...........................................   119
    Response to written questions of:
        Chairman Dodd............................................   216
        Senator Shelby...........................................   220
        Senator Menendez.........................................   225
Arturo Cifuentes, Ph.D., Managing Director, R.W. Pressprich & Co.    43
    Prepared statement...........................................   125
    Response to written questions of:
        Senator Shelby...........................................   240

              Additional Material Supplied for the Record

Aaron Lucchetti, The Wall Street Journal, ``As housing boomed, 
  Moody's opened up,'' article dated April 11, 2008..............   242

 
   TURMOIL IN U.S. CREDIT MARKETS: THE ROLE OF CREDIT RATING AGENCIES

                              ----------                              


                        TUESDAY, APRIL 22, 2008

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:12 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order, and my 
apologies to my colleagues and others for being a few minutes 
late this morning. I was taking the shuttle down, which is 
always a bit of roll of the dice. So I apologize for being a 
few minutes late, but I want to thank all in attendance for 
being here this morning. Let me share some opening thoughts. I 
will turn to Senator Shelby and then to other Members of the 
Committee who would like to make, if they so desire, some 
opening comments on the subject matter of today's hearing.
    Today we are going to talk about the role played by the 
credit rating agencies in the subprime mortgage crisis. I asked 
the staff a short time ago, just to go back over this, this is 
our 13th hearing this year on this subject matter or related 
matters to it. We had 35 hearings last year. So it is almost 
48, close to 50 hearings since beginning February 7th of last 
year. Some of those hearings were conducted by my colleagues 
here. I want to thank Jack Reed particularly for doing some of 
this last year--in fact, on this very subject matter. And 
Senator Shelby, of course, has been deeply involved in these 
issues, and we owe him a debt of gratitude for what he has 
done. But the Committee has spent an inordinate amount of time 
over the last year on this subject matter. Including even when 
we had hearings on student loan issues the other day, it was 
really related in many ways to the subprime problem. So almost 
every other matter we are looking at bears some relevancy to 
the subject matter here today. We could have a hearing on 
credit rating agencies, but obviously in the context of the 
subprime mortgage crisis, it has real relevancy.
    Senator Reed, as I mentioned a minute ago, chaired a 
hearing of the full Committee on this subject matter, and 
Senator Shelby, of course, has been deeply involved in the 
subject matter of credit rating agency reform. In fact, during 
his tenure or stewardship as Chairman of this Committee, he not 
only held hearings on the topic of the credit rating agencies, 
but, in addition, the Committee passed legislation. That 
legislation, the Credit Rating Agency Reform Act of 2006, was 
signed into law on September 29, 2006. It makes important 
reforms in the area of capital market reforms, which in my view 
were prescient.
    Credit rating agencies played a very important role in our 
economy and continue to do so. They provide opinions to 
investors about the ability of debt issuers to make timely 
payments on debt instruments. That may sound like a simple 
modest function, but it is an indispensable one. Decisions 
about how to invest enormous sums of money are based, at least 
in part, on credit ratings. As one commentator has said, 
``Credit rating agencies can, with the stroke of a pen, 
effectively add or subtract millions from a company's bottom 
line, rattle a city budget, shock the stock and bond markets, 
and reroute international investment.''
    We have seen over the past few months just how influential 
a role credit rating agencies play in our markets, and 
particularly in the structured finance markets, and not in a 
positive sense. Credit rating agencies have played a central 
role in the subprime mortgage crisis and, by extension, on the 
volatility and illiquidity plaguing our capital markets.
    During the past several months, these agencies, which are 
technically referred to as nationally recognized statistical 
rating organizations, have downgraded their ratings of 
thousands of tranches of residential mortgage-backed 
securities. Bloomberg recently reported that the three largest 
of these organizations began cutting in July and have since 
either downgraded or put on review a total of 38,000 subprime 
bonds. Moody's and S&P combined have downgraded more than 9,500 
of these securities dating from 2005. These downgrades meant 
that, with the stroke of a pen, again, assets once seen as safe 
and profitable were suddenly something quite the opposite.
    Many investors who by Federal or State law must invest in 
securities within investment grade ratings were suddenly forced 
to sell. Others suddenly found the value of their securities 
reduced to a fraction of their previous value. The net result 
is that investors have lost tens of billions of dollars.
    The impact of these downgrades has spread beyond the 
downgraded bonds themselves. Imagine, if you will, using this 
analogy, going to a grocery store to buy food for your family. 
You are told that almost all of the food in the store is safe 
and healthy, but that a small fraction--a small fraction--of 
the items contained a very toxic substance that could cause 
serious illness or death. It is doubtful that you or anyone 
else is going to be doing much shopping in that store without 
some assurance that it is free from the taint of any toxic 
substance.
    In the same manner, the downgrading of some subprime 
mortgage securities have sown doubt and fear in investors about 
a much larger universe of securities. It has cut investors' 
appetite for subprime mortgage securities generally and for a 
host of other asset-backed securities. As a result, our credit 
markets are experiencing unprecedented levels of volatility and 
illiquidity.
    These recent rating downgrades have raised serious 
questions about the role, function, and performance of credit 
rating agencies. For instance, do the credit rating agencies 
give ratings that are overly optimistic in order to obtain more 
business? Do they sufficiently analyze the data they are given 
by clients before issuing ratings? Do they properly manage real 
or perceived conflicts of interest with clients who pay for 
rating and/or consulting services? And, last, when Congress 
acted 2 years ago, it gave the SEC the authority ``to prohibit 
or require the management and disclosure of any conflicts of 
interest.'' Has the SEC used this authority effectively? Can or 
should it do more?
    These are some of the important questions that our 
witnesses will address this morning. The investing public, of 
course, deserves to know that every step is being taken to 
protect one of their most basic rights, and that is the right 
to sound, reliable, credible information. They deserve to know 
that our regulatory agencies will apply and enforce the law 
with vigor on their behalf. And they want to see the credit 
rating agencies demonstrate that they have learned from their 
mistakes and have reformed their practices so that this very 
sorry chapter in their history will never be repeated.
    I want to welcome Chairman Cox of the SEC to the Committee 
once again. We know he is currently working to implement by 
rulemaking the new act, and we look forward obviously to 
hearing his testimony this morning. Let me also welcome our 
other distinguished witnesses who will be here this morning. We 
appreciate their willingness to appear before us.
    Let me now turn to Senator Shelby and then to other Members 
of the Committee for any comments they may have about this 
very, very important subject matter.

         OPENING STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman. Welcome, Chairman 
Cox.
    Since our last hearing on this subject, the situation in 
our financial markets has underscored the role played by the 
rating agencies. The past few months have also demonstrated 
that the rating agencies were not meeting their 
responsibilities. We have witnessed this series of ratings 
downgrades particularly in structured finance. It seems that 
rating agencies grossly underestimated the risks associated 
with these securities. Unfortunately, these products were 
widely distributed and held by a broad array of investors and 
institutions. The severity of these downgrades sent banks, 
pension, and money market funds scrambling for capital. 
Plunging investor confidence ultimately led credit markets to 
tank worldwide.
    The markets for commercial paper, municipal securities, and 
auction rate securities have all experienced disruptions in 
part because financial institutions no longer trust the credit 
ratings of issuers, bond insurers, and other counterparties. 
Rather than conduct their own due diligence, too many investors 
appear to have relied solely on credit ratings to assess credit 
risk. And while credit ratings play and should continue to play 
an important part in evaluating risk in our economy, over 
reliance on the ratings of just a few firms appears to have 
diminished the amount of independent risk assessment undertaken 
by market participants.
    Because rating agencies underestimated the risk of 
subprime-based securities, these securities were allowed to 
spread throughout our financial system without their real risk 
being detected until it was too late. In our modern economy, we 
need not only better ratings but also more market participants 
assessing risk to prevent this from happening again.
    Before the current crisis began, this Committee worked and 
enacted the Credit Rating Agency Reform Act of 2006. This act 
sought to improve the quality of ratings and to foster 
accountability, transparency, and competition in the industry. 
The Securities and Exchange Commission was given broad 
authority to enforce this act. Last year, the SEC issued 
initial rules governing registration of NRSROs and prohibiting 
certain conflicts of interest. These rules have opened up the 
process for new firms to become NRSROs, fostering more 
competition in the industry. The SEC is now preparing to 
propose additional rules to implement the act.
    Today, we look forward to hearing Chairman Cox discuss the 
types of rules the SEC is considering adopting and what 
additional reforms he believes are needed. I believe the SEC 
has a chance to help restore confidence in our markets and 
establish a more competitive and accountable credit rating 
industry. For example, rules that improve the transparency of 
the ratings process will make it easier for investors to assess 
and compare ratings.
    I am also interested in the preliminary finding of the 
SEC's ongoing examination of the rating agencies, and we would 
like to learn more about the relationship between the agencies 
and investment banks. A rating, after all, is only as good as 
the information on which it is based.
    If there was insufficient due diligence and risk assessment 
in the process of creating and underwriting structured 
financial products, the ratings will be flawed from their 
inception. We found that they were.
    Mr. Chairman, given the critical role underwriters played 
in this crisis, I hope that our examination--I believe our 
examination is incomplete without the participation of the 
firms that created these products, and I hope that we will 
address those two in the future. The sophisticated underwriters 
that structured and sold these securities reaped huge fees for 
their efforts, regardless of how the securities performed for 
investors. I hope their absence from this discussion is not 
permanent, Mr. Chairman.
    Chairman Dodd. Well, thank you very much, Senator Shelby. 
Just on that point of the investment banks, we had a hearing 
last year--in fact, Senator Reed looked into that.
    Senator Shelby. We did.
    Chairman Dodd. And I am certainly willing to hold an 
additional one. As I mentioned, we have had a lot of hearings 
on the subject matter, but certainly that is a very legitimate 
question that you raise, Senator Shelby, and we will do that.
    Senator Reed.
    Senator Reed. Mr. Chairman, I will yield to Senator 
Menendez. He has----
    Chairman Dodd. Fine. Absolutely.

          OPENING STATEMENT OF SENATOR ROBERT MENENDEZ

    Senator Menendez. Thank you. Let me thank both Senator Reed 
and Senator Schumer for their courtesy. I have to chair a 
Foreign Relations Subcommittee hearing at 10:30, and I hope to 
get back for our second panel, Mr. Chairman. So I appreciate 
them both for their courtesy. This is something I have been 
following along with the Committee and am very interested in.
    Over the last year, we have grappled with a foreclosure 
crisis that has swept across our country, devastating families 
and neighborhoods and a credit crunch that has spread 
throughout our markets with ripple effects throughout our 
economy. Within the turmoil, there are many pieces for us to 
focus on as we seek to help homeowners, stem any further 
spillover into other markets, and work to stabilize our 
economy. But the worse mistake I think we could make is not to 
learn from what happened and to let the cracks in the system 
slip by unfixed. Our credit rating system threatens to possibly 
be something that slipped by, and I am glad through your 
leadership and the Ranking Member's that we are not letting 
that happen.
    Last year, we held what I thought was a very important 
hearing to examine one of the most severe and overlooked cracks 
in the mortgage and the securitization chain. While the credit 
rating agencies were not a direct cause of the subprime crisis, 
they certainly were a key link in the securitization chain and 
had a hand in perpetuating a mortgage process in which no one 
asked the right questions. That chain failed in large part 
because the very ratings that the market was supposed to rely 
on were flawed. And often I think they played the conflicting 
roles of referee and coach.
    Recently, we witnessed what happens when the whole system 
fails. Extenuating circumstances or not, our regulatory system 
did not know what hit it when Bear Stearns collapsed. In 
addition to the questions I and many of my colleagues have had 
about how our regulators missed the warning signs, I have 
serious questions about the role that the ratings played or 
could have played in helping raise flags earlier. The fact is 
credit ratings play an essential role for our markets. Issuers 
depend upon them to seek investments. Investors depend upon 
them to know the creditworthiness of the investments they are 
making. The system as a whole depends upon them to track risk. 
But the question is: Who is rating the rating agencies? And 
that answer has been clear: No one.
    So I want to applaud the SEC for taking seriously the need 
to reform this process. I have raised some questions with the 
Chairman when he came to visit--I appreciate his visit--of 
whether some of the SEC plans go far enough, and I hope we can 
find solutions that will increase disclosure and root out the 
practices that keep the ratings from being what they should be: 
fair, simple, and accurate.
    Finally, I hope, Mr. Chairman, we look at the bigger 
picture for a moment. This discussion about how to reform the 
rating system is largely cleaning up the mess. We are still 
mopping up the aisles and trying to figure out what broke and 
why. But beyond this, as I spoke to Chairman Cox when he 
visited me--and, again, I appreciate that visit--the larger 
challenge at hand is getting ahead of the curve. The problem is 
not just that the ratings were flawed or that there are 
conflicts in the system. It is that what is going on in the 
market and on the street is light years ahead often of what is 
going on in our regulatory system. How can our regulators watch 
for the warning signs and respond if they do not even know what 
the signals are? I feel like they are in the same struggle as 
parents who cannot keep up with their teenage kids texting back 
and forth on their cell phones.
    The fact is much of our market operations are taking place 
in a language all its own, and we need our regulators to be 
fluent in that language as well. And I am looking forward to 
the Chairman's proposals in this particular regard and the 
Commission's proposals, and I am hoping that we will have a 
system that puts us ahead of the curve.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    Senator Corker.
    [No response.]
    Chairman Dodd. Senator Reed.

             OPENING STATEMENT OF SENATOR JACK REED

    Senator Reed. Well, Mr. Chairman, thank you very much, and 
I will make some comments.
    First, welcome, Chairman Cox. We have been down this road 
before. In the wake of Enron, we saw flaws in the credit rating 
system. We have tried to address those faults. I want to 
commend Senator Shelby for his efforts as Chair last year and 
at least giving the SEC some authority and some traction in 
this regard. But I think what we have seen in the last 12 
months has been another indication that we have to take more 
directed action.
    Twelve months ago, when at your request I chaired a 
hearing, the subprime crisis was seen as a $19 billion 
worldwide phenomenon that was already self-correcting. That is 
not the case, and so I think we have to do much more. We have 
to ensure that the Commission has the authority to adequately 
supervise, regulate, or direct the credit rating agencies. We 
have to ensure, I think, that the new rules that they are 
promulgating really do the job. As I said, we have been down 
this road before, and we are still going down it. I think we 
want to reach an appropriate conclusion.
    We have to, I think, ensure that we have the appropriate 
balance between market discipline and good rules and 
regulations. That is something, I think, that is out of balance 
at this moment.
    I will conclude with the comments of Lew Ranieri, who 
created the mortgage-backed security years ago, when he said, 
``The mortgage-backed security sector was unfettered in its 
enthusiasm and unchecked by today's regulatory framework. We 
have a quasi-gatekeeper in the rating services, and in the end 
the SEC is the regulator of the capital market. It is the one 
who can touch this stuff and make a difference.'' And I think 
we have to touch this stuff and make a difference now since we 
have not in the past.
    Chairman Dodd. Thank you very much, Senator. And, again, 
for the purpose of the record, all statements, complete 
statements of Members and witnesses, will be included in the 
record as well.
    Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, thank you for holding this 
hearing, and also Ranking Member Shelby. I would just make a 
few brief comments.
    The nationally recognized statistical rating organizations 
play an important role in financial markets. Confidence in 
these ratings have been shaken following a number of downgrades 
of residential mortgage-backed securities. And so this lack of 
confidence is of concern to me. I have said this to a lot of 
people, I believe. And I just would remind us of a quote from 
former Federal Reserve Chairman Alan Greenspan when he said 
that people believe that they--meaning the credit rating 
agencies--``knew what they were doing, and they don't. What 
kept them in place was a belief on the part of those who 
invested in that that they were properly priced.''
    Now everyone knows that they weren't, and they know that 
they can't really be properly priced. And I am anxious to hear 
what Chairman Cox might have to say about that particular 
statement.
    As always, I would like to welcome my friend and former 
colleague from the House. It is always good to see you, Mr. 
Chairman.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Well, thank you, Mr. Chairman. I very much 
appreciate the opportunity to have this hearing and very much 
appreciate your being here. And I think it is appropriate 
because, at least to me, credit rating agencies were the weak 
link in the subprime crisis. They, along with mortgage brokers, 
are probably more at the center of this than just about anybody 
else. And, incidentally, at least until we passed our 
legislation--and much of the action occurred before that--
neither the mortgage brokers nor the credit rating agencies had 
any real regulation at all. And so it is difficult to ask the 
SEC--they now have regulation, and we have met and talked 
about--have the ability to look at things like conflict of 
interest, but they did not back then. So, to me, the credit 
rating agencies are at the heart of this problem, and we need 
to do a thorough examination of what is happening. That is why 
I appreciate you, Mr. Chairman, and the Ranking Member being so 
interested in this issue, which he was when he was Chairman as 
well, as well as Senator Reed.
    Second, I really regret that the heads of--I want to 
commend Fitch's for sending their CEO, but where are the heads 
of Moody's and Standard & Poor's? The bottom line, this is 
really serious stuff. The whole world is focused on this. And 
for the CEOs not to come is very disappointing. They should be 
here. And particularly they should be here because I met with 
the President of Moody's a while ago, and I asked him, Did 
Moody's do anything wrong? And he said no. I would like to know 
if he still believes that. He said no, they did nothing wrong. 
I was incredulous.
    And so, again, I think the credit rating agencies really 
have an obligation to send their leaders and to find out what 
happened and what is going on here. And I want to register my 
disappointment.
    Third, to me, the nub of this problem is conflict of 
interest. Obviously, when you are paying for a rating, there is 
an inherent conflict of interest, and that has to change. And 
there was a story in The Wall Street Journal--which I would 
just ask unanimous consent to put into the record.
    Chairman Dodd. It will be included.
    Senator Schumer. It is an article from April 11th that just 
documented one instance of a conflict where analysts were 
changed because people did not like the rating agency. Here is 
a quote from the article: ``On occasion, Moody's agreed to 
switch analysts on deals after bankers complained.'' And 
another quote: ``There was, rather, a palpable erosion of 
institutional support for rating analysis that threatened 
market share.'' Moody's decided they would increase market 
share in this area, and their standards declined at the same 
time.
    Conflict is inherent sometimes, and, look, sometimes there 
are legitimate reasons to complain: you did not take this into 
account; there has to be a dialog between the agency and the 
issuer. But disclosure is key, and I asked you, Mr. Chairman, 
when we met, would you make sure that this is all disclosed 
when an analysis was changed after a complaint or if a rater 
was switched? That should be known. Again, you cannot say that 
the issuer can never complain. Maybe they missed something. But 
at least disclosure would be a prophylactic. And the new 
legislation that we supported and Chairman Shelby shepherded 
through this Congress allows for that disclosure, and we 
eagerly await the regulations that you will have.
    One final point I would make here. For somebody to say 
nothing is wrong, here is the nub of it: How did no-doc loans, 
loans with no documentation that were parts of these packages, 
get AAA ratings? Now, when you ask the credit rating agencies 
how did no-doc loans deserve AAA ratings, they said, well--not 
them but the people analyzing them. They say, well, they 
thought housing would go up no matter what. And so, therefore, 
it did not matter if the guy could not repay, so you did not 
have to look at the loan.
    Well, maybe they should have paid one of us. We could have 
told them housing prices would go up forever. We did not need 
to do any analysis either, or somebody, or the guy on the 
street.
    So something is really wrong here. Something is really 
wrong. I know some of it has been self-corrected already, but 
there has to be more to be done, and this hearing is a very 
constructive step along that path. And I thank you for holding 
it, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    We invited the CEO. Today is their shareholder meeting, and 
so he--though we could maybe schedule it another time. I did 
not know that at the time, and he let us know he would have 
been here but for presiding over the shareholder meeting. 
Moody's, anyway, I want to include that in the record.
    Senator Schumer. Well, I would like an opportunity for them 
maybe to come back at some point if we have time, either at the 
Committee or the Subcommittee level.
    Chairman Dodd. Very good point.
    Senator Tester.

            OPENING STATEMENT OF SENATOR JON TESTER

    Senator Tester. Thank you, Chairman Dodd and Ranking Member 
Shelby, for calling today's hearing on credit rating agencies 
as another in a series of hearings looking into the turmoil in 
the credit markets. I want to welcome Chairman Cox and the 
members of the second panel.
    My stay here today is going to be limited because I have to 
chair on the floor, but this is a topic that is both timely and 
critical as issues that surround the credit rating agencies and 
their role in the current credit market crisis keep arising. In 
Montana, we are confronted with uncertainties in the student 
loan market, as the auction rate bond market is no longer 
viable, due in no small part, some say, to mistrust in the 
credit rating agencies.
    As important as it is to delve into the oversight of the 
credit rating agencies, I really want to spend my opening 
statement today addressing the distinguished witness Chairman 
Cox on the possibility that market manipulation led to the fall 
of Bear Stearns leading up to its merger with JPMorgan Chase.
    Mr. Chairman, you testified before this panel on April 3rd, 
along with Chairman Bernanke and other distinguished panelists, 
to discuss recent actions of Federal financial regulators as it 
related to the Government's role in the Bear Stearns saga. At 
the time, I inquired if there is any evidence suggesting that 
speculators had bet heavily that Bear Stearns' share price 
would fall, known on Wall Street as ``short selling.'' You 
responded, and I quote, ``I am a little bit constrained because 
the SEC is in the law enforcement business.'' You then 
continued to say that the SEC pursues insider trading 
aggressively and that your agency was mulling several law 
enforcement matters that have not been filed in any U.S. court.
    A week after, on April 10th, I sent a letter to you and to 
Attorney General Mukasey asking you to immediately and 
thoroughly investigate whether illegal insider trading led to 
last month's downfall of Bear Stearns. To date, I have not 
heard back from your office, nor have I heard back from the 
Department of Justice. I understand your response is currently 
being drafted and will likely echo the sentiments that you told 
me on April 3rd, that you were in the law enforcement business 
and cannot confirm nor deny, but you will investigate if any 
wrongdoing has taken place.
    While I respect that, and I admire the SEC for playing an 
integral role in the investigations of securities law 
violations, I want you to know that this is not an ordinary 
situation, and the events that followed what some view as 
market manipulation were unprecedented--a $29 billion loan from 
the Government to facilitate a merger of two of the world's 
largest banks.
    I am not sitting here to criticize the Federal Reserve Bank 
of New York for their actions if risking nearly $30 billion of 
taxpayer dollars with a limited amount of due diligence was 
necessary, but I do want to know if it could have been avoided, 
if speculators conducted insider trading to make a buck, a 
whole lot of bucks, which led to taxpayers being forced to 
stand behind the loan that is big even by Washington, D.C., 
standards, much less the standards of my home State of Montana.
    As I stated earlier, I will have to leave very shortly to 
go preside on the floor, but we will continue to have a 
dialogue. You will continue to hear from me in the coming 
months on the need for a thorough investigation. Hopefully that 
is going on as we speak, and hopefully it will get to the 
bottom of the situation. I have asked other financial 
regulators, investors, and knowledgeable individuals their 
thoughts, and to a person, they believe fear and speculation 
alone did not eat up Bear's significant liquidity position. But 
I want to hear it officially from you.
    So thank you, Chairman Cox. Thank you, Chairman Dodd.
    Chairman Dodd. Thank you very much, Senator.
    Senator Bayh has joined us. Senator, do you have any 
opening comments you want to make?
    Senator Bayh. Thank you, Mr. Chairman. No. I am looking 
forward to hearing from Chairman Cox, and I did want to note 
my--this takes me back a few years, Mr. Chairman. My corporate 
law professor in law school, John Coffee, is here, and I just 
wanted to give him my best regards.
    Chairman Dodd. Now we are going to really have an 
interesting hearing.
    Senator Bayh. And for both our sakes, I hope he will not 
disclose what my grade in the course was.
    Chairman Dodd. I tell you, we expect very tough questioning 
from you, though, Senator, of the witness.
    Chairman Cox, welcome to the Committee once again. You have 
been before the Committee on numerous occasions over the last 
year, and we appreciate your being back here today.
    Mr. Cox. Thank you. Senator Tester I notice is just 
leaving, but----
    [Laughter.]
    Mr. Cox. Just on your way out, I think you recognize that 
both the Department of Justice and the SEC do not confirm 
investigations into people for privacy reasons before they have 
been publicly identified with wrongdoing. But I also stated at 
that hearing that the problem with Bear Stearns was too big to 
miss and people should take comfort that the SEC was doing its 
job in this area. So I hope to signal by that within the silent 
forum that we all must operate in the law enforcement agency 
business that that is the case. And beyond that, I look forward 
to speaking with you in private to give you the maximum amount 
of comfort in that respect.
    Senator Tester. You took the words right out of my mouth, 
Chairman Cox. I would like to set up a meeting with you, and we 
can visit about the issue in private. That would be great. 
Thank you.
    Mr. Cox. Thank you.
    Chairman Dodd. Thanks very much. Mr. Chairman, we look 
forward to your statement.

STATEMENT OF CHRISTOPHER COX, CHAIRMAN, SECURITIES AND EXCHANGE 
                           COMMISSION

    Mr. Cox. Thank you, Chairman Dodd, Senator Shelby, Members 
of the Committee, for inviting me today to discuss the work of 
the SEC concerning credit rating agencies.
    When Congress passed the Credit Rating Agency Reform Act 
and President Bush signed it into law in late 2006, its purpose 
was to improve ratings quality by fostering accountability, 
transparency, and competition in the credit rating industry. 
Prior to the Rating Agency Act, credit rating agencies were 
essentially unregulated by the Federal Government, and the SEC 
had no authority to make rules governing their business or to 
subject them to examinations as nationally recognized 
statistical rating organizations. With the passage of the act, 
the Commission became their regulator, and since that time, we 
have devoted considerable new resources to this responsibility.
    Since the end of September 2007, seven credit rating 
agencies, including those that were most active in rating 
subprime-related products, have been subject to the 
Commission's new oversight authority, and subject as well to 
our newly adopted rules. In the 6\1/2\ months since the SEC's 
authority over CRAs went into effect, the Commission has 
aggressively used its authority to examine the adequacy of 
their public disclosures, their recordkeeping, and their 
procedures to prevent the disclosure of material non-public 
information.
    The review process has included hundreds of thousands of 
pages of the rating agencies' internal records and e-mail. In 
addition, the staff are reviewing the ratings agencies' public 
disclosures relating to the ratings process for those 
securities, and Commission staff have analyzed the ratings 
history of thousands of structured finance products. These 
extensive examinations have involved approximately 40 SEC 
professional staff.
    Much has been accomplished already on these examinations, 
but there is still much more work to be done. The Commission 
expects that the report describing the staff's observations 
from the examinations will be issued by early summer. At this 
stage, with more examination work to be completed and the 
staff's across-the-board inferences yet to be drawn, it is 
premature to describe the results. I can say that it appears 
the volume of the structured finance deals that were brought to 
the credit rating agencies increased substantially from 2004 to 
2006, and at the same time, the structured products that the 
rating agencies were being asked to evaluate were becoming 
increasingly complex, with many employing derivatives such as 
credit default swaps to replicate the performance of mortgage-
backed securities.
    Meanwhile, the loan assets underlying these securities 
shifted from primarily plain vanilla 30-year mortgages to a 
range of more difficult-to-assess products, including ARMs and 
second-lien loans. We are currently evaluating whether and how 
the credit rating agencies adapted their ratings approaches in 
this rapidly changing environment. We expect the results of 
these staff examinations will provide significant and useful 
new information that will help not only the SEC but also 
issuers and users of credit ratings to address the problems 
that we have seen.
    Because the Commission's authority over credit rating 
agencies took effect just over 6 months ago, the SEC is already 
far along in preparing for a second round of rulemaking. This 
second round of rulemaking will be based on information 
provided by the staff's ongoing examinations of these firms as 
well as the many empirical analyses provided by regulators and 
industry groups, academics, and multinational organizations, 
including many in which the SEC itself has participated. I 
expect the Commission will issue rule proposals for public 
comment in the near future. Of course, the internal development 
process for these rules within the Commission is still very 
much ongoing. So while I am happy to provide you today with an 
outline of the rulemaking areas that are under consideration, I 
do so with the caveat that what ultimately is included in these 
new proposed rules has yet to be decided.
    That said, the rules that we are likely to consider will 
fall into three broad categories: rules designed to foster 
accountability, rules to enhance transparency, and rules to 
promote competition in the credit rating agency industry. 
These, of course, are the three goals of the Rating Agency Act 
itself.
    To strengthen accountability, the new rules may include 
requirements for enhanced disclosures about ratings' 
performance. This would enable market participants to better 
compare one NRSRO with another. To ensure NRSRO accountability 
for the management of their conflicts of interest, the new 
rules could include specific prohibitions on certain practices. 
They could also establish requirements to address potential 
conflicts of interest that could impair the process for rating-
structured products.
    Among the conflicts of interest that could be addressed are 
the provision of consulting services by credit rating agencies 
to the issuers of the securities that they rate and the rating 
of structured securities that the credit rating agency itself 
helped to design. The proposed rules may also include 
requirements that the firms furnish the Commission with annual 
reports describing their internal reviews of how well they 
adhere to their own procedures for determining ratings, 
managing conflicts of interest, and complying with the 
securities laws.
    In the second category of enhancing transparency, the 
Commission may consider rules to require the disclosure of 
information underlying the ratings of subprime-related 
products, including, for example, the particular assets backing 
MBS, CDOs, and other types of structured products. This would 
allow market participants to better analyze the assets 
underlying the structured securities and reach their own 
conclusions about creditworthiness.
    Making this data available to the market could particularly 
benefit subscriber-based NRSROs who could use it to perform 
independent assessments of the validity of their competitor's 
ratings. Other improvements that the new rules could make in 
the area of transparency could come from enhanced disclosure 
about how NRSROs determine their ratings for structured 
products. This new disclosure could include, for example, the 
kind of analysis that is done on the degree to which the 
mortgages behind asset-backed securities conform with 
underwriting standards. Additional disclosure could be required 
as well for the firms' procedures for monitoring their current 
credit ratings. The Commission may also consider rules to help 
investors to readily distinguish the ratings for different 
types of securities such as structured products, corporate 
securities, and municipal securities.
    In the third area of potential rulemaking, promoting 
competition, the new rules could include provisions to enhance 
disclosure about ratings' performance so that it affords other 
credit rating agencies, including newly recognized NRSROs, an 
opportunity to identify flaws in their competitive approach or 
to demonstrate to investors that their ratings performed 
better. The Commission is also reconsidering its extensive 
reliance on credit ratings in our own rules. Limiting the use 
of credit ratings for regulatory compliance purposes could 
encourage investors in the marketplace as a whole to use 
ratings for their informational value rather than merely to 
satisfy a regulatory requirement. This could induce greater 
competition among rating agencies to produce the highest-
quality, most reliable ratings.
    Yet another way the new rules might seek to enhance 
competition could be to ensure that all NRSROs have access to 
the same information underlying a credit rating. In that way, 
regardless of whether the NRSRO follows the issuer-pays 
approach or the subscriber-based approach, there would be no 
competitive advantage or disadvantage based on access to 
information on the assets underlying a structured credit 
product. And at the same time, NRSROs that were not paid by the 
issuers to rate securities could develop their own track record 
for rating these products.
    To the extent both the issuer-pays and the subscriber-based 
models were to flourish in a competitive marketplace, each 
could act as a healthy competitive check on the other. Of 
course, because this planned proposed rulemaking is ongoing, 
there could and undoubtedly will be other subjects covered in 
the draft rules that the staff will present to the Commission 
for its consideration.
    In closing, Mr. Chairman, I want to emphasize that the 
Commission is very much open to ideas from the Congress on this 
proposed rulemaking, and we especially welcome ideas from this 
Committee since you are the authors of the Credit Rating Agency 
Act and it is your intent in writing the law that the 
Commission is now working to fulfill.
    I appreciate this opportunity to provide the Committee with 
this update on the SEC's new regulatory responsibilities for 
credit rating agencies, and I look forward to answering your 
questions.
    Chairman Dodd. Well, thank you very much, Mr. Chairman, and 
I want to ask the clerk to put up about 7 minutes per Member 
here so that we can give everyone a good chance to raise some 
issues with you.
    First, I was pleased to hear your plans to require greater 
clarity of methodologies and to make issuer data available to 
all NRSROs and to propose needed reforms. Let me ask you a 
couple of sort of underlying questions, and then there is a 
series of specific ideas that have been raised, including some 
of our witnesses who submitted their testimony and will be 
before us a little later this morning.
    I guess one question we would have for you, all of us would 
up here, putting aside the various ideas, do you need any 
additional statutory authority, do you think, for the SEC to 
act? And if so, would you share with this Committee what 
limitations you have in that regard and what recommendations 
you would make if, in fact, there is a gap in terms of what you 
think you need to do and the authority that you have been given 
either by the legislation we adopted or previous legislation?
    Mr. Cox. Mr. Chairman, thank you for the question and for 
the opportunity. In connection with this latest proposed round 
of rulemaking, we have come upon a number of topics where we 
had to ask ourselves, Do we have the authority aggressively to 
do this? And thus far, the answers that we have been able to 
give are all yes. We do have the authority, not only in the 
Rating Agencies Act, but also under the Exchange Act and the 
other Commission authorities in combination. And so thus far, 
what we have in mind is amply supported by the new legislation 
that you have just written.
    Chairman Dodd. The second question would be budget. I 
expressed in my views and estimates letter to the Budget 
Committee of February 25th of this year, I raised concerns as 
to whether or not the President's fiscal year 2009 budget 
request of $913 million for the SEC would be adequate to 
examine and regulate the NRSROs as well as to deal with 
enforcement, the subprime crisis, consolidated supervision, and 
other issues.
    Do you feel, Mr. Chairman, that the amount that you are 
going to be given here is enough, will provide enough resources 
to effectively oversee the securities markets? And if not, 
would you share with the Committee what you believe you are 
going to need?
    Mr. Cox. Mr. Chairman, as you know, the budget that the 
President has put before you is the largest budget that the SEC 
would ever have received. It is approaching $1 billion. I think 
it would be appropriate for this Committee as authorizers to 
consider both the CSE program and the CRA program from the 
standpoint of their place within the agency. I think overall 
the nearly $1 billion that Congress has provided us in the 
latest budget is ample for the overall achievement of our 
goals, and I have been able as CEO of the agency to allocate 
resources, for example, to credit rating agencies and to our 
CSE program.
    At the same time, because both of these programs are 
relatively new, the CRA program itself very new and it has 
never been the subject of extensive consideration, therefore, 
on the Appropriations Committee, and because the CSE program is 
a voluntary program based on old authority and not itself 
authorized in law, I just think it would be very useful if 
there were a dedicated funding stream for these two significant 
new responsibilities for the agency because they have changed 
overall the responsibilities of the SEC.
    Chairman Dodd. Well, we will take that into consideration. 
Of course, we have some Members of the Appropriations Committee 
here, including Senator Shelby, so we can examine that issue 
further.
    Let me raise a couple of specific suggestions that will be 
raised in testimony from some of our witnesses coming along 
that I thought were interesting. Again, I agree with your 
intent to enable market participants to better compare the 
rating agencies. And Professor Coffee has proposed an idea 
along these lines that I think has some merit, and I would be 
interested in your own reaction to it, and that is, a neutral 
website that displays the past ratings for each security rated 
by multiple NRSROs so investors could compare the accuracy of 
the different rating agencies.
    I wonder what your views would be on a proposal such as 
that, and could the SEC maintain such a website? Is there 
anything that would prohibit you from doing that?
    Mr. Cox. Well, the idea of enhancing the transparency of 
the ratings themselves and their performance is at the heart of 
what we have been talking about, of course. Making the 
information as easily available to the public in the most 
easily comparable form also is a natural objective. And so 
Professor Coffee's proposals in that respect are very much 
consonant with at least what I am thinking and I believe what 
the Commission staff and perhaps the other Commissioners are 
thinking.
    As you know, the statute, I think wisely, says that the 
Federal Government should not dictate the ratings themselves, 
should not tell rating agencies in this competitive market 
precisely how they should do it, but there is ample support in 
the statute for disclosure around these things. So provided 
that the scorecard was disclosure and not indirect regulation--
--
    Chairman Dodd. No, I think that is what we are talking 
about. Professor Coffee can contradict me when he testifies, 
but I think the idea was just to allow--so you would have some 
way of looking at the accuracy of this and making judgments.
    Mr. Cox. The final point that I would make is that were the 
disclosure mandated to be tagged with XPRL data tags in 
interactive data form, then almost anyone could put together 
their own comparative scorecard, and I think that a lot of 
financial intermediaries on the Web would do this probably for 
free for consumers and investors in addition to whatever the 
SEC might do on its own website.
    Chairman Dodd. Yes. Of course, the SEC, that Good 
Housekeeping Seal of Approval is a very valued determinant.
    Mr. Cox. Yes, of course, and if the SEC requires more 
detailed disclosure beyond what already is provided on the 
NRSRO, then, of course, all of that data would be official SEC-
filed data.
    Chairman Dodd. An additional suggestion from Professor 
Coffee would have the SEC temporarily suspend an NRSRO, the 
status of a rating agency that consistently errs in rating a 
particular type of security over a period of time. What are 
your thoughts on that?
    Mr. Cox. The authority that you have just given to the SEC 
includes not only censure but revocation of the registration of 
an NRSRO.
    Chairman Dodd. So you have that authority?
    Mr. Cox. Yes, we do.
    Chairman Dodd. There has been----
    Mr. Cox. Now, I should add, not if that authority were to 
be used to sanction someone for getting the rating wrong, but 
for violating any of the rules or provisions of the statute, 
that sanction would be appropriate. And as I mentioned before, 
you did not want us, the SEC, to actually regulate the 
substance of the ratings. But we would not revoke a 
registration for that reason.
    Chairman Dodd. There has been a suggestion as well that a 
rating agency separate its rating business from its rating 
analysis function. We have heard similar arguments in the past 
in other related areas of financial services. What is your 
reaction to that suggestion?
    Mr. Cox. Conflicts of interest of that sort are very much 
at the heart of what we are looking at in the proposed new 
rulemaking, and I agree both with the mandate in the act very 
strongly and with the inferences that have been drawn from it 
that conflicts of interest are directly related to some of the 
problems that we see in the market.
    Chairman Dodd. Let me come back to the previous question. I 
heard your answer to it. It is one thing to break rules and 
certainly suspend. I understand that, you have that authority. 
What I was driving at more is the error in judgment of 
consistently--I am not talking about, obviously--and this would 
have to be, you know, over a period of time you get just error 
after error in judgments and drawing conclusions about various 
instruments here. It seems to me there that--well, anyway, you 
don't believe that that is an appropriate role for the SEC 
where you have a consistent error in judgment on these ratings, 
that that would be a justification for suspending that rating 
agency's function?
    Mr. Cox. Well, what the law contemplates--and I think what 
our rules will flesh out when they become final later this 
year--is a world in which everyone knows what the rating 
agencies are doing and why and how. We know what their internal 
procedures are. We know how they deal with conflicts of 
interest. We know what the prohibited practices are. If then in 
a competitive world their ratings fare less well even though 
they are performed exactly according to spec than someone 
else's, that fact alone would not be grounds under the statute 
for revocation of their registration.
    If, on the other hand, the reason that their ratings were 
consistently wrong is that they had not followed the procedures 
that they described, not disclosed fully what they were doing--
they had, for example, changed their ratings model under 
pressure to get business or what have you, or committed any 
other kind of error, or worse, in judgment, then I think their 
registration under the statute could be revoked by the SEC, and 
we would have the authority to do so.
    Chairman Dodd. My time has expired, but I suspect my 
colleagues may want to pursue this line of questioning with you 
a little further.
    Senator Shelby.
    Senator Shelby. Thank you, Senator Dodd, and thank you for 
bringing that up. I want to continue along that line for a 
minute.
    If some firm or NRSRO is consistently wrong on their 
ratings, you know, they rate them, then they are downgraded--
and we have seen this over and over and over consistently--
wouldn't that call in, just common sense, the confidence of 
that firm, or whoever it was? And why wouldn't you jerk their 
license or whatever they have to do business if they are 
consistently wrong, they are ignorant, they are incompetent, or 
they do not care, or they are sloppy, they are not diligent? I 
think that is what we were getting at, among other things.
    Mr. Cox. Well, I think it stands to reason that there would 
be a connection in most cases--this is obviously a hypothetical 
discussion--between that kind of horrible track record and 
failure to follow all of the good hygiene that is mandated in 
law and regulation. This has heretofore been an unregulated 
industry. Once the regulations are in place and once people 
have an opportunity to either be in compliance or not with 
them, you will be able to draw a correlation, I imagine, 
between compliance with the law and regulation and failure in 
the marketplace.
    Senator Shelby. But incompetence in the marketplace like 
this, especially rating securities that are so important, I 
think calls for rigorous enforcement of the rules and whatever 
they are. But you take doctors, if they are incompetent, they 
jerk their license, you know, lawyers after a while, but why 
not something like this that goes to the very heart of our 
financial system?
    Mr. Cox. Well, I think you may be asking me for advice on 
new legislation, because what I am trying to do is interpret--
--
    Senator Shelby. I think Senator Dodd asked did you need 
anything else.
    Mr. Cox. Yes, interpret----
    Senator Shelby. You might and you might not. I do not know.
    Mr. Cox. Well, I will say that if you want the SEC to 
revoke the charter of a credit rating agency simply for being 
wrong, even though it has followed all of its own rules and 
procedures, fully disclosed them, and fully disclosed the basis 
for all of its ratings, then we would need new law to do that 
because----
    Senator Shelby. Mr. Chairman, we are not asking for being 
wrong once. I believe Chairman Dodd used the words 
``consistently wrong,'' which would bring about incompetence, 
the lack of diligence, and so forth. A lot of these rating 
agencies have been consistently wrong on the subprime, and I 
think they have contributed greatly to the financial debacle 
that we have today. Do you not agree with that?
    Mr. Cox. Actually, over a long period of time in a number 
of circumstances, I have observed the pattern of ratings of 
very high levels, preceding almost by days in many cases 
horrible consequences thereafter. There is no question that the 
legislation that you provided us and the new authorities that 
we are going to exercise are much needed for that reason.
    I think, however, that the judgment that you made in 
passing the law is a good one, that there is a role for 
competition here; that if the Federal Government were to be the 
open arbiter of whether ratings approaches were good or bad, 
that would probably result in poorer ratings performance over 
time because people would not be able to update their models 
without regulatory approval. They would always stand to be 
second-guessed and so on. I think a system such as the one that 
you have designed in which everyone has to be aboveboard about 
the approach that they are taking and they are subjecting to 
competitive pressures, they are accountable, they are 
transparent, is probably most likely to get us the results that 
we want to achieve.
    Chairman Dodd. Richard, would you let me----
    Senator Shelby. Go ahead.
    Chairman Dodd. Just on this point, Mr. Chairman, under the 
act that was signed in 2006, let me just read the language here 
and see if this gives you any pause in terms of your response. 
It is entitled, under Section 3, ``Grounds for Decision. The 
Commission shall grant registration under this subsection,'' 
and then there are two or three--or two subparagraphs. 
Subparagraph (2), ``unless the Commission finds, in which case 
the Commission shall deny such registration, that, one, the 
applicant does not have adequate financial and managerial 
resources to consistently produce credit ratings with 
integrity.'' Now, that would be at the initial granting of a 
charter. So we are talking about something a little different 
here, and that is to withdraw a charter or to suspend a 
charter.
    So if you make a decision to grant one based on the ability 
to produce results with integrity, it would seem to raise the 
question that at least the Commission would have the authority 
to suspend that charter if, in fact, that integrity were 
compromised.
    Mr. Cox. I think that is exactly right. In fact, that is 
authority that we intend to use aggressively. That provision, 
of course, goes to resources. So I think we are talking 
hypothetically here.
    What we have done, rather unnaturally, in this hypothetical 
discussion is we have isolated just the ratings performance, 
and we have imagined that it has nothing to do with lousy 
management or violations of rules or procedures or other 
things, which undoubtedly in the real world it would. But this 
provision that you have just cited concerning failing to 
maintain adequate financial and managerial resources goes to 
quantity, and if the place spent tens of millions of dollars on 
their analysis, they probably would get past this.
    In any case, the provision that is the bar to our 
regulating the substance of credit rating agencies and the 
procedures by--or, pardon me, the substance of credit ratings 
or the procedures by which they are adopted is prefaced with 
the legislative language, notwithstanding any other provision 
of law. So it trumps everything else in the statute, and it 
says that what we cannot do is regulate the substance of credit 
ratings, and we cannot by regulation prescribe the 
methodologies by which they are obtained.
    Senator Shelby. Chairman Cox, what are we trying to do with 
the rating agencies? Maybe you have a different take than I 
have. I hope we are trying to restore confidence in the rating 
system, their methodology, how they do what they do, because 
there is no trust out there in the market today. I don't know 
many people that trust the rating system. They see that as a 
big contributor of where we are today and what we are trying to 
do, working with the SEC, and I was trying to do when I offered 
that legislation, what Chairman Dodd is trying to do now, is to 
give the SEC the tools that you need not to do business as 
usual. Doing business as usual with a rating agency, that is 
gone. So many conflicts of interest, as I see it, always so 
many cozy relationships, so much money made if the ratings went 
this way and that way.
    How do we change that? That is what we are after, is 
transparency and so forth, because I think the rating agencies 
can play and have played a tremendous positive role in our 
financial markets. But today, my gosh, you know, would I buy 
bonds that Moody's or S&P rated AAA without looking at them and 
having somebody else look at them closely? No. I would be 
foolish to do it, wouldn't I be?
    Mr. Cox. I think that is exactly right, Senator. And as you 
know, as the author of the legislation, the overarching purpose 
is to improve ratings quality. The devices of transparency and 
accountability and competition are the means to achieving that 
result. And, of course, improving the quality of ratings is the 
prerequisite to improving confidence in that whole rating 
system.
    Senator Shelby. Well, you are the Chairman of the SEC. 
There have been some recommendations to Secretary Paulson to 
change the role of the SEC, to make the Fed, you know, the 
great arbiter of everything, which I think would be kind of 
dangerous and foolish myself. But if the SEC is not going to do 
the job, somebody else will have to do the job. I hope that you 
and your leadership and your other Commissioners will do the 
job that needs to be done. We are at a crisis here, a crisis of 
trust, a crisis of confidence, looking at rating agencies with 
so many obvious conflicts of interest. I think it is horrible.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator Shelby.
    Senator Reed.
    Senator Reed. Well, thank you, Mr. Chairman.
    Borrowing an analogy from another field, do you think that 
any of these rating agencies were guilty of malpractice, not 
meeting the standard that you would expect as the Chairman of 
the Securities and Exchange Commission in the execution of 
their responsibilities to rate some of these securities?
    Mr. Cox. That is one of the questions that we are asking 
and in part coming to answers on in our ongoing examination of 
the three largest firms. As you know, we have some 40 people on 
that project right now, and we expect to report fully to you by 
early summer.
    Senator Reed. Your typical remedy, again, using this rough 
analogy, for malpractice is some type of action against the 
individual institutions and restitution or something, or at 
least to correct the behavior. And I am trying to sort of 
connect the dots here between at least the possibility of not 
operating appropriately and any type of sanction. They claim--
and the claim has been, I think, affirmed--that they are 
protected under the First Amendment in terms of any type of 
legal liability.
    How do we get them to behave differently if, in fact, there 
is a serious question of misperformance?
    Mr. Cox. Well, I think that from the fourth quarter of 2007 
forward, we are in a different world, because now we have a 
regulated industry with legal standards of conduct, as we were 
just discussing. They can be censured. They can be hit with 
targeted sanctions. They can get the death penalty. There are 
all sorts of regulatory norms that they will now have to comply 
with.
    In addition, we will have a marketplace that is now much 
more competitive, not so oligopolistic. We already have 
additional credit rating agencies that have been able to enter 
the business as NRSROs as a result of the new legislation. And 
the disclosure and transparency that the new regime should 
provide will force--I think it is the legislative intent, and 
we expect it as well--some quality as a result.
    Senator Reed. You said, Mr. Chairman, that you have got 40 
individuals working on this analysis. When you implement the 
regulations, will you have the dedicated staff of roughly that 
size with the expertise to continue to evaluate the performance 
under the new regulations?
    Mr. Cox. It is not necessary to have the current 
examination staff on a permanent basis as part of the CRA 
program. But we do have budgeted approximately in the range of 
10 to 20 people over the long haul for this purpose.
    Senator Reed. It just seems to me that in everything we 
read about these products, they are inherently complicated, 
complex. In fact, many people will not buy them. Jamie Diamond 
has been quoted several times saying, ``They are too 
complicated. I do not understand them. I will not buy them.'' 
And yet you will have about 20 people who are going to overlook 
the credit rating agencies. Do you think that is adequate 
resources to ensure that they are--unless it is simply 
procedural, they check the blocks, you know, we did this, we 
did this, we did this, but with no substantive regulation?
    Mr. Cox. For purposes of managing the registration and 
inspection regime--and, remember, we can use the resources as 
we are using now our Office of Compliance, Inspections, and 
Examinations for this purpose in the future as well. But for 
the ongoing purposes of managing the registration and 
compliance regime, I think that that is about the right number.
    On the other hand, the reason that I am inviting the views 
of this Committee on the size and scope of this program is so 
that we can be sure that within the context of the overall SEC, 
we have, in fact, right-sized this function. It is a brand-new 
function. We want to get it right.
    Senator Reed. In that regard, how thoroughly will you 
anticipate the staff looking down through--and maybe this is 
not exactly correct, but a simple security model of a mortgage-
backed security, where there are actually mortgages and a pool 
of mortgages, you sell securities. Then there is the CDOs, 
which basically gets more complicated, CDOs, squares, et 
cetera. Do you anticipate that your staff would be looking all 
the way through independently to the collateral of these 
securities, or at least on a spot-checking basis?
    Mr. Cox. Most certainly on a sampling basis, and probably 
across the board just in terms of the different genres of 
products that are being rated.
    Senator Reed. You raised in your opening statement the 
possibility of less reliance under the SEC rules on ratings. 
Can you amplify that?
    Mr. Cox. One of the concerns that has been expressed in 
several of the multinational fora, including the Financial 
Stability Forum and IOSCO, is that that there was insufficient 
attention paid to what these rating were and what they were not 
and that there was in some cases nearly mindless reliance on 
the fact that it said AAA. In order to make sure that the 
ratings are understood for what they are and what they are not, 
we are going to have a lot of new disclosure. At the same time, 
we want to make sure that there is not a check-the-box 
mentality, and if the rule says you can do X if you have a AAA 
rating, that might induce that kind of behavior.
    So we will not be able to purge, by any means, our rules of 
references to ratings, but there may be some fine-tuning that 
we can do in order to make sure that we do not create that 
moral hazard.
    Senator Reed. Well, it would seem to me that, 
theoretically, as you diminish purposely the role of the 
ratings, not that, you know, Good Housekeeping Seal of 
Approval, put the onus, I think, either directly by rules for 
publicly registered companies to independently evaluate the 
ratings that they are either buying or they are arranging to 
obtain, that might be appropriate for some larger institutions, 
but for small investors, for municipalities, for people who are 
looking--do not have the infrastructure, how effective would 
that be?
    Mr. Cox. Well, I think if the only consequence of a change 
were to increase the investor burden, then we would not have 
accomplished the objective. We have got to be very, very 
sensitive to that. The opportunity, I think, that we have is to 
state very clearly in our rules what is the point that we are 
trying to establish, what is the objective test that we are 
asking people to meet. And if a rating----
    Senator Reed. What is that test?
    Mr. Cox. It depends entirely on the circumstances. The 
ratings themselves are mentioned in rules and in statute, I 
should add, in many different contexts. But if we can simply 
clearly state, and in plain English, what it is that the law 
and the rules are trying to accomplish by referencing these 
ratings, we can add a little more context to it so it is not 
just a mindless act of I got the rating even if the use of a 
rating for that purpose would not be appropriate.
    Senator Reed. Thank you.
    Chairman Dodd. Thank you very much.
    Senator Corker.
    Senator Corker. Yes, Mr. Chairman, thank you.
    I thank you for your testimony, Mr. Chairman, also, and we 
have had you up here many times, and we appreciate very much 
the position that you are in.
    I have to tell you, the rating agencies do not spend a lot 
of time on accounting issues, and we have heard of the fact 
that they are not audits, which obviously they are not. But it 
seems to me that it would be almost impossible in many cases 
for a rating agency to give a rating without at least looking 
at some of the basic accounting principles that are being dealt 
with.
    I spent all day yesterday with the leaders of financial 
institutions in New York, and this whole fair-value accounting 
system, which needs some kind of updating, there is a huge, 
huge issue there. But for them not to at least get into some of 
the things that are occurring there as a rating agency and how 
judgments are being made as to assets being written down and 
that type of thing seems to me a very important--and there are 
many others--a very important thing for a rating agency to be 
able to do to actually issue a rating. Otherwise, I do not know 
how it would occur, and I would love for you to comment on that 
if you would.
    Mr. Cox. Well, there is no question that particularly in 
terms of market pricing, those kinds of accounting judgments 
associated with fair value and related issues have had big 
impacts. The rating agencies have described on occasion their 
purpose and their object as being slightly different than 
predicting market prices. They are in the business, they tell 
us, of predicting the creditworthiness of the ultimate 
instrument on maturity and so on, and that, therefore, gainsays 
a lot of the wave motion that might occur, even if the wave 
motion capsizes the boat in the short run. And so these issues, 
at least in the current market turmoil, have really conflated--
I do not think it is any longer possible to neatly parse what 
is the ultimate creditworthiness of the instrument from what is 
going on in the marketplace.
    If an instrument, for example, is totally illiquid, then it 
is reduced to something like worthless for an indefinite period 
of time, and it is very difficult for adults to say that, 
nonetheless, it is a very valuable security and we want to own 
it because ultimately it is going to pay off.
    Senator Corker. So then what should be the role? I mean, 
should rating agencies not indulge more, if you will, on the 
accounting side? I mean, is that not a valuable piece of 
information for them, if you will, as to--because there are 
people, obviously, that do rely on these ratings; you know, 
that is what they have been put in place for in the first 
place. Is that not something that rating agencies should be 
somewhat involved in as they make these ratings?
    Mr. Cox. Yes, I think one of the sources of confusion for 
investors has been this big gulf between what they see 
happening in the marketplace and what they say with the 
ratings. And before the round of significant downgrades, there 
was this big gap. Ultimately, many of the downgrades had the 
effect of conforming the ratings with the judgment of the 
marketplace. And so I think that there is no question what is 
going on now inside the rating agencies is informed by this 
much different world.
    Senator Corker. Talk to us a little bit about the notion 
that has been floated--and we have heard a lot from 
constituencies about this--of separating out ratings for 
structured finance itself and the impact that that might have, 
if you will, on those particular instruments. If you would, 
expand a little bit on those discussions.
    Mr. Cox. Well, the suggestion has been made--and it is 
under careful consideration by the SEC and may be included in 
our proposed rules--that there be different symbologies for 
different kinds of products, whether they be structured 
products, corporate or municipal, for example. There is no 
question that a AAA rating on a structured product is very 
different than on a corporate, and yet the same labels being 
applied to all of these things might have caused confusion in 
that respect in the marketplace.
    So I think this is a very valuable subject for us to 
explore in connection with our proposed rulemaking, and I can 
confidently predict, even though I do not know what the 
ultimate proposed rules look like, that we will expose that 
whole idea for public comment.
    Senator Corker. And that would obviously have a 
tremendously dampening effect on the structured finance market 
if that occurred, at least in the short term. Is that not 
correct?
    Mr. Cox. I do not think that would be the idea at all. The 
idea would rather be to let people know exactly what it is, 
what a rating means.
    Senator Corker. And is there a notion of maybe actually 
stamping structured finance as sort of a scarlet letter-type 
approach, if you will, to this type of financing?
    Mr. Cox. Well, there have been calls from State governments 
and State finance officers for different symbology for 
municipals as well. They believe that having--at least some 
people believe that having different symbology would actually 
advantage them because they believe their default rates are 
provably lower. And so I do not think it is inherent in the 
nature of having unique symbology that you are advantaged or 
disadvantaged in the marketplace. It is just simply a way for 
people to understand what it is they are talking about.
    Senator Corker. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman, and you, Mr. 
Chairman.
    It seems to me that the issue we are focused on here, Mr. 
Chairman, is that one of the principal factors that has led to 
the market failures we have experienced--and I gather Senator 
Schumer touched upon this before I arrived--at the originating 
end you had brokers who had incentives to just kind of get 
these mortgages out the door and not adequately assess the 
underlying risks involved, the likelihood of the mortgages 
being repaid, you know, that sort of thing. Here we had the 
rating agencies giving their blessings to the repackaging and 
selling of these loans, again, possibly with incentives to do 
that without really digging in and accurately assessing the 
risks involved. And markets can't function very well without 
access to accurate information, and so here we are today to try 
and ensure that we do have accurate information going forward.
    Mr. Chairman, it seems to me that this is in some ways 
analogous, as I think you mentioned in your testimony, to some 
of the accounting issues that we dealt with before. I mean, for 
example, can you imagine any reason why a rating agency should 
be allowed to pass judgment on products that it has itself 
helped to structure? Isn't there just an unavoidable conflict 
in such an arrangement? And didn't we decide that in some 
respects in the accounting arena?
    Mr. Cox. Well, there is an unavoidable conflict in that 
arrangement, and there are, in fact, other unavoidable 
conflicts that are built into either the issuer-pays or the 
subscriber-based models. And so what we are preparing to do in 
our proposed rulemaking is in some cases just flat out to 
prohibit them if we can see our way clear to doing that without 
disrupting markets and the ability of firms to function. And on 
the other hand, if you cannot bar a practice altogether without 
upending the whole thing, then to come up with approaches to 
manage those conflicts very clearly, for example, to make sure 
that at a minimum people who are in the business of negotiating 
fees do not have anything to do with the ratings process.
    Senator Bayh. If we are going to be living going forward in 
a more robustly competitive world with new entrants coming into 
the rating marketplace, as you were describing, why would a 
prohibition not work since there are all the new entrants 
coming in and it would presumably be easier to just prohibit 
this without it disrupting the marketplace?
    Mr. Cox. Well, the only reason I left it open to either 
interpretation is I did not say what specific practice it was 
that we are talking about prohibiting.
    Senator Bayh. Same thing for consulting----
    Mr. Cox. Without question, the easier way, even from, I 
would think, the firm's standpoint because they know what the 
rules are, would be just to flat out prohibit these virulent 
practices.
    Senator Bayh. Same thing for consulting services by rating 
agencies?
    Mr. Cox. Yes. I think that is undoubtedly a conflict of 
interest, and properly structured, speaking for myself, I do 
not see why that could not be prohibited. But I should add once 
again, because while I am appearing here as an individual and 
as Chairman, that I am part of a five-member Commission, that 
there are a lot of issues here, and I do not know what we might 
propose in our rules.
    Senator Bayh. In the previous enactment of the new law 
governing this area and the new robust nature of the 
competition you have described that is beginning to take root 
in this area, is it your opinion, did real competition exist 
among these ratings agencies before this problem we have 
encountered here? Was there real competition or not?
    Mr. Cox. Barely. If----
    Senator Bayh. Somebody used the word ``oligopoly,'' I 
think.
    Mr. Cox. I think that was I earlier in this proceeding, and 
that is my view. This industry needs more competition, and the 
legislation that you have passed will help it to mature into a 
much more competitive industry. That in turn, I believe, will 
improve the quality of the ratings.
    Senator Bayh. Do you see a problem between--again, 
competition and markets function very well. It is somewhat 
dependent upon the incentives that exist in the marketplace. Is 
there the potential for a disconnect, a continuing disconnect 
between short-term incentives and long-term incentives leading 
rational decisionmakers to perhaps make decisions that are in 
their own best interests but not in the better interests of the 
overall functioning of the marketplace? I will give you an 
example here.
    Just as the loan originators, the mortgage brokers, were 
pushing a lot of this stuff out because they were compensated 
in many cases by volume rather than the ultimate accuracy of 
the loans they were making, do we have a problem here? I know 
at least one of the rating agencies was publicly held directly; 
another is held under another publicly held company. In any 
event, you might get people who were being compensated because 
of their short-term performance, and they get bonuses. If they 
have stock in a publicly held company, they can cash their 
options or sell their stock as it becomes unrestricted. So they 
are making real money in the short run, so there is a real 
incentive to do that, even if in the long run, if things go 
badly, there may be some risk to the reputation of the firm and 
ultimately the long-term value of the stock in the firm, but 
the pressure is on now, they are being compensated to perform 
now. What about that disconnect? And how does the marketplace 
take that into account? Were there such strong, you know, 
personal reasons to make a set of decisions today but then in 
the long run a rational decisionmaker might not make? What do 
we do about that ongoing problem with the way people are 
compensated in these businesses? And how does the competitive 
model--is there a risk to the competitive model when you have 
that kind of disconnect between the short-term incentives and 
perhaps long-term factors?
    Mr. Cox. Well, that is very much a part of the short-
termism that afflicts our markets overall. There has been on 
occasion a call to eliminate quarterly guidance for earnings 
for companies, for example, for related reasons. The 
compensation structure of a firm, and I would think now credit 
rating agencies, since they are now a regulated industry, have 
to be thought of in terms of the objects of the regulation and 
the objects of the ratings themselves in that particular 
industry's case.
    So as we look at conflicts of interest, compensation won't 
be off limits.
    Senator Bayh. Oh, it won't. Very good, because it seems to 
me, again, you could have, let's say, with, you know, seven 
participants or nine or ten, whatever the number ends up being, 
if we have a system that rewards people for making certain 
kinds of decisions in the short run, irrespective of their 
accuracy in the longer term, we could get, you know, warped 
outcomes that affect the entire marketplace and, hence, you 
know, the economy and society at large that would not be in 
anybody's best interest. So I am glad to hear that you will be 
addressing some of those issues as well.
    Mr. Chairman, thank you. I am surprised you can do the rest 
of your day job. You have been up here with us so many times. 
But we do appreciate it very much.
    Mr. Cox. Well, if I may say so, Senator, in respect of this 
particular part of my job, writing regulations under this 
statute, it is of enormous value for me to have these 
conversations, these colloquies, because as I said, it is the 
intent behind this legislation, which is so fresh, that we are 
trying to flesh out with the regulations. And so I am entirely 
sincere when I say we want all the ideas we can get. This is 
the second round of rulemaking, and it is the most important 
one, because it is based on the very recent experience that we 
have had in the subprime debacle.
    Senator Bayh. Thank you.
    Chairman Dodd. Thank you, Senator. Hence, the initial 
question: Do you need more statutory authority? What I do not 
want to discover here is have you complete this process and 
turn around and discover you needed additional authority to do 
something and we did not provide it for you when we had an 
opportunity to do so. And I heard your answer to the question, 
but I assume you will keep us posted if you encounter something 
different.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    Where I see the greatest conflict of interest might be in 
the payment model that has been set up with the credit 
agencies; in other words, the one who is being evaluated ends 
up paying the credit agency for the outcome. Do you see a 
conflict there that concerns you? Or are you comfortable with 
that model?
    Mr. Cox. Well, it is a necessary conflict of interest that 
somebody pay, because whoever pays is going to have some 
interest. And so in the issuer-pays model, you get one set of 
conflicts. In a subscriber-pays model, there are other kinds of 
conflicts that can arise; for example, the people who want to 
include certain things in their portfolio might want to have 
ratings that permit them to do so. And so there is really no 
way out, provided that someone is paying. What you are stuck 
with is recognizing and sharply identifying those conflicts and 
then managing them.
    Senator Allard. Even if the taxpayer pays, there is a 
conflict, I guess, in a way. Or is there not?
    Mr. Cox. Well, there is a conflict with the Federal budget, 
I would imagine at some point.
    Senator Allard. Yes.
    Mr. Cox. If we nationalize all these functions.
    Senator Allard. You know, it is not that that model has not 
been used. I think in my own profession where we write a health 
certificate, when we write a health certificate, we are an 
agent of the Federal Government. We are paid by the--we act as 
an agent for the Federal Government, and we also act as an 
agent of the State that the animal is being shipped to. But the 
one who pays us is the one who is shipping the animal and is 
asking for--you know, and he will pay, and obviously we will 
pay a fee or whatever. But the consequences of not finding that 
you did something that was unethical or whatever can be pretty 
severe, and you could lose your license and not be able to 
practice in the profession.
    Do you think that you have the consequences there that are 
severe enough to prevent bad behavior?
    Mr. Cox. There is no question, Senator. In addition to the 
sanctions that can be applied directly to the rating agencies 
under this new law, sanctions can be addressed to their 
associated persons. And so every single individual who works in 
an NRSRO can be the subject of SEC sanctions as well.
    Senator Allard. I want to take you into a hypothetical area 
because ``consistency'' has been a term that has been 
frequently used by my colleagues here on the panel, you know, 
consistent results.
    If we were to use--and we have consistency, I guess, in 
law. How in the world do you evaluate what consistency is? I 
mean, is it 20 percent error? Is it 30, 40, or 50? Or is it 
some deviation from the normal from your competitors? Do you 
have any idea how we would determine consistency?
    Mr. Cox. I think to begin with, it would depend upon the 
subject of the rating. It would depend upon the industry and 
its volatility and its history. So that coming up with a very 
simple rule of thumb that would apply across the board to 
everything in the capital markets I think would be impossible.
    The best approach to that kind of complexity is to have the 
maximum amount of disclosure of all the material information 
and then to permit comparison in the marketplace.
    Senator Allard. Let me ask a question about disclosure. If 
you have foreign securities, is disclosure a problem? You know, 
you might, for example, have a business that is partially owned 
by some foreign government. And so how do you get an adequate 
disclosure as to the background of how you are going to valuate 
that security? It kind of gets to the accounting issues, I 
think, that we were talking about earlier here on the 
Committee. How do you handle those kind of foreign securities?
    Mr. Cox. Well, transparency varies dramatically from 
jurisdiction to jurisdiction, and in some cases, one is left 
with nothing more than a brand name to go on, because there is 
so little behind it when making an investment decision.
    On the other hand, in some other jurisdictions, there is a 
great deal of transparency, and the level of accounting detail 
and disclosure about management and ultimate parents and so on 
is what we would be accustomed to here in the United States, 
ordinarily so.
    So it just depends entirely on the jurisdiction in which--
--
    Senator Allard. A brand name is pretty subjective, isn't 
it?
    Mr. Cox. Yes, of course. And I think that people investing 
in those parts of the world tend to use diversification at some 
protection for the risk that they are taking.
    Senator Allard. I have always been under the impression 
that what happens in the marketplace as far as rate of return 
is somewhat influenced by the risk of the investment. Do you 
think that holds up still today? And do you see a correlation 
between--I suppose there is because what happens with the rate 
of return--I mean, when they do an anticipated rate of return, 
I suppose they take into account how the rating agency rated 
that particular security.
    Mr. Cox. The correlation between risk and return is as 
ironclad as the certainty of death and taxes.
    Senator Allard. And you see it--and what you are seeing 
in--did you see an instance in these securities, particularly 
the home mortgage products, was there a higher rate of return 
with those more risky mortgages or not?
    Mr. Cox. Well, I think that part of the alchemy that led to 
what we saw in the subprime turmoil was this sense that there 
was a cost-free way to improve the return.
    Senator Allard. A cost-free way to----
    Mr. Cox. Yes. It turned out not to be the case.
    Senator Allard. Yes. But there was an anticipation of 
greater return on their investment, would you say?
    Mr. Cox. Yes, of course.
    Senator Allard. And so----
    Mr. Cox. And from the issuer standpoint, the opportunity to 
securitize permitted them to borrow at lower rates.
    Senator Allard. And that assumption of where that rate of 
return came from, do you think it was just the experience of 
the investor with the market? Of course, every individual would 
have different experiences in that regard. Or was it based 
pretty much on credit rating? Or both?
    Mr. Cox. Well, I think the overall sense in the short run 
was that a better mousetrap had been built, that one of the 
working parts of that mousetrap was the credit rating, and even 
against the evidence, late in the game people clung to the hope 
and the belief that somehow it could be true.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much. You raise a couple of 
issues, and I think Senator Schumer may be on his way over as 
well to ask a couple of questions before we move to our second 
panel.
    If I may, we received a letter yesterday from a group of 
individuals, the Real Estate Roundtable, the Mortgage Bankers 
Association, Commercial Mortgage Securities Association, the 
National Association of Realtors. I presume that was all one 
letter. Was that one letter?
    They were opposed to proposals of the President's Working 
Group to differentiate between credit ratings for structured 
finance products and other assets. What is your reaction to 
that? I will see you get a copy of the letter, too, but I would 
be curious what is your reaction.
    Mr. Cox. Just a moment, if I may.
    [Pause.]
    Chairman Dodd. They make a case, by the way, in the letter, 
in fairness, they say that the changes would--and I quote them 
here--``contribute to greater market volatility and investor 
confusion.''
    Mr. Cox. Well, I have not seen the letter myself, but this 
is a subject that I think we are very interested in. I know 
that at IOSCO, regulators around the world are interested in 
this topic; within the Financial Stability Forum, it has been 
discussed; within the President's Working Group it has been 
discussed; at the staff level at the Securities and Exchange 
Commission and at the Commissioner level, it has been 
discussed.
    So I would predict that whatever occurs in our proposed 
rules, we would ask the public questions about this and 
engender more of that kind of comment on both sides of the 
issue.
    Chairman Dodd. I would be very interested in hearing if you 
do develop that or where maybe the Commission is heading with 
that. I would be interested.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman. And thank you. I 
am sorry that I could not be here for the testimony, but I have 
a few questions based--some based on our discussions that we 
had, which I want to again reiterate I appreciate your coming 
to my office and briefing me on these ahead of time.
    Now, we all know now that the SEC has stronger oversight 
authority over the agencies since the legislation that Senator 
Shelby, Senator Dodd, and others of us endorsed is now the law. 
And so you have had examiners at the firms, and my focus is on 
the conflict of interest issue.
    I know your investigations are ongoing, but can you just 
give us a sense of what you found regarding the agencies' 
compliance with their stated procedures intended to control 
conflict? In other words, the article here that I referred to 
earlier, which I found did a very good job, seems to indicate 
that before you were given authority, there were conflicts and 
nobody paid much attention to them within the credit rating 
agencies themselves. Is it getting better? Do they have their 
own controls? Does some little buzzer go off when a supervisor 
wants to change the person on the job because he is not giving 
or she is not giving as good a rating?
    Tell me--I am not asking for any specific investigation 
about a specific agency. I am asking in general how good are 
the agencies at uncovering these conflicts now that it is 
against the law to--you know, now that these conflicts are 
against the law.
    Mr. Cox. Well, I feel very confident in saying that it is 
better. It is better for obvious reasons. There is so much 
focus on this right now and so much has gone wrong that many 
have reacted with alarm, and there is a lot of attention being 
paid to it.
    We have in the course of our examination thus far found 
examples of apparent failure to adequately manage conflicts of 
interest, and some instances have even occurred this year.
    Senator Schumer. So it would be better, but there are still 
lapses, even after all the focus on credit rating agencies. Is 
that a fair way to put it?
    Mr. Cox. That is a fair way to put it.
    Senator Schumer. And what are you doing when you find these 
lapses?
    Mr. Cox. Well, of course, we are in there with live bodies 
in real time, and so anything that is brought to our attention 
is dealt with on the spot. But, in addition, we are going to 
make broad inferences based on our examination of the three 
largest firms and present those publicly, as well as to the 
firms in early summer.
    Senator Schumer. Good. So we will learn about some of these 
lapses.
    Mr. Cox. Yes.
    Senator Schumer. And that should be somewhat prophylactic 
as well in terms of preventing them from doing it again.
    Is it that the agencies do not want to? Or is it just so 
embedded in their culture? You know, this article points out 
when new management came in at Moody's, the whole world changed 
because they wanted to increase market share in something that 
ended up being risky, although it probably was not thought to 
be risky at the time. When you go to the higher-ups in the 
firms, do they want to change? Do they want to get rid of these 
conflicts of interest? Or do they say, hey, we will lose 
business, we better be careful and not do it so fast?
    Mr. Cox. Well, it sounds as if you have, as I have, met 
with the leaders of these firms, and they certainly express a 
strong desire to deal with these problems and to take them 
seriously. I think the only proof, however, is going to be in 
the pudding.
    Senator Schumer. Right, and they are not there yet. OK.
    One other question related to this, and I thank you, Mr. 
Chairman. People have questioned the agencies' reliance on 
information supplied by the issuer to determine their ratings. 
You know, I guess the average person, maybe even the average 
investor feels that the credit rating agencies do not just take 
the information that is given, but go investigate and see if it 
is for real, because obviously the issuer is going to put their 
best foot forward.
    Have you found--shouldn't there be some disclosure on the 
amount, or the lack thereof, of the due diligence that is 
performed on a bond?
    Mr. Cox. Yes.
    Senator Schumer. In other words, if they did not 
investigate it, if it has another no-doc loan in some other 
area, they should say that clearly: This is has no 
documentation, and we did not investigate it; or, It has 
documentation, and we did not investigate it; or--you know what 
I am saying.
    Mr. Cox. Yes, that is an important subject for disclosure. 
It is one that I mentioned in my testimony that I think may 
well be covered in our proposed rules.
    Senator Schumer. Right. Now, let me ask you this: Do you 
think--this is, again, based on that article, which I guess you 
might think from my testimony I am obsessed with, which I am 
not.
    [Laughter.]
    Senator Schumer. But do you think that--it is just a good 
article. That is all. I did put it in the record in my opening 
statement, Mr. Ranking Member.
    Do you think significant changes in market share should 
automatically trigger enhanced scrutiny by the SEC over the 
rating agency activity? If all of a sudden they rated 20 
percent of these bonds and now they are getting 70 percent in a 
year, something is up. What do you think of that idea?
    Mr. Cox. Well, because you provided it to me, I have had a 
chance to read that article, and----
    Senator Schumer. Oh, there you go.
    Mr. Cox. There is absolutely no question that that kind of 
red flag should be a guidepost for an examiner.
    Senator Schumer. Good. That is good to hear. And what about 
other red flags, such as significant deviation in ratings 
performance from historic averages or significant analyst 
turnover? In other words, you may not have the specific on this 
case, but you are seeing there are a lot of analysts that have 
been turned over lately. Should that also provide a similar red 
flag?
    Mr. Cox. I think so. Obviously, the facts will inform in 
any particular examination where the examiners want to go, and 
I think over time, as the SEC develops more and more expertise 
in this, we will have, either formally or informally, a whole 
set of----
    Senator Schumer. Right. And we can expect some of these in 
the proposed rules that you are going to put out this summer, I 
presume.
    Mr. Cox. Yes, although what we are talking about right now 
is the kind of thing that examiners are going to look to.
    Senator Schumer. Right, or guidance to the examiners that 
might be made public. We are going to see concrete evidence of 
some of these things happening, and it will be sort of out 
there publicly that you are doing it.
    Mr. Cox. I----
    Senator Schumer. Not specifics. The general things.
    Mr. Cox. I can undertake to do that, yes.
    Senator Schumer. Good.
    Mr. Chairman, thank you.
    Chairman Dodd. Thank you very much, Senator.
    Let me ask one more question. Again, Professor Coffee is 
here and obviously is going to be testifying, but he, I 
thought, raised a very good issue in his testimony. It goes 
beyond the issue of the due diligence and all of the questions 
that Senator Schumer, Senator Shelby, Senator Reed, and Senator 
Corker raised, and that is the staleness of data. It is one 
thing to get it wrong initially, but then to have a conclusion 
hanging around for a long time, when information emerges that 
would certainly warrant at least someone stepping up to the 
plate and saying something--in fact, he calls it the ``gravest 
problem'' may be the staleness of the debt ratings. And I guess 
the agencies--are agencies timely in updating ratings and 
withdrawing obsolete ratings? What standards should they 
observe in that process?
    On page 8 of his testimony, the professor points out that 
major downgrades of CDO securities came more than a year after 
the Comptroller of the Currency first publicly called attention 
to the deteriorating conditions in the subprime market and many 
months after the agencies themselves first noted problems in 
the markets. I think it is a very good point, and we have 
talked a lot about the front end of this. But the staleness of 
data I think is a very good observation. What is the reaction 
of the Commission to that?
    Mr. Cox. Well, I think that overall, first, I should say 
that the contribution that Professor Coffee has made to this 
whole discussion has been exceptional, and I want to thank him, 
and I am glad you have him on your next panel. I am glad he is 
here today. And certainly at the agency, we have spent a good 
deal of time taking all of that in.
    Second, at least as a matter of pure disclosure, it seems 
completely feasible to deal with this issue, to require 
disclosure of how often the models are updated and how they do 
surveillance, how the rating agencies do surveillance of their 
past ratings.
    Chairman Dodd. I appreciate that.
    Senator Shelby.
    Senator Shelby. I want to pick up on something Senator 
Schumer brought up. Thank you, Senator Dodd.
    How do you measure these rating agencies in a sense? 
Transparency will help, but the SEC has to play a role here 
because this is such a debacle. They tell us at times--and I 
have talked to some of them--well, gosh, you know, we are just 
giving our opinion. Are they? Is it more than my opinion? They 
say, well, under the First Amendment of the Constitution, we 
are just giving our opinion, free speech. But they are selling 
this information, and then it is relied on all through our 
financial system. So there is something amiss here, Mr. 
Chairman. You know, as Chairman of the SEC, I know you are 
going to look at all this, but Senator Dodd brought up that the 
Comptroller of the Currency has to start asking some questions 
about some of the subprime things. Where were the rating 
agencies early on in this? I am afraid what they were doing is 
continuing to rate a lot of these subprime securities at 
investment grade, some even AAA and so forth. And, Mr. 
Chairman, I will ask you as you get into this: When did they 
start downgrading their ratings? Was it after the whole thing 
was in a free fall?
    I do not know, but I just know something is amiss here in 
all of this. We went through the Enron deal, but, gosh, this is 
so much bigger, you know, in many ways than that. And I know 
that the rating agencies play an integral role here. The SEC 
has to play a big role of oversight here. Make no mistake about 
it.
    Mr. Cox. Well, I think the fundamental answer to your 
question of how you measure their performance is the quality of 
their ratings. And, you know, up until very recently, there has 
not been a lot of competitive pressure on that quality, and so 
whatever----
    Senator Shelby. Is that because everybody bought into it, 
you know, the euphoria?
    Mr. Cox. It is for a variety of reasons, but not least of 
which is that there are very few of them, and yet ratings were 
by regulation and by law in many cases required. And so they 
had a Government-required function. There was no place else to 
shop, and so that is not a good competitive climate to begin 
with.
    The measurement of the quality of ratings is inherently 
subjective. It is going to be quantitative, to be sure. It is 
going to be analytical. But there are so many things that go 
into it, it is going to inherently be subjective. It is the 
kind of thing that markets are good at.
    Our disclosure system at the SEC when it comes to price 
discovery for all sorts of things, like corporate equities, 
helps people arrive at a very specific number, the price for a 
security, whether people think that that price is the future 
discounted cash-flow, the quality of management, new product 
introductions, or what have you. Reducing complexity to a 
measurement like that is what markets are very good at, and the 
SEC is very good at disgorging information to the public and 
making sure there is full disclosure so that the public can 
make those judgments. I think that is what we are about to do 
now with credit rating agencies.
    Senator Shelby. Mr. Chairman, if the rating agencies are 
the linchpin of our financial markets, our securities market--
and a lot of people believe they are--our linchpin is broken 
right now as far as confidence, trust in the financial markets. 
And I believe it is going to be--a lot of what you do, and your 
other Commissioners, and what we try to help you do is going to 
help restore some of that. But the old way of doing business 
with the rating agencies, that has got to go. I believe it has 
to, and it should have already gone.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, and I am going to leave 
the record open, Mr. Chairman, for additional questions that 
may come from members here. We have a second panel I want to 
get.
    Senator Reed and I were chatting and, you know, raised the 
issue--which I will not raise with you right now because--
unless Jack wanted to bring it up, but the whole notion of 
whether or not--I have had some people say to me, Why even 
bother having rating agencies in this day and age? There is a 
case to be made for people who are in this world who wonder 
whether or not we are just spinning our wheels in a sense by 
doing this. I think there is an argument for it. And, second, 
why not even consider the possibility of sort of a nonprofit 
sort of a credit rating agency, have a colleges approach that 
sit and determine whether or not something is a good 
institution or not, to take all the conflict out altogether?
    Now, that is a bigger question than what we have asked you 
to do here, but do you have any quick comments on that at all? 
I mean, that is an idea that has been raised by some. We may 
never be able to address--as you point out, both from the 
subscriber as well as the issuer, the conflicts are going to be 
there, no matter which side of this you flip it. And so are we 
reaching a point that maybe we ought to be talking about a 
different system altogether? To go to the question Senator 
Shelby has raised here, if this is the linchpin in all of this. 
What are your thoughts on that?
    Mr. Cox. I think it is entirely possible to have private 
sector entities that are commercial in nature that are, 
nonetheless, independent from the securities that they rate and 
who do a good job of it.
    There is a conflict of interest in virtually every 
commercial relationship in the sense that, you know, if you go 
to the dentist and it is the dentist's interest to charge as 
much money as possible and you do not really know that much 
about dentistry, well, the dentist could tell you that you need 
all your teeth replaced.
    Chairman Dodd. I can sue that guy for medical malpractice. 
I cannot sue this guy.
    Mr. Cox. Well, I think that that is what is changing. The 
result of the legislation that you passed and the regulatory 
authority that you have given us, the ability that we now have 
to define practices, define what is necessary to manage, 
mitigate, or end entirely those kinds of conflicts of interest 
makes this all very different.
    The authorities that we have under the securities laws will 
now apply in like way to participants in this market; not only 
the firms themselves but their associated persons will now be 
subject to sanction by the SEC. And so the difference between 
being completely unregulated, which was the case 6\1/2\ months 
ago, and now being a regulated industry is enormous. And I 
think there is a good deal of reason to expect that it will do 
a lot of good.
    Senator Schumer. Mr. Chairman?
    Chairman Dodd. Yes.
    Senator Schumer. Just one question, if I might. I mean, 
there is an intermediate step. Senator Dodd's ideas are, as 
usual, intriguing. But do you think there is less conflict in 
the investor when the investor pays the agency as opposed to 
the issuer paying the agency? I mean, it is conflict from the 
other side. It puts the premium on not AAA but maybe failing 
grade, you know; or it moves it in one direction rather than 
the other, is a better way to put it. But does one make more 
sense than the other? Should that be something that is 
seriously explored as well?
    Mr. Cox. Well, I think that both make more sense in 
combination, because each is a check against the other. And 
what your legislation has opened the door for now is relatively 
easy entry into the market for subscribed-based ratings.
    Senator Schumer. And there are few right now.
    Mr. Cox. There are already two that we have registered. I 
expect there will be more in short order.
    Chairman Dodd. Interesting. Mr. Chairman, very good We 
thank you immensely, and please stay tuned. And stay in touch 
with us, too, on this issue, on that question. If there is 
additional statutory authority that your agency thinks you may 
need in this area, this Committee would very much want to know 
that as soon as possible.
    Mr. Cox. Thank you very much, Mr. Chairman.
    Chairman Dodd. If our second panel would come up quickly, 
and I apologize. You have been waiting a long time.
    We hardly need to introduce Professor Coffee. He has been 
talked about so often here that he has already been sort of 
introduced. But Professor John Coffee, Columbia Law School, 
served on distinguished legal bodies, published significant 
research, and contributed to the work on Sarbanes-Oxley.
    We are pleased to welcome Dr. Arturo Cifuentes, the 
Managing Director on the Structured Finance Department of R.W. 
Pressprich, and former Managing Director of Global--the global 
head of collateralized debt obligation research at Wachovia 
Securities.
    I want to welcome the representatives of the three largest 
NRSROs: Vickie Tillman, Executive Vice President, Standard & 
Poor's; Claire Robinson, Senior Managing Director of Moody's 
Investor Service; and Stephen Joynt, President and Chief 
Executive Officer of Fitch Ratings.
    I want to underscore the point that Senator Schumer raised 
earlier, and I understand in Moody's case there was a conflict 
today because of shareholder meetings. And obviously his 
obligation is to be there for that. But for these other rating 
agencies, I would very much like to have heard from the heads 
of them. We have got people here from these agencies, but, 
candidly, it is a little more difficult to expect them to 
respond to these questions that we are all going to have for 
them.
    Senator Shelby. May I say one thing, Mr. Chairman?
    Chairman Dodd. Let me turn to Senator Shelby.
    Senator Shelby. Mr. Chairman, I want to associate myself 
with your remarks. I want to commend the President and Chief 
Executive Officer of Fitch Ratings for coming to this hearing. 
But I am disappointed, as you are, and Senator Schumer was, and 
others, that the other CEOs of Standard & Poor and also 
Moody's, regardless of conflict--this is a Senate hearing on 
something that I think is very, very important. And we are 
going to get them here, I hope, Mr. Chairman, because although 
they will have able people here testifying on their behalf, it 
is not like having them here themselves.
    Thank you.
    Chairman Dodd. I appreciate that.
    I appreciate your patience. First of all, you have been--I 
hope this hearing has been instructive as you have been sitting 
there listening to all of this, and helpful to some degree. 
Certainly you have heard the expressions expressed by almost 
every member here about their concerns about all of this and 
the importance of this issue. So let me begin by asking for 
your comments, and, again, your testimony will be included in 
the record, beginning with you, Professor Coffee, and we will 
then turn to Ms. Tillman, Ms. Robinson, Mr. Joynt, and Mr. 
Cifuentes.

 STATEMENT OF JOHN C. COFFEE, JR., ADOLF A. BERLE PROFESSOR OF 
              LAW, COLUMBIA UNIVERSITY LAW SCHOOL

    Mr. Coffee. Thank you, Chairman Dodd, Ranking Member 
Shelby, and it is a pleasure to be back again in front of your 
Committee. In order to be brief, let me break my testimony down 
into three short segments.
    First, and very briefly, what have we long known about the 
rating agencies? And I suggest none of this is about to change. 
We have long known that they face limited competition, and if 
you want, they share an oligopoly.
    Two, we have long known that they face very little 
liability to investors, and, indeed, they have never been held 
liable to investors. That is different than every other 
financial gatekeeper, auditors, securities analysts, or anyone 
else.
    Next, they have a built-in conflict because they are a 
watchdog paid by the party they are to watch. Now, auditors are 
also, but auditors face real liability.
    And, fourth, they have a business model under which they 
can make money, even if no one trusts their ratings, because 
they are also selling regulatory licenses. Institutional 
investors cannot buy debt securities without their rating, and 
that protects them even if they are off the mark.
    OK. That is what we have always known. What have we learned 
recently? We have learned, first of all, that the rise of 
structured finance was immensely profitable, but it did 
destabilize this industry by aggravating those longstanding 
conflict of interest problems. Why? There is no single 
corporate issue that has any leverage over a major ratings 
agency. But structured finance is controlled by basically five 
or six large investment banks. They package these deals on a 
monthly basis. They do have some real leverage with respect to 
their rating agencies, and thus, that means for the first time 
there are clients that have clout with respect to you. That was 
different than the past.
    Next we have learned that rating structured finance is very 
different than rating straight corporate debt. You rate 
straight corporate debt largely based on publicly available 
financial information, SEC reports, stock market and bond 
market prices--all of which tell you a lot. You rate a pile of 
mortgages--3,000 mortgages in this pile--it is opaque, it is 
non-transparent. It is much more difficult to do, and it is 
done basically on a quantitative model--a quantitative model 
that has never been in existence that long enough to have been 
fully checked out. That is point one.
    Point two of what we learned recently, loan originators and 
investment banks have learned how to game the model, how to 
play with it. This is partly because for a large advisory fee, 
the rating agency showed them how their model works. And once 
you are shown how it works, you learn how just tweaking it a 
little bit and selectively editing the data can get you a 
better rating.
    Now, I am not saying that rating agencies engage in fraud. 
What I am saying instead is that because the rating agencies 
are very vulnerable to selectively edited information, and also 
to misleading information, we have a system that is defenseless 
against loan originators and others who have strong incentives 
to try and game the system.
    Next point. Because the credit rating agencies do not 
perform any due diligence themselves--and some of the Senators 
were making this point earlier--because they do not do 
verification work themselves, they are almost uniquely 
vulnerable, maybe even defenseless, to selective editing and 
misinformation given to them by loan originators who have every 
incentive to game the system and try to get a higher rating.
    OK. The credit rating agencies also appear to have 
responded, in my judgment, in a fashion that I have to call 
tardy and slow to massive changes in the housing market. The 
Comptroller of the Currency and others--and they knew it 
themselves--saw major changes in which for the first time home 
purchasers were getting 100 percent financing without any 
equity stake. They were able to get mortgage loans based on no 
documentation. All of these things means that you are 
vulnerable to significant problems, and there was a worldwide 
market demanding all of the CDO securities that you could sell 
if they had that letter rating. All of this meant there was 
vulnerability, but it was not until after the crisis broke that 
we saw the major fall, the major downgradings, which really as 
a major downgrading began in July of 2007.
    Now, against that backdrop, what do I suggest most needs to 
be done? Well, let me suggest that the single biggest problem 
is probably that no one verifies the data. In the world of 
structured finance where you are using a quantitative model, 
the oldest rule about quantitative models is: Garbage in, 
garbage out. And you are going to get people selectively giving 
you somewhat incomplete information, and there is little you 
can do about it. Even for the future, we have to expect that 
loan originators will continue to provide biased or selectively 
edited information. It is in their own self-interest.
    It is difficult to overstate this. This is almost as if the 
credit rating agency were in the position of an accounting firm 
that went to the corporate client and said, Give us your data, 
your revenues, your costs, your liabilities, and thank you very 
much; we won't check this, we will just produce your net income 
figures, and we will tell the world what your earnings per 
share is.
    That is where I think you have to begin, and I suggest that 
SEC rules to be meaningful have to introduce some form of 
greater verification. Verification is being done. I recognize 
it cannot be easily done by the rating agencies because they do 
not have the in-house staff to carefully verify thousands of 
thousands of securities.
    But issuers and underwriters today hire independent, due 
diligence firms that go out there and evaluate the quality of 
the collateral in the loan pool. That information, I suggest, 
should also be provided to the rating agency. And, indeed, the 
strongest rule that I would suggest to you is that NRSROs, 
Government-licensed rating agencies, should not be able to give 
an investment grade rating on structured finance products 
without having before them some report from an independent 
expert that sampled the loan collateral and reported that the 
loan collateral met the following parameters: there were not 
more than 10 percent of these mortgages that were without an 
equity investment, there were not more than 10 percent that had 
no documentation, or there were more, and we will disclose 
that. That I think is necessary so that we have a gatekeeper 
that really has both the auditing and sampling component as 
well as the analytical component.
    I would suggest to you today that the credit rating 
agencies have a lot of competence, a lot of skill of analysis, 
but very little on verifying and gathering data.
    Now, two other ideas that are in my testimony, I will be 
very brief about these. One, there is the problem of stale 
ratings. If you compared the debt rating agency to the 
securities analyst--and they are functionally similar--
securities analysts update their ratings on a quarterly basis. 
I would suggest there is a lot of harm to the smaller 
institutional investor--and you have them in each of your 
districts. These are the school boards, the colleges, the 
charities, and the endowments who sit there and see that 2-
year-old credit rating, that may no longer be accurate, that 
may no longer even be what the agency itself would give under 
its newer model. I would suggest something like an annual 
revision requirement. You go back, you review it, and you 
either renew it, change it, or withdraw your rating. But stale 
ratings are dangerous to less than sophisticated institutional 
investors.
    I would suggest something like an annual revision of your 
rating; and, second, when you change your model, make a 
material change in your model of methodology, you should go 
back and figure how that would change your past ratings, 
because today there are ratings that are sitting out there even 
though the model has changed and you would not give that same 
rating today.
    The last thing I would suggest to you besides dealing with 
this problem of staleness is the financial scoreboard. I think 
there are lots of less than sophisticated institutions that sit 
there and know one rating agency or two. They do not know there 
might be eight or nine or ten in another year from now. If you 
had the SEC giving us one financial scoreboard that showed the 
ratings of all of the NRSRO rating agencies, what would they 
learn? They would learn that, well, agency one and agency two 
gave an investment grades. Some of these newer subscriber-pay 
rating agencies are more critical and have given it junk or 
intermediate status. You would learn the diversity of opinion. 
And when you learn that diversity of opinion, you might decide 
to put your short-term money in Government securities or 
something else rather than AAA-rated CDOs.
    I think the SEC would be the right party to do this because 
you do need to standardize some of the terms. Things like 
default rates that should be on this website can be computed in 
different ways. I do not know which way is best, but I think 
the SEC could give us one standardized technique so they could 
tell us the default rates on these various classes of products 
for each of the major rating agencies that are NRSROs.
    I think I have gone over my time, so I will stop there and 
answer any questions that you have.
    Chairman Dodd. No, that is very helpful and very insightful 
as well. Obviously, we want to hear the witnesses.
    I hate to interrupt here. Have you voted, Jack?
    Senator Reed. No.
    Chairman Dodd. All right. What we will do is we will go 
over and vote, and whoever gets back here first, just start 
right in. So if you would be patient for about 7 minutes, we 
will come right back to you. I apologize to you, but we have a 
vote on the floor of the Senate. But thank you very much for 
your testimony, Dr. Coffee. When we come back, we will hear 
from Ms. Tillman.
    The Committee will stand in recess.
    [Recess.]
    Senator Reed [presiding]. If I can ask you to take your 
seats, Chairman Dodd asked the first returning member to 
reconvene and to begin to take the testimonies. And I believe 
we have concluded with Professor Coffee.
    Ms. Tillman, please.

 STATEMENT OF VICKIE A. TILLMAN, EXECUTIVE VICE PRESIDENT FOR 
           CREDIT MARKET SERVICES, STANDARD & POOR'S

    Ms. Tillman. Thank you, Mr. Chairman, Mr. Ranking Member, 
Members of the Committee, and good morning. I am Vickie 
Tillman. I am Executive Vice President and head of the ratings 
business for Standard & Poor's, and I appreciate the 
opportunity to speak before you today.
    Senator Menendez. Ms. Tillman, could you put your 
microphone toward you.
    Ms. Tillman. Oh, sure.
    Senator Menendez. Thank you.
    Ms. Tillman. You are very welcome.
    At Standard & Poor's, a core principle of our business and 
key driver of our long track record of analytical excellence is 
a constant commitment to improvement. Over the past several 
months, rating agencies have been the object of significant 
focus, including much critical attention. We have listened to, 
and reflected on, the numerous comments and concerns, and we 
have focused our efforts to enhance our ratings process, 
provide better and more information to investors, and promote 
confidence again in our ratings. The result has been a series 
of actions that we announced in February earlier this year. But 
before I go over those actions, I would like to note that 
ratings speak only to creditworthiness, and there have been a 
significant number of downgrades, and downgrades, again, are 
not defaults. They are movements because things do change in 
the environment. But there have been significant downgrades in 
the RMBs area and in other structured finance securities. But, 
to date, the volume of actual defaults on those securities has 
been less than one-fifth of 1 percent of all U.S. RMB assets 
Standard & Poor's has rated between 2005 and the third quarter 
of 2007. And those numbers at one-fifth of 1 percent are those 
that have actually defaulted.
    I have attached to my testimony a detailed description of 
these actions that we released in February, and they include an 
update that we published earlier this month outlining the 
significant progress we have made to date in implementing them.
    In total, there were 27 different initiatives. I would like 
to highlight four broad categories.
    The first category of actions relates to our governance 
procedures and controls. Notably, initiatives in this category 
include: establishing an ``Office of the Ombudsman'' to address 
concerns related to, for instance, potential conflicts of 
interest; implementing ``look back'' reviews when analysts 
leave to work for an issuer; implementing periodic rotations 
for lead analysts.
    The second area is in analytics. The category of actions 
focuses on the substantive analysis we do in arriving at our 
ratings opinions. Notable initiatives in this category include: 
establishing an independent ``Model Oversight Committee'' to 
assess and validate the quality of the models used in our 
analysis; complementing traditional credit ratings analysis by 
highlighting non-default risk factors that can affect rated 
securities, such as volatility of ratings, correlation, and 
recovery.
    The third area is in terms of information. Notably, 
initiatives in this category include: presenting ``what if'' 
scenario analysis in our rating reports; implementing 
procedures to collect more information about the processes used 
by issuers and originators to assess the accuracy and integrity 
of their data and their fraud detection measures; increased 
dissemination of ratings-related data, including default 
statistics; developing an identifier to highlight when a rating 
is on a securitization or a new type of structure.
    And the final area is very important as well, and that is 
education. And these actions relate to our efforts to educate 
the market about ratings, their role, and their limitations. 
Notably, initiatives in this category include: launching a 
market outreach program to promote better understanding of 
complex securities that Standard & Poor's may rate; working 
with other NRSROs to promote ratings quality through the 
introduction of best practices and issuer disclosure standards.
    We have been working aggressively to implement these 
actions. We welcome further suggestions as to how we can 
enhance market confidence and continue our tradition of quality 
of ratings that offer opinions on creditworthiness to the 
market.
    In addition to these initiatives, we have been engaged in 
discussions with legislators, regulators, market participant in 
the United States and around the world. For example, we have 
actively been involved with IOSCO as it considers possible 
revisions to the model of a code of conduct as it relates to 
securitization. Similarly, we have participated in an ongoing 
review of rating agencies by CESR and having engaged with the 
Financial Stability Forum members in a dialog about their 
suggestions. Here at home, we have been working with the SEC as 
it conducts its first exam of our ratings process under a 
recently established regulatory framework. That exam is still 
in progress. Its scope is extensive, and the SEC staff has been 
extremely active and thorough in their work.
    We look forward to the SEC's completion of its work, and we 
are committed to addressing any recommendations that the 
Commission may have following its review process.
    We are also focused on the work being done by the 
President's Working Group. We fully support the group's efforts 
to bring transparency, stability, and confidence to the capital 
markets, and we look forward to working with them to help drive 
the effective functioning of the credit markets.
    In conclusion, I would like to thank you for the 
opportunity to participate in this hearing, and I would like to 
let you know that we are committed to improving on our 
analytical excellence and our desire to continue to work with 
the Committee as it explores developments affecting the capital 
markets, and I would be happy to answer any questions that you 
may have. Thank you.
    Chairman Dodd [presiding]. Thank you.
    Ms. Robinson, welcome.

STATEMENT OF CLAIRE ROBINSON, SENIOR MANAGING DIRECTOR, MOODY'S 
                       INVESTORS SERVICE

    Ms. Robinson. Good morning, Chairman Dodd and Members of 
the Committee. I am pleased to be here on behalf of my 
colleagues at Moody's Investor Service to discuss our views of 
some of the recent developments in the credit markets and the 
initiatives underway to address them, both at Moody's and 
across the industry.
    As you are well aware, the global credit markets have seen 
incredible turmoil over the past year. That turmoil has been 
driven by many causes, one of which is the deterioration in the 
U.S. housing sector resulting from an unprecedented confluence 
of factors. These include a sharp erosion in mortgage 
underwriting standards, misrepresentations in the mortgage 
application process, the steep decline in home prices, and a 
sharp contraction in credit available for refinancing.
    The rating agencies are one of many players with 
historically well-defined roles in the credit and structured 
finance markets. We believe that addressing the current 
challenges in the credit markets, including the general loss of 
confidence among many individuals and institutions, will 
require action on the part of all market participants. We are 
eager to work with the Congress, regulators, and other market 
participants to that end.
    Over the past several months, Moody's has been working 
constructively with various global authorities, policymakers, 
and others to identify and begin implementing initiatives that 
can enhance confidence in the global credit markets. We have 
been cooperating fully with the SEC in its review of these 
issues. That review has been extensive, and it is continuing.
    The President's Working Group in the U.S. and the Financial 
Stability Forum internationally also have examined the current 
market turmoil and developed a series of recommendations for 
addressing it.
    We believe that implementing these measures globally can 
have a positive impact in helping to address some of the 
current issues in the credit markets. And we have already begun 
to adopt many of these recommendations.
    Moody's has always been committed to continuously improving 
our ratings processes and analytic capabilities. We have 
recently undertaken several significant initiatives to enhance 
the quality of our analysis, address concerns in the 
marketplace, and further improve the usefulness of our credit 
ratings to investors. These measures include steps to: enhance 
our analytical methodologies, enhance our review of the due 
diligence process conducted by originators and underwriters, 
provide more clarity about the credit characteristics of 
structured finance ratings, promote objective measurement of 
ratings performance, continue effectively managing potential 
conflicts of interest, and enhance investors' understanding of 
the attributes and limitations of our ratings.
    Let me elaborate on two of these initiatives.
    Moody's has implemented several measures to further 
demonstrate the independence of our rating process. These 
include formalizing the separation of our ratings-related and 
non-rating businesses, enhancing our credit policy function, 
and codifying our existing policies about analysts' 
communications with issuers.
    We are also implementing a lookback review to confirm the 
integrity of analysis performed by any analyst who goes to work 
for an issuer or issuer's agent that he or she covered while at 
Moody's.
    We have also undertaken a review of our rating system for 
structured securities. We have proposed five different 
potential alternatives to the current structured finance rating 
scale and asked market participants for their reactions to 
these proposals. Those alternatives could include moving to a 
completely new rating scale, adding a modifier to ratings on 
the existing scale to identify them as structured finance, or 
adding a suffix to the existing rating scale to indicate rating 
volatility risk.
    Finally, recent events show how rapidly and dramatically 
markets can change in today's global economy. That is why we 
believe improvements to all market practices, including 
improvements to credit analysis, must be pursued vigorously to 
restore confidence in credit markets. We are firmly committed 
to the effectiveness, integrity, and transparency of our rating 
methodologies and practices. In this regard, we look forward to 
continuing our dialog with the authorities and market 
participants to help strengthen confidence in the financial 
markets.
    I am happy to respond to any questions.
    Chairman Dodd. Thank you very, very much. We appreciate 
your being here.
    Mr. Joynt, we thank you very much.

 STATEMENT OF STEPHEN W. JOYNT, PRESIDENT AND CHIEF EXECUTIVE 
                     OFFICER, FITCH RATINGS

    Mr. Joynt. Thank you, Mr. Chairman, for inviting me. My 
name is Steve Joynt. I have been President and CEO of Fitch 
Ratings. I have been with the company for 18 years, and I have 
been President for 12 years, so I have a good degree of 
experience in the industry. I am happy to answer your questions 
after some brief remarks.
    The past 10 months have seen continuing deterioration in 
first the U.S. and then in global fixed-income markets. Severe 
asset quality deterioration in the U.S. subprime market and 
related CDO securities initially caused large market price 
declines that required revaluations of these securities by 
financial institutions because ultimate credit losses are now 
expected to be far greater than anyone anticipated.
    Today's market stresses, however, have become more broad 
based and emanate from a global reassessment of the degree of 
leverage and the appropriateness of short-term financing 
techniques inherent in today's regulated and unregulated 
financial institutions. Deleveraging is dramatically reducing 
liquidity and contributing to price volatility. Many financial 
market participants today are seeking ways to enhance stability 
in the system.
    Fitch's contribution to a better functioning market 
requires a reassessment of the changed risk environment, rating 
changes that reflect these changes in risk, ratings that are 
more stable and reliable, an improvement in our analysis and 
modeling techniques, and, finally, full transparency so 
investors and all market participants can understand and use 
our ratings to supplement their own risk analysis and their own 
decisionmaking.
    Like all of the major rating agencies, our structured 
finance ratings have not performed well and have been too 
volatile. We have downgraded large numbers of structured 
finance securities, particularly in the subprime mortgage and 
CDO areas, in many cases by multiple rating notches. While we 
still expect almost all AAA securities to pay off, we have 
downgraded many, and some previously highly rated securities 
are at risk of incurring losses in the future.
    While we were aware of, and accounted for, the many risks 
posed by subprime mortgages and the rapidly changing 
underwriting environment in the U.S. housing market, we did not 
foresee the magnitude or velocity of the decline in the U.S. 
housing market nor the dramatic shift in borrower behavior 
brought on by the changing practices in the market. We also did 
not foresee and are surprised by the far-reaching impact the 
subprime crisis has had on markets throughout the world.
    Understandably, the rating agencies have lost some 
confidence of the market for which I am disappointed. I think 
it will be a long and difficult road to win back confidence. We 
have, however, aggressively started down that road, and we 
believe we are making progress, although slowly.
    To win back investor confidence, we simply must do a better 
job with our structured finance ratings and all our ratings. 
Our structured finance ratings must be more predictive and 
stable. Our research and analysis must be more forward thinking 
and insightful. We must tell investors about what might happen 
tomorrow instead of just what has happened yesterday. We, of 
course, remain committed to ensure that our work is of the 
highest integrity and objectivity.
    We have reevaluated our ratings across all structured 
finance areas and the financial services industry broadly as 
the credit turmoil has progressed. We are working hard to 
anticipate what might come next. Fitch has also been busy 
reassessing our structured finance criteria and models, 
changing them to reflect what we have observed in this turmoil. 
It has been our belief that we best serve the market by 
concentrating our efforts on improving our ratings, our 
criteria, and our models before doing anything else.
    As we conduct this work, we have decided to stop rating new 
issues in some structured finance markets that have experienced 
some of the greatest turmoil, such as CDOs. We will remain out 
of these markets until we can assure the market and ourselves 
that we have adequately updated our models and criteria to 
reflect what we have observed during this turmoil.
    The world's financial infrastructure has become 
increasingly interconnected, and it seems as a result that 
credit ratings have become increasingly important to all market 
participants. Unfortunately, we have come to learn that ratings 
have been used in some cases as a proxy to measure liquidity 
and market risk, which ratings were never designed to address. 
Accordingly, we must do a better job at providing ratings and 
additional tools that allow investors to better assess risk in 
this increasingly complicated environment.
    We have been busy working with the other rating agencies as 
a group to increase transparency and the quality of ratings and 
to address the many varied concerns of regulators around the 
world. Here in the U.S., we have worked with the SEC 
extensively in their extensive examination of us. They began 
their formal examination last September. They have been 
conducting a thorough examination. We believe that will prove 
constructive to the SEC as it undertakes the important work 
Chairman Cox described, considering new rules for credit 
ratings and credit rating agencies. We support their efforts to 
improve transparency, integrity, and quality of ratings, and we 
believe their work will aid our efforts to win back investor 
confidence.
    We have been actively meeting with the staff of this 
Committee and the staff of the House Financial Services 
Committee, who have both taken a leadership role in 
understanding this market turmoil. And since last spring, we 
have been meeting with the Treasury Department, many bank 
regulators, State insurance commissioners, and many State and 
local officials, as well as the broad base of investors to 
share our perspective and gain insight from them.
    Thank you. I am happy to answer your questions.
    Chairman Dodd. Thank you very much.
    Mr. Cifuentes, thank you for being here.

 STATEMENT OF ARTURO CIFUENTES, Ph.D., MANAGING DIRECTOR, R.W. 
                        PRESSPRICH & CO.

    Mr. Cifuentes. Good afternoon, Chairman Dodd, Senator 
Shelby, Members of the Committee. My name is Arturo Cifuentes. 
I am an investment banker based in New York. Thank you very 
much for the opportunity to be here. I am really honored to 
have my opinion considered in the matter at hand.
    I submitted yesterday a long sort of statement with my 
recommendations and my views. I am not going to read it here. I 
am just going to make a couple of points which I think are 
relevant. As I said in my testimony, just for the sake of 
clarity, my opinions here are my own opinions, for good or for 
bad. I do not intend to represent anybody but myself.
    One thing that we have here and I think is important to 
realize is that the press and in general there has been a view 
that the U.S. is having a credit crunch or a subprime crisis. 
Actually, I happen to believe that that is true, but actually 
the situation is far more serious than that.
    What we really have is the collapse of the alternative 
banking system, and by that I mean the system of finance that 
was created with securitization and credit derivatives, and 
that is very unfortunate because that was a big engine of 
growth behind the U.S. economy, and now there is a limit of 
trust. The market does not seem to be really convinced that the 
structured finance ratings are accurate, and that has impacted 
that market; for example, the asset-backed commercial paper is 
impacted. That is a very serious problem. So I think there is 
an issue of trust here.
    The other thing we need to keep in mind, this is a very 
global market; 50 percent of the participants in the fixed-
income market are outside the U.S., and they trust the market 
because they trust the transparency of the market and they like 
the ratings. We are at the risk of losing that right now.
    Now, we are going to march into the right thing. I think it 
should--I mean, we have this view that the rating agencies are 
getting quite a few things wrong, but I think it is important 
to realize the nature of the problem. The rating agencies, 
unfortunately, initially rated the mortgages wrong. So there 
was a mistake there. For whatever reason, the rating of the 
mortgages was wrong.
    Then there was a second mistake, and I am going to use a 
term that sounds a little bit technical here, but, 
nevertheless, we have to mention it: CDOs of ABS. So I included 
a diagram here at the end of my testimony to clarify the issue 
of what is a CDO of ABS. But the point is there was a second 
mistake there. So, in addition to the wrong ratings on the 
mortgages, we had the wrong ratings on the CDOs of ABS. These 
were securitizations that included already the mortgages.
    And the further reality is also this happened at the same 
time, so they all got it wrong at the same time, which really 
magnified the problem. Now, I am not trying to suggest that the 
rating agencies acted in coordination to give the wrong 
ratings, but I think the system somehow encourages that kind of 
outcome.
    I just want to make one issue that might sound a little bit 
theoretical, but I think we need to keep it in mind, and then I 
am going to make a couple of recommendations.
    If you remember, initially the ratings were created with 
the whole purpose of giving investors information regarding 
credit risk. That is it. Information for investors. And that 
was fine. Later, the regulators sort of took advantage of that 
and decided to use the rating as a proxy for other things, I 
mean, for example, capital requirements, where the bank needs 
enough resources, et cetera.
    Now, so we have two constituencies right now. We have the 
regulators using the ratings, and then we have here the 
investors. It is not obvious to me that both have the same 
goals in mind. It is not that they have contradictory goals, 
but a rating which is good for the regulator, presumably a 
rating that needs to be more stable, is not necessarily a 
rating useful for somebody who is an active participant trading 
securities in the secondary market. I mean, there is a little 
bit of--I do not want to say conflict of interest, but it is 
not clear that these two things are the same. So something to 
think about there.
    I want to also mention something that, unfortunately, in my 
opinion, has taken a great deal of attention in the press and 
everywhere, and I think it is the wrong issue, and it is not a 
good idea to spend a lot of time talking about that because it 
is not the main problem. There is a much more serious deal.
    We have talked about the conflict of interest because 
allegedly the investment banker pays the fee to the rating 
agency. I believe that is not the case. In reality, what 
happens, an investment banker raises money. You issue the 
securitization bonds, and at the same time, everybody gets 
paid--the rating agencies, the lawyers, the trustee, et cetera. 
So I do not believe there is a link there between the--I mean, 
paying attention to that potential conflict of interest, in my 
opinion there is no problem there.
    In addition to that, there has been the thought that the 
rating agencies have somehow been involved in designing this 
concept. Having been on all sides of this business, that is 
simply not the case. You have the regular give-and-take between 
what could have been an architect that wants to build a 
building and the city engineer telling him what he can and 
cannot do. So that is not really a serious problem.
    What I do believe is a serious problem--and if you remember 
one thing of my testimony, I think that is probably the key 
point here. We need to have a Chinese wall. We have gone 
through this road before. This is the same situation we had 
when we had the issue with the research in investment banking 
before. You remember at that time there was a gentleman or a 
lady writing research on the research side, and then there is 
the business side. So there is a very serious conflict of 
interest here. Evidently, if you have a rating analyst who is 
rating something and the person who is supervising the analyst 
is more concerned about credit risk, creates a very serious 
problem of interest.
    Now, this is more serious than investment banking or any 
other activity because if I do not like the research that the 
bank writes, I just do not read it, or I toss it and do not pay 
any attention to it. But the rating agencies have regulatory 
power. So the opinion of the research analyst or the credit 
analyst is very, very relevant. So I think the idea of having a 
Chinese wall in which analysts will be protected, I think it is 
something that we should think about.
    The other point that I believe--I made a few points there, 
some correlated highly with what Professor Coffee said, so I am 
not going to expand on that. But one thing that puzzles market 
participants at this point, because they do not believe very 
much in ratings--and when I say ratings, I mean just for the 
sake of clarity, I am talking about structured finance ratings. 
I am not talking about corporate debt or emerging market or any 
security. Well, it seems like the rating agencies got it very 
wrong in the structured products, and so people wonder what 
else do they need to do in order to prevent from backing the 
security--yes, I mean, it seems like it could be unfortunate. 
We might be in a situation in which we have only three ratings 
agencies, and there is nobody on the horizon. That is why I am 
a little bit concerned about the 3-year requirement in terms of 
operating as a rating agency before you are approved. And I 
would pose that it is difficult to operate as a rating agency 
and making any money if you are not allowed to issue real 
ratings. I mean, you would need venture capital or somebody 
willing to finance you for 3 years.
    One final point that I would like to make, and, again, it 
might sound a little bit academic here, but we have been 
talking about ratings, and we have been talking about mortgages 
and subprime, et cetera, et cetera. Well, that is fine, but in 
my view, that is 50 percent of the problem. The other 50 
percent of the problem are the CDOs of ABS, which in my view 
were rated using wrong assumptions.
    If you look at what happened in 2007, CDOs of ABS I believe 
accounted for more than 90 percent of CDOs downgrade. As I show 
in my diagram here, this is the securitization, so using 
information that is probably contaminated or something like 
that.
    So, I mean, that is something to look into. That market 
obviously is completely paralyzed today, but just a casual 
inspection of the morals and assumption that were done for CDOs 
of ABS, it seems to me that maybe they were a little bit too 
relaxed. I mean, that is my impression based on some 
preliminary observations.
    The only thing--I think I am going to stop here. The only 
comment that I would like to make just in response to some of 
the things that have been said is that, well, maybe the reason 
we are seeing this massive amount of downgrades is because 
there is a unique situation, and the U.S. housing market maybe 
is having an extraordinarily bad time. Well, there is some 
truth in that, but I happen to believe that the argument is a 
little bit circular, because we would not be having this 
situation if somebody would have said initially, look, I am not 
going to allow you to put these mortgages in these CLOs because 
they are really bad. So I would make the case that perhaps the 
situation was exacerbated--in fact, it was not stopped because 
some of the ratings in these mortgages were not particularly 
accurate.
    So I think I am going to stop here. I thank Chairman Dodd 
and Senator Shelby, and I really appreciate being here, and I 
would be happy to answer whatever questions you may have.
    Chairman Dodd. Well, thank you very, very much, and I will 
ask the clerk to keep the clock on about 5 minutes here so we 
can get around. We have kept you a long time this morning, and 
we will probably have a lot of additional questions to raise 
with you.
    Let me, if I can, jump right in. Ms. Robinson, let me begin 
with you on the due diligence issue, if I could. It has been 
raised earlier. You have heard the conversation. I think 
Senator Corker was sort of talking about it to one degree. 
Senator Shelby raised it and others have as well. And I am 
looking at Moody's Code of Professional Conduct, and let me 
quote it. It says, ``Moody's has no obligation to perform and 
does not perform due diligence with respect to the accuracy of 
information it receives or obtains in connection with the 
rating process. Moody does not independently verify any such 
information.'' That is of June 2005. Now, it may have changed. 
Maybe that has changed since then. If it has, you will correct 
me.
    Obviously, when you have got a proliferation of liar loans, 
as we know about, the no-doc loans going forward here, how do 
you answer the question that obviously you probably have been 
asked before, that a rating agency should not be required to 
perform some due diligence when you are branding these bundles 
as being AAA, and yet not a heavy due diligence would have 
informed one that these products were anything but investment 
grade. I mean, these were products here that were very shaky, 
and how do you make that case that there is not a requirement 
here since so many people are relying--their long-term 
financial security, the security of a municipality, 
foundations, colleges, all these things depending upon that, 
and that there is no requirement for any due diligence and a 
Code of Conduct of ethical conduct when so much has been at 
risk here and so much lost for people, how do you address that?
    Ms. Robinson. Well, Mr. Chairman, the accuracy of the 
information that we receive is central in importance to our 
analysis. And we rely on the work of other parties to verify 
and establish the accuracy of that information. So, first of 
all, it is primarily the responsibility of the issuer and the 
loan originator to provide information to rating agencies and 
others that is accurate.
    Furthermore, the underwriters, the investment bankers who 
market the securities have an obligation to perform due 
diligence on the loans included in the securitization. And, 
finally, information presented in the offering documents 
associated with those securities is vetted by accounting firms.
    And so I agree that the accuracy of the information is very 
important, but there are others whose role it is to check and 
verify that information.
    Chairman Dodd. But people are relying--I mean, people are 
saying this is--Moody's puts its Good Housekeeping Seal of 
Approval on this. That is what people are counting on. I am 
counting on when you say this is AAA, Senator Dodd, this is a 
good product here, I am saying, you know, Moody's told me so, 
Moody's gave me that advice. And you are suggesting to me here 
that you do not bear any responsibility to me as someone who is 
counting on you here to do any kind of work at all to let me 
know that something is not--I understand that others have 
obligations, but what is the obligation of the rating agency if 
not to do some homework on this, so that when I count on you to 
give me that recommendation, that there has been some work that 
has caused you to draw that conclusion, not some lesser 
conclusion about it?
    Ms. Robinson. Well, Mr. Chairman, our role as a rating 
agency is to provide our best opinion about the credit risk 
associated with the securities that we rate. And our opinion 
really goes to the creditworthiness of the securities.
    Chairman Dodd. Well, let me--I do not want to--I have 
limited time here. Let me go to you, Mr. Joynt. We thank you 
for coming today.
    Mr. Joynt. Sure.
    Chairman Dodd. All my colleagues, we express our gratitude 
to you.
    Mr. Joynt. Thank you.
    Chairman Dodd. And I raised earlier Professor Coffee's--
which I thought was a very, very good point, the staleness of 
data. And I do not recall your exact statement in your opening 
remarks, but you talked about an obligation to sort of be 
current. At least that is how I read your statement. And yet 
here you have downgrades that did not occur--here you had--they 
came after the Comptroller of the Currency had drawn his 
conclusions. They come after, months after the agencies 
themselves know there are problems in the markets. You know, 
you say you were surprised by this. When we met here last year 
and asked the Federal Reserve staff, when did you have any idea 
this problem was becoming--I was stunned as the new Chairman of 
this Committee to learn it had been 3\1/2\ years earlier that 
they began to identify a problem. Now, that is a separate 
issue. But the fact of the matter is how could you be stunned 
if you--it seems to me if you were doing your work in this 
area, one, how do you get stunned by it as a rating agency? 
And, second, what about the staleness of the information? Why 
can't we do a better job here? When you are getting the 
Comptroller of the Currency and regulatory bodies acting and 
yet still the downgrades do not occur until months after that 
occurs, I mean, the credibility has been shot here.
    Mr. Joynt. Yes. So I think the awareness of the problem 
from subprime loans in the first instance was most obvious, to 
us at least, in the beginning of last year and only started 
being reflected in the delinquency data that we were seeing in 
the securities that we were looking at in a way in which we 
could incorporate that new information into our modeling.
    Chairman Dodd. Did you pay any attention when the 
Comptroller of the Currency--I mean----
    Mr. Joynt. Of course. Also, we need to recognize that we 
reflected, as did others, that the underlying loans were quite 
poor quality, and so when we are speaking about giving high 
ratings, behind those high ratings was a large amount of 
subordination. So there was a recognition that the loans were 
not--were subprime, were very weak. So it obviously was not 
enough recognition in hindsight, but it was not like we were 
unaware of these being weak loans. We were not aware, it is 
certainly true, and did not do the due diligence function of 
trying to recognize whether there was fraud involved in the 
origination of loans. That is certainly true. And I believe 
that has become one of the biggest accelerants for why there 
have been problems so across the board in the mortgage markets 
itself, so extending to all, and even prime mortgages now. So 
that part we did not do. But we were aware of the weakness of 
the loans. We were aware that the securities in being put 
together were tranched so that senior classes were supported by 
junior classes. But I----
    Chairman Dodd. But did any of you think--were any of you 
facing liability that someone could sue you for not being 
forthcoming with information, that that might change the 
reaction of the agencies, the fact that you are sort of 
protected under the First Amendment--and I see my good friend 
Floyd Abrams here, who I respect immensely as a good First 
Amendment lawyer, and I have great respect for the First 
Amendment. But the whole idea you are insulated in a sense--
anyone else gives me bad information like that, I can sue them. 
I can take them to court.
    Mr. Joynt. Yes. So that is difficult for me to answer. I am 
not a lawyer. But I would say that our reputation is as 
important to us as the money that might come from a lawsuit, 
and that has been damaged. So by not being able to be accurate 
and forward thinking about our ratings, then you--you are 
holding us accountable, not you but everyone, accountable for 
that and reflecting on how good the credit ratings are. And so 
I think that is pretty significant. We treat that seriously.
    Chairman Dodd. Senator Shelby.
    Senator Shelby. All this is troubling to me, the role of 
the rating agencies, lack of due diligence and so forth. 
Professor Coffee, thank you again for coming here to bring some 
light to this subject, and I mean this sincerely. You were 
succinct about what you believe needs to be done.
    Were the rating agencies basically blinded by events? In 
other words, the subprime situation was going on. They were 
pumping them out, the assemblers of it, and they were rating 
them, and they were all making a lot of money. But this product 
was a new product, as I understand it, the packaging and 
slicing and so forth and rating of subprime loans as opposed to 
the old method of very few defaults and so forth. Were they 
blinded by greed? Were they blind to the situation? Were they 
blinded by the fact that they were telling themselves and 
others were telling them that, gosh, their opinion--they just 
gave their opinion, it did not mean anything, yet as I said 
earlier, it seems to be the linchpin of the financial industry. 
What is your comment there?
    Mr. Coffee. I do not know----
    Senator Shelby. Turn your microphone on.
    Mr. Coffee. I cannot tell you whether they knew these 
ratings were false. I do not happen to believe that. I happen 
to believe that in a bubble market and a time when everyone 
sees prices rising and the world getting better and great 
profit being received, you do not look too carefully at whether 
the data you are receiving is phony. And you are structurally 
in a position where you are relying upon the loan originator to 
tell you everything because you yourself do not have the in-
house capacity to do that verification.
    As we go forward, I think the answer is to try to find ways 
to bring third-party verification into the credit rating 
process.
    Senator Shelby. Do you believe that credit rating agencies 
should have some responsibility for what they rate and how they 
rate it because so many people rely on it in the marketplace?
    Mr. Coffee. Absolutely. They are the unique financial 
gatekeeper in that they do not have liability--and I am not 
pushing liability remedies as the answer.
    Senator Shelby. We know.
    Mr. Coffee. But they do not have anything like the risks 
and exposure of accountants or securities analysts. And they 
are functionally a securities analyst for debt markets. So I 
think we should look at the reforms that Congress and the New 
York Stock Exchange and the NASD have recently imposed on 
securities analysts to reduce conflicts of interest. That would 
involve Chinese walls around the rating agency, less consulting 
income, and other ways----
    Senator Shelby. Consulting income, conflicts?
    Mr. Coffee. Well, you have heard Chairman Cox say he is 
thinking seriously about this, and I congratulate them, because 
I think that deserves a serious look.
    Senator Shelby. Do you believe that the SEC--and you teach 
law and you are into all this very deeply. Do you believe the 
SEC can help remedy this situation?
    Mr. Coffee. Well, they can certainly help remedy it. I 
think there are some ways in which they have to take maybe some 
bolder steps than I have yet heard----
    Senator Shelby. Absolutely.
    Mr. Coffee [continuing]. About both verification, 
staleness, and some way that you can ultimately tell a rating 
agency that it no longer is an NRSRO without having to prove 
they were personally at fault. If you have to show that they 
were personally at fault, we are talking about 5 years of 
litigation because they will get challenged in court.
    I think the real outlier, the rating agency that has a 50-
percent default rate when the next highest default rate is 20 
percent, should not continue to be an NRSRO because too many 
people are relying upon them.
    Senator Shelby. Ms. Robinson, Moody's 12-month downgrade 
rate for global structured finance products reached a historic 
high of 7.4 percent in 2007. In a recent Wall Street Journal 
article dated April 11th of this year, Moody's President, your 
President, Brian Clarkson, was cited as saying that the top 
thing that could get a Managing Director fired was inaccurate 
ratings. Is this report correct, that inaccurate ratings are 
the top thing that can get somebody fired? And if so, what 
steps has Moody's taken to hold its executives accountable for 
its poor ratings?
    Ms. Robinson. Well, the accuracy of our ratings are a 
primary concern, and, you know, we are a learning institution, 
you know, we like to say, and we are constantly reevaluating 
our analysis and our methods to make sure that we incorporate 
all of the information that is available to us at the time. You 
know, our business really rests on our reputation and the 
confidence----
    Senator Shelby. And your reputation is in tatters right 
now, wouldn't you think, in the financial world, all the rating 
agencies, or challenged deeply now? You wouldn't agree to that?
    Ms. Robinson. Oh, yes, we are challenged at the present 
time.
    Senator Shelby. Ms. Robinson, in your written testimony, 
you also stated that Moody's tracks debt for more than 11,000 
corporate issuers, 26,000 public finance issuers, and 110,000 
structured finance obligations--110,000. How often does Moody's 
review and, if necessary, update each rating, or do you do that 
when you see pandemonium in the marketplace?
    Ms. Robinson. Well, to take an example of the RMBS market, 
we receive data monthly on all of the mortgage-backed 
securities that we rate. We have a separate surveillance team 
that is charged with reviewing those ratings, and we review 
that data every month.
    Senator Shelby. Professor Coffee, what would you say that 
the SEC, and perhaps this Committee as the Committee of 
jurisdiction, needs to do to make sure as best we can that we 
can restore some confidence in the rating agencies and what 
they do?
    Mr. Coffee. I think there----
    Chairman Dodd. The microphone again.
    Mr. Coffee. I think there are a number of things. You 
already heard me talk about the need for getting some kind of 
verification----
    Senator Shelby. Absolutely.
    Mr. Coffee [continuing]. A mandatory element before you 
give an investment grade rating on structured finance. You 
heard me talk about currency, and I would say there should be 
at least the requirement that you annually reaffirm, republish, 
reduce, or withdraw your rating, not just get information but 
state it again: I am reaffirming this because I believe this, 
or I am upgrading, downgrading, or withdrawing it.
    I also would say when you change your model, you have got 
to, within 90 days, say we are going to reduce ratings on every 
model that would produce different results had it been used 
back when these ratings were given. That is what I talked about 
earlier with the financial scorecard.
    Beyond that, I would tell you that you probably should 
disclose all fees. When you give a rating, there is today a 
problem of what I will call the hidden advisory fee. You get a 
fee as a consultant and as advisor, and you get a fee when you 
give the rating. This produces an incentive for what I will 
call ``forum shopping.'' You can find out from five agencies 
what their fee will be and get it from only the one or two that 
give you the highest rating. Forum shopping is a problem. One 
way to discourage forum shopping is to require rating agencies 
to disclose any fee they have received from an issuer or a 
structured finance offering, even if they did not give the 
rating, and that could show up on the SEC's website, because 
they could show you that for this offering there were four 
ratings, two other agencies that got fees but did not rate. 
That would tell you there is something funny here that they got 
a fee and didn't give a rating. So forum shopping is one of the 
problems.
    I have also suggested in prior testimony that there is an 
SEC rule called Regulation FD which effectively exempts the 
credit rating agencies and thereby permits selective 
disclosure. There are new agencies coming in that are 
subscriber-paid. I wish them well. It is a new form of 
competition. But they are not going to get cooperation from any 
issuers or underwriters because they prefer dealing with the 
agencies that they pay because they can predict what will 
happen with the agencies----
    Senator Shelby. We have got to change the rules, have we 
not?
    Mr. Coffee. You have got to change Regulation FD so that 
all rating agencies get access to the same data.
    Senator Shelby. I hope the SEC is listening.
    Chairman Dodd. They are listening.
    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Coffee. Thank you.
    Chairman Dodd. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Professor Coffee, one of the themes that is constant in 
Chairman Cox's comments and the questions of my colleagues is 
accountability. Today, before this new regulation is proposed, 
other than shareholders, who are the rating agencies 
accountable to in a material sense?
    Mr. Coffee. It is easier----
    Chairman Dodd. Again, you have got to----
    Mr. Coffee. It is easier to say ways in which they are not 
accountable. They do not have private liability. There is no 
regulatory agency like the NASD or PCAOB for accountants that 
has jurisdiction over them. It is only now that the SEC is 
proposing rules.
    Sure, they have a reputation, but in a world in which for 
the past there have only been three agencies, it is not a world 
where reputation counts as much. And reputation means less when 
you are also selling a regulatory license. So even if the 
market does not trust you, they will still pay you a fee to get 
that regulatory license.
    They are left in a position where they are only very weakly 
accountable and less accountable than the other major financial 
gatekeepers.
    Senator Reed. Chairman Cox suggested that when these new 
rules are rolled out, there will be a new world, a world in 
which the presumptive immunity from even a suit for negligence 
would be overturned. Can you comment on that? What is your 
sense of this newer world that is emerging?
    Mr. Coffee. I have a great respect for Chairman Cox, but 
the devil is always in the details. And I do not know what 
these new rules will say. I think that there are areas in which 
we need some strong rules, and while I thought he gave us a 
strong statement, much of it was a little opaque on exactly 
what the rules are going to look like. And I cannot evaluate 
rules until I see them.
    But I do not think absent some kind of either liability 
risk of possibility of suspension or forfeiture that we are 
going to have the same governmental oversight powers over the 
rating agencies that we have over the accounting profession or 
the securities analysts.
    Senator Reed. A final question, because you have all been 
very patient, and I am not picking on Professor Coffee, nor 
anyone else. Thank you all, ladies and gentlemen, for your 
testimony. But it would seem--I mean, I think the system could 
be described as there is absolutely no incentive for an 
investment bank that is putting together an issuance and going 
to a credit agency to then come back and say you gave us a 
lousy rating, because what they are trying to buy is the best 
rating, and when they get it, they have got what they paid for.
    So there is nothing in the system today for any one 
individual to come back and say you did not do the job. And 
that goes back, I think, to the same point about it is easier 
to list the lack of accountability than the points of 
accountability.
    Mr. Coffee. And as a result, this market has collapsed. No 
longer are there any real estate mortgage-backed 
securitizations. There are also very few commercial mortgage 
securitizations. Thus, I think the industry does have a common 
interest with the regulators. This market is not going to come 
back, and there are not going to be fees for rating 
securitizations that do not happen, unless we can make the 
rating agency credible again.
    So I want to focus prospectively, and I think the industry 
as well as regulators have to find a way to create confidence, 
because without it there are not going to be fees.
    Senator Reed. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Dodd. Just to make that point--I think I made it 
the other day in a hearing here. In the commercial mortgage-
backed security area, last year that industry did $230 billion 
worth of business in 2007. And this year, as of late April, 
they have done $5 billion worth of business, just by 
comparison, to give a sense of the magnitude of the problem.
    Senator Corker.
    Senator Corker. Thank you, Mr. Chairman. It is another 
great hearing, and I just want to emphasize something that Ms. 
Robinson said. And, by the way, I want you all to know I am 
loath to sort of pile on after the fact. You know, it is not 
really what I like to do. I will say in this case that it is 
hard not to, OK? But obviously you guys have lost reputation, 
credibility. I know recently I called about a specific thing. I 
remember the broker saying, ``Oh, this is AAA rated,'' and now 
I guess all of us in the world are realizing, What difference 
does it make if it is AAA rated?
    I would just go back and say to the Chairman that we make 
people use these folks, and I think that is something that we 
need to look at. We make people use these folks. And then if 
they do not use them, in essence, they cannot issue securities. 
So that whole situation is something we need to certainly look 
at.
    But, Mr. Coffee, I really enjoyed your testimony. I have 
never taken any law courses. Yours is one I actually wish I had 
taken. But what would the third party do that you mentioned 
earlier? You talked about a third party being involved in some 
verification. What exactly would they do?
    Mr. Coffee. Well, what they do today, and they do this for 
the underwriters. The underwriters will hire a so-called due 
diligence firm--the best known is Clayton Holdings, Inc.--and 
they will send a team of investigators out to look at this 
mortgage pool. There may be in the old-fashioned real estate-
backed securities, there may have been 5,000 mortgages in this 
pool. They will sample it, and they will do the kind of 
sampling that is similar to what an auditor might do to say 
they are reasonably confident that no more than 10 percent of 
these loans lack documentation, no more than 10 percent of 
these loans had no equity stake, no more than 10 percent of 
these loans had a credit score below the minimum level that the 
bank or underwriter wants.
    So they will tell you how many of these loans are exception 
loans, outside the normal lending criteria. And if you hear 
there are 30, 40, or 50 percent, which was the statistics that 
were occurring in 2007 and 2006, you now have a warning signal 
that tells you this is really dangerous.
    I think if you give that information to the rating 
agencies, they will respond by downgrading or not giving an 
investment grade rating. The underwriters overlooked this in 
some cases because they thought their lawyers could write 
boilerplate that would protect them from any fraud liability. 
But I think the rating agency would be more sensitive to this 
if they got the information.
    Chairman Dodd. Can I ask a simple question?
    Senator Corker. Yes.
    Chairman Dodd. Why wouldn't you have the rating agency--why 
hire a consultant? Why not just do it?
    Mr. Coffee. Because--you heard the numbers--there might be 
100,000 securitizations out there that they have to perform 
ratings on. The underwriters are already doing this and bearing 
the cost. If you give this information to the rating agency, 
whether it is the bank that gives it to them or whether it is 
the third-party firm, I think you have a way that will work, 
and it is more feasible, given the small in-house staff.
    Chairman Dodd. Thank you, Bob.
    Senator Corker. Of course, no, no. Of course, the fact is 
the underwriter is driven to get this product out, too. So 
there are actually conflicts there, too.
    Mr. Coffee. Lots of conflicts in this business.
    Senator Corker. OK. So I would go back--actually, that was 
my next question.
    Chairman Dodd. How about having the underwriter have some 
skin in the game, too? That may increase the likelihood of 
accountability, I think.
    Mr. Coffee. The underwriter does have liability and is 
somewhat better deterred, but the underwriter's liability is 
for fraud, and if he puts in a lot of boilerplate disclosures, 
it will say, ``We told the market that there was this 
problem.''
    Senator Corker. There is not, I do not think, any 
meaningful liability there. But going back to the liability 
issue--and obviously I think all of us are really puzzled to 
realize that there is just absolutely zero liability. You would 
have to perform--I am talking to the rating agencies now. You 
would have to perform lots of due diligence to take on 
liabilities, and just sort of the flip side of this is 
obviously fees would be very different if you were taking on 
liability--is that correct? Rating agency charges would be 
much, much higher, much different if you were taking on 
liability. Is that correct?
    Mr. Joynt. Yes.
    Senator Corker. OK. And is it reasonable for us sitting 
here, realizing the meltdown that has occurred was reliance 
upon--and the reliance that was placed in structured finance 
being rated AAA, AA, whatever. Should you have liability? I 
mean, would that be a good step forward for your various 
companies? Obviously, it would change your entire business 
model, but is that something you would actually advocate?
    Mr. Joynt. I would say no. I do not think in the case of 
the responsibility for the due diligence, which we assume 
someone else is doing, that we would have to structure 
ourselves in such a way that we would be organized to do that 
and charge for it appropriately. But it is not really our main 
business function. It is not the business that I really want to 
be in. I certainly would not want to take on that business in 
order to take on liability in that way. We would prefer to have 
a business model that is opinion oriented, and so that is the 
business model that we have now.
    Ms. Tillman. If I may add, you know, I do not totally 
disagree with what Professor Coffee was saying, because in some 
of the leadership actions that we are proposing, I think it is 
important that we get better disclosure and make more of an 
effort on the quality of the information that we are receiving. 
Some of the things that we are looking at is just the--yes, the 
obligation for the due diligence is on the bankers, it is on 
firms like Clayton that do it for the bankers. They have a 
whole different business model. But at the same time, we as a 
rating agency can request and require a certain level of reps. 
and warranties and/or a certification or comfort level that the 
types of due diligence that is required to ensure that the 
quality of the information we get is, in fact, at that level. 
We do look at--I mean, a lot of the comments here make it 
appear that we do not do anything. In fact, we do do a lot. We 
do take all the loans that are in the pool. We run them through 
our models. We make our model assumptions available to 
everybody. We publish our scenario analysis. We publish our 
criteria.
    But I do think that there is an important element around 
the veracity and the integrity of the data quality, and I think 
that is something the market and the rating agencies need to 
deal with.
    Senator Corker. I know we have a bit of an interchange. I 
just have many questions, and I will wait until after Senator 
Menendez. But the last question in this round, Mr. Cifuentes--I 
may have pronounced that incorrectly.
    Mr. Cifuentes. No. You pronounced it correctly.
    Senator Corker. Good. Well, I will not try again.
    Mr. Cifuentes. AAA for pronunciation.
    Senator Corker. Thank you very much for being here. The 
structured finance is basically over.
    Mr. Cifuentes. I hope not.
    Senator Corker. Well, it----
    Mr. Cifuentes. It is in a state of semi-paralysis right 
now.
    Senator Corker. OK. If you could give us a vision of how 
this--whatever potion is going to be used to basically cause it 
to move out of paralysis and how you see the industry being, if 
you will, in 6 months.
    Mr. Cifuentes. Well, your statement was 90 percent correct. 
It is not totally paralyzed, but it is very paralyzed.
    Basically, what we have right now is asset-backed 
commercial paper that is very much--CBOs of ABS, that is 
totally gone, and we slowly see a recovery of CLOs, which are 
CDOs supported by bank loans. So, broadly speaking, yes, the 
structured finance market, it is pretty paralyzed right now. I 
hope that is not forever, because as I said, we are talking 
about the market in the trillions of dollars. So it is a very 
significant amount when it comes to financing.
    As I said initially, the only way people and investors are 
going to recover the confidence is the confidence in the 
ratings. I mean, that is the end of it. I mean, there is 
nothing beyond that.
    Now, I just want to make a brief comment, if I may, if I 
can elaborate on an important point.
    Senator Corker. Let me just----
    Mr. Cifuentes. Sure.
    Senator Corker. That is a big statement. I mean, that is 
kind of like the market will return once people believe in the 
ratings.
    Mr. Cifuentes. That is my hope.
    Senator Corker. But based on the scenario that has just 
been laid out as to how the ratings occur, how could there be 
faith in the ratings when there is no accounting activity, 
there is no audit activity, there is no understanding of how 
these are really put together. How could there be?
    Mr. Cifuentes. But let me--I think that is a very valid 
point, and let me elaborate on that, because I work rating CDOs 
so I do not want to give the impression that we just feed data 
into the computer.
    Just to give you an idea regarding--I work rating CDOs, so 
I am not familiar with the process of mortgages as to how--but 
I will tell you about the due diligence, and I think it is 
something that should be recovered, I guess, if it was lost.
    I rated, for example, the first French CLO, a CDO done with 
French bank loans. So the bank came to us, they told us what 
they wanted to do. The first thing we did, I took a plane and I 
went to Paris with a colleague of mine. We met with the CEO of 
the bank. We looked him in the eye. They showed the loans they 
had. They had an internal rating system from 1 to 6. Obviously, 
we said fine. We took a sample of those loans, and we gave it 
to the people at Moody's who rated bank loans, because I have 
no idea how to rate a bank loan. They gave sort of a 
correspondence between the internal rating of the bank and what 
Moody's had, and then after some verification of the data, we 
used that to proceed.
    My understanding, my recollection, whenever we did CLOs at 
that time, that is the way it was done. The data was verified. 
So the point that Professor Coffee made I think is very valid. 
A rating which is not based on verification of the data, what 
is it? I mean, basically it's some input that somebody told me 
that I put into the computer program, and then it comes out OK.
    Now, I am not very optimistic about all these things about 
disclosure and conflict and things like that because, at the 
end of the day, as it was pointed out, the rating is no longer 
an opinion. It is an opinion with regulatory power, and you do 
not have any choice. I mean, you have to use the rating.
    So I think at the very least there should be an element of 
serious due diligence, making sure the quality of the data you 
are being presented, there is some integrity there. I mean, 
what it will define statistical processes so somebody gives you 
a pool with, say, 1,000 loans, you can take a small sample, do 
some analysis, and at least have a rough idea of how good or 
how bad they are. Apparently that was not the case.
    Senator Corker. Thank you.
    Chairman Dodd. Thank you.
    Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. Thank you for 
the hearing, and I appreciate all of our panelists here.
    Let me ask the three rating agencies here, in November and 
December, all three of your agencies downgraded various Bear 
ratings slightly, but they were still investment grade. The day 
the collapse was announced on that Friday, you all downgraded 
Bear. S&P downgraded them to the second lowest investment 
grade. Moody's downgraded them to three levels above junk, 
which is non-investment grade. And the question is: Did you 
make any changes prior to March? Or is that the right 
timeframe? You did something in November and December, but they 
were all still investment grade. And you did not do anything 
until the collapse. Is that a fair statement?
    Mr. Joynt. I do not have the answer off the top of my head 
on Bear Stearns. I could look into it for you.
    Ms. Tillman. I would say the same thing. I do not have the 
answer off the top of my head. I would have to check back and 
get back to you.
    Senator Menendez. I would have thought that on one of the 
biggest challenges we have had that has spurred $29 billion by 
the Federal Reserve to prop up JP, you would have thought maybe 
that question would have been asked of you. But----
    Ms. Tillman. Yes, but I would like to give you the accurate 
information.
    Senator Menendez. All right. I will look forward to the 
accurate information. But from all my research, the answer is 
you did not. And in my mind, how is it possible that Wall 
Street seemed to know that Bear was in trouble since they 
started pulling out and demanding their money back before the 
collapse, yet the regulators seemed unaware of the looming 
downfall, and we got no signs from the ratings--you know, which 
to my knowledge, as I said--you can correct me if your facts 
are different, but remain unchanged until after the collapse.
    This goes to the heart of this problem. You know, because 
at the end of the day, as I listened to Professor Coffee and 
Dr. Cifuentes, you know, this is about valuating the underlying 
debt, the underlying instruments. And if you do not have a good 
sense of that valuation, I do not know how you give these 
ratings. And if you do not look at the transition over time, as 
Professor Coffee has suggested, how do you continue to maintain 
a rating in the midst of Wall Street acting in a different way, 
the regulators then following up and nothing changing from the 
rating agencies?
    Ms. Tillman. If I may, I do know that we had put out 
articles and made comments on the prime mortgage market, the 
brokerage market, the securities industry. What I cannot tell 
you exactly is the chronology in terms of the rating action.
    Senator Menendez. But just take for a moment, Ms. Tillman 
my facts for a given, just for argument's sake. And I am pretty 
sure you will find them to be the case. If those are the facts, 
isn't something wrong? Isn't something wrong that you did 
absolutely nothing in making the appropriate downgrades until 
after the collapse? What good is it to the investors at the end 
of the day to have that information after the collapse?
    You know, I know you all--I hear you say that you are 
listening. I wonder whether you are--you are hearing. I am 
wondering whether you are listening. I did not hear anything in 
the testimony that leads me to believe that you are ready to 
make the fundamental changes that I think need to be made and I 
hope the Securities and Exchange Commission, Mr. Chairman, is 
going to make, and then this Committee will hopefully instigate 
them to move in that direction.
    Let me ask you another question. Recently, the example of 
MBIA, Fitch downgraded MBIA's rating from AAA to AA citing a 
lack of capital. It also called MBIA's outlook ``negative.'' 
However, S&P and Moody's both kept MBIA's ratings at the 
highest level. Before Fitch's announcement, MBIA decided it did 
not want to be rated by Fitch anymore.
    Now, Professor Coffee, is that an example of rating 
shopping?
    Mr. Coffee. It may be, but I cannot tell you. I cannot 
point the finger and tell you the answer to that question, but 
it could be.
    Senator Menendez. Clearly, if MBIA saw it was going to get 
downgraded, it basically could have said, well, let me pull the 
plug and say thanks, but no thanks, because at the end of the 
day, there is a consequence to it. And so this whole effort of 
transparency and openness that some of us have advocated for 
the SEC is incredibly important because it would give people 
across the spectrum to say, you know, we went to an agency, we 
decided not to take their rating, and that pretty much gives us 
at least a cautionary flag at the end of the day.
    You know, I do not quite understand how ratings without 
valuation with an uncertainty--it is almost like, you know, you 
put--whatever you put into a process, it is what you are going 
to get out. And if at the end of the day we have ratings 
without valuations of the underlying instruments and the change 
of these instruments--these instruments have dramatically 
changed over time, so understanding the nature of those 
instruments and what their underlying values are is incredibly 
important. Otherwise, I do not quite understand how a rating 
means anything other than the fact that you are largely the 
only game in town. There may be a couple other rating agencies, 
but last year, at the end of 2007, of the 356,000 asset-backed 
securities for which there were ratings, you three did all but 
1,000 of them. So that pretty much makes it the only game in 
town. And when that game is wrong, there is a real consequence 
to the investors in this country. And that is what is at stake.
    So, Mr. Chairman, I look forward to working with you to 
make sure that we are more aggressive than what I have heard 
the agencies are willing to pursue themselves.
    Chairman Dodd. Thank you, Senator, very much.
    Let me just follow up on the forum shopping issue to you, 
Ms. Tillman and Ms. Robinson and Mr. Joynt. You have heard 
Professor Coffee talk about how this works. Do you have 
anything to add to that discussion? And is the suggestion about 
how this works, do you think, a legitimate point?
    Ms. Tillman. Well, I think at least from Standard & Poor's 
perspective, we certainly do not like the practice of ratings 
shopping, if that is what you mean by forum shopping. That is 
what I am assuming what you are talking about.
    Chairman Dodd. But it is ongoing.
    Ms. Tillman. We believe that it does, in fact, happen, yes. 
But the difficulty, for instance, at Standard & Poor's is we 
know that when someone comes to Standard & Poor's and requests 
a rating and then does not choose to have that rating. What we 
do not know is then who they eventually go to. So if there is a 
way that there is some kind of disclosure that is involved that 
can indicate, you know, and let there be transparency around 
who does give ratings and who does not and who went to the 
rating agency and not, that is certainly something that 
Standard & Poor's would feel comfortable with.
    Chairman Dodd. How about you, Ms. Robinson? How do you feel 
about that?
    Ms. Robinson. I think our view is that rating shopping does 
exist, and I think issuers naturally wish to obtain the best 
rating they can obtain.
    One of the ways in which we feel that we can kind of 
counterbalance that tendency of issuers is we feel it is very 
important that we make sure that investors understand what 
Moody's rating approach is and what Moody's point of view is, 
because ultimately investors are the users of our ratings. So 
although issuers obtain the ratings, it is really ultimately 
investors' comfort level and satisfaction with those ratings.
    Chairman Dodd. Well, doesn't it help the investor to feel 
more comfortable if, in fact, they know that maybe they have 
tried to get a rating from someone else and did not get one? As 
an investor, aren't I in better shape to be more comfortable if 
I know that?
    Ms. Robinson. Oh, well, we are fully supportive of efforts 
to provide more disclosure in this area.
    Chairman Dodd. So you would agree with that. How about you, 
Mr. Joynt?
    Mr. Joynt. I have a slightly different view than that. I 
disagree with Ms. Tillman on the topic of the rating shopping 
and the disclosure of the ratings. In the case of MBIA, they 
asked to withdraw the rating from Fitch. We have maintained it 
so far and subsequently changed the rating to what we thought 
was the accurate rating. But they have suggested that we may 
not have enough information to keep an accurate rating, and we 
are dialoguing and debating that ourselves. That would be based 
on public information, the ability to rate on public 
information.
    Several month ago, a large financing, Texas toll road 
financing, a several-billion-dollar financing, we also were 
asked not to rate that financing because we thought they were 
taking on additional debt load, and our rating was falling 
below the A category into BBB, where the other two rating 
agencies were continuing ratings at A. So we have been asked 
and have had to, because we do not have the information, to 
withdraw the rating in that case.
    So I think there is an important job for the SEC and 
others, in the case of the public finance market, to make sure 
there is adequate information outstanding for any of the rating 
agencies to do an appropriate rating.
    On the second point, I believe that if you force people to 
disclose the fact that they have gone to rating agencies and 
subsequently not accepted their rating, they will limit their 
initial approach to rating agencies, and our view is probably 
to the largest and dominant rating agencies so that they do not 
have to disclose that they went to others and got more 
conservative rating opinions. So that would discourage 
competition, I think, in a very significant way.
    Chairman Dodd. Professor Coffee, how do you answer that?
    Mr. Coffee. Well, first of all, the new agencies are 
subscriber-paid agencies, and they are not going to be getting 
a fee. So we are not going to have forum shopping to them. 
There may be contact and you could ideally disclose any 
application or any forum submitted. But I do not think that the 
subscriber-paid agencies are going to be deterred by rules that 
seek to disclose forum shopping.
    Mr. Joynt. Well, we are not sure all the new agencies will 
only be investor-oriented, though. Yes?
    Chairman Dodd. Well, that is why you have got to apply the 
same rules to everybody.
    Mr. Joynt. Correct. I think the simple remedy, as I was 
suggesting earlier, is if the SEC had one website and you had 
all the NRSROs up there, you could say there are three agencies 
that gave a rating, two that got an advisory fee but did not 
rate, and one that got an application for a rating but it was 
withdrawn. You could show that all on one simple chart.
    Chairman Dodd. Yes. That was, I think, my first or second 
question to the Chairman. And I think he sort of endorsed the 
idea. I thought he did, anyway. It was unclear.
    Mr. Joynt. I thought he was at least sympathetic to it, but 
the devil is in the details.
    Chairman Dodd. That was the opaque answer I think you 
talked about earlier.
    This has been most fascinating, and it is a very important 
hearing. Just the hearing itself I think could be helpful to 
enlighten, obviously, our colleagues and the Committee and 
others who are following this, but also I think important for 
the SEC to hear from the office of the legislation about the 
direction we would like it to move in. And it is very 
enlightening for us to understand how this works and how we can 
get it right, because it is a critical component in all of 
this. And while we have made some recommendations and 
suggestions on how to deal with the underlying problems of 
foreclosure, which I think we have got to address, if we do 
that and do not also structurally address these issues, then 
these problems can recur again. So it is an important issue to 
look at.
    I thank you all very, very much for being here. I will 
leave the record open because there were Members who were not 
able to be here this morning who may have questions and others 
who were here may have additional questions for you. And I 
would ask you to respond in a timely fashion, if you could. But 
I am very grateful to all of you for your presence here this 
morning.
    The Committee will stand adjourned.
    [Whereupon, at 1:38 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record to follow:]

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 


RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM CHRISTOPHER 
                              COX

Q.1. Conflicts--Separate Analysts from Business? Dr. Cifuentes' 
testimony contains a recommendation by Mr. Mark Froeba that a 
rating agency be required to separate its rating business 
function from its rating analysis function. Has the Commission 
considered whether a significant conflict exists in this area 
and whether it should be addressed by regulation?

A.1. Yes. The Commission recently proposed rule amendments that 
would prohibit issuance of a credit rating if the NRSRO or an 
affiliate of the NRSRO made recommendations to the obligor or 
the issuer, underwriter, or sponsor of the security about the 
corporate or legal structure, assets, liabilities, or 
activities of the obligor or issuer of the security. The 
amendments would also prohibit a person within a NRSRO who 
participates in determining credit ratings, or in developing or 
approving procedures or methodologies used, from participating 
in any fee discussions or arrangements.

Q.2. Timeliness of Updates of Ratings. Professor Coffee's 
written testimony states ``the gravest problem today may be the 
staleness of debt ratings.'' What standards should NRSROs 
observe in updating ratings and in withdrawing obsolete ratings 
for the benefit of investors and the integrity of markets?

A.2. The Commission believes credit ratings should reflect 
current assessments of the credit worthiness of an obligor or 
debt security. Consequently, NRSROs should have policies and 
procedures for monitoring and reviewing existing credit 
ratings. Furthermore, the Commission recently proposed new 
rules and rule amendments to require greater disclosure about 
the NRSROs' procedures and methodologies for monitoring 
existing ratings, including how frequently ratings are reviewed 
and whether different models are used in the initial rating and 
monitoring processes. This proposal is designed to provide the 
market with sufficient information on the surveillance 
processes of the NRSROs to allow for comparisons with respect 
to how actively they monitor and review existing ratings.

Q.3. Due Diligence. You testified that ``The Commission's 
intent is to promote greater due diligence by market 
participants.'' Would the quality of ratings improve if NRSROs 
themselves performed some form of checking or due diligence on 
the data they receive before issuing ratings?

A.3. Because of the sheer volume of securities they rate, 
credit rating agencies may be less suited to performing due 
diligence than issuers and underwriters. But this should not 
relieve credit rating agencies of the responsibility to ensure 
that their ratings are based on reliable information, even if 
the due diligence is performed by others. The Commission 
recently proposed new rules and rule amendments that would 
require disclosure as to the level of verification performed by 
issuers and underwriters and NRSROs, and how the NRSROs take 
that verification into account when determining credit ratings.
                                ------                                


     RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM 
                        CHRISTOPHER COX

    Chairman Cox, in his written testimony, Professor Coffee 
notes that because only a limited number of investment banks 
underwrite structured finance products, they have leverage over 
the rating agencies. If they don't like the ratings they get 
from one rating agency, they can go to another rating agency 
that has lower standards. Since a few investment banks control 
which ratings agencies receive the large revenues that come 
from rating structured finance products, rating agencies may be 
compelled to lower their ratings to remain competitive.
Q.1.a. Do you agree with Professor Coffee about the market 
power of investment banks over rating agencies?

A.1.a. This is one of the issues the Commission is reviewing as 
part of its examination of the role of credit rating agencies 
in the credit market turmoil. The Credit Rating Agency Reform 
Act and our proposed new rules recognize that this could 
happen, and therefore provide broadened competition and 
transparency as a remedy. At this date, the Commission has not 
reached any final conclusions as to whether investment banks 
unduly influenced the rating process.

Q.1.b. Has the SEC's investigation of the rating agencies 
revealed evidence that (1) the rating agencies compromised the 
integrity of their ratings in order to increase their profits, 
(2) there is a relationship between securities that have been 
downgraded and the investment banks that underwrote them or the 
credit rating agency that rated them, or (3) investment banks 
actively steered business to the rating agencies with lower 
standards?

A.1.b. The Commission will be making a formal report to you of 
its examination findings on this question very soon. (1) 
Preliminary observations suggest the credit rating agencies 
were in fact focused on how the ratings they issued influenced 
their market share. (2) The staff's preliminary evaluations 
have not found any significant relationship between the 
securities whose ratings were downgraded and the investment 
banks that issued those securities. In addition, examiners have 
not found a link between the downgraded securities and certain 
credit rating agencies. (3) The ongoing reviews have not found 
indications that investment banks actively steered business to 
the rating agencies with lower standards.
    Chairman Cox, many institutional investors can purchase 
only securities rated by the rating agencies listed in the 
investment guidelines that govern their funds. Because S&P and 
Moody's have historically dominated the ratings market, the 
investment guidelines for many investment firms list only one 
or both of those firms. It has been suggested that the fact 
that investors do not regularly update or re-consider which 
rating agencies are specified in their investment guidelines 
places new rating agencies at a competitive disadvantage. Even 
if a new firm produces better ratings than S&P and Moody's, 
investors may still have to use S&P and Moody's ratings due to 
the requirements of their investment guidelines.

Q.2.a. As matter of good business practice, should 
institutional investors regularly review their investment 
guidelines and conduct due diligence to determine which credit 
rating agencies' ratings their guidelines should require?

A.2.a. Yes. As with any number of institutional investors' 
screening methods and evaluation criteria, it is prudent for 
those investors to periodically review their guidelines that 
incorporate credit ratings. In conducting a review, 
institutional investors should consider the reliability of the 
agencies on whose ratings they may rely and consider available 
alternative rating firms. Moreover, for many institutional 
investors, a security's rating likely would operate only as a 
starting point in a reasonable due diligence process. Further, 
where modeling is a significant part of the rating process, 
institutional investors should develop an understanding of the 
credit rating agencies' models. For example, that understanding 
could include the various risks those models seek and do not 
seek to capture.

Q.2.b. If institutional investors reviewed more regularly the 
rating agencies listed in their investment guidelines, would it 
provide an additional incentive for rating agencies to produce 
high quality ratings?

A.2.b. Yes. To the extent they do not do so today, 
institutional investors' periodic review of the efficacy and 
adequacy of their investment guidelines, including the 
reliability of credit ratings and the firms that issue them, 
could provide an additional incentive for credit rating 
agencies to provide higher quality ratings. In addition, it 
would be useful if issuers seeking ratings and the rating 
agencies themselves were fully aware of investors' perceptions 
of, and perspectives on, both those agencies and the ratings 
they issue.
    Chairman Cox, S&P, Moody's, and Fitch indicated in their 
testimony that they are taking steps to make it easier for 
investors to understand the methodologies used in rating 
different types of securities. However, they have stopped short 
of proposing that different symbols be used to distinguish 
ratings on corporate, structured finance, and municipal 
securities.

Q.3. Would having different ratings symbols for each rating 
category provide investors with useful information about the 
nature of those ratings?

A.3. Yes. However, there are also questions about the costs of 
such a requirement, which the Commission is carefully 
evaluating. Given the reliance of some investors on ratings of 
subprime securities, the Commission has proposed requiring 
NRSROs to provide investors and other users of credit ratings 
with more useful information about credit ratings and processes 
used by credit rating agencies to determine credit ratings. An 
amendment proposed by the Commission would require a NRSRO to 
attach a report each time it publishes a credit rating for a 
structured finance product that describes the rating 
methodology used to determine the credit rating and how it 
differs from the determination of a rating for any other type 
of obligor or debt security, and how the credit risk 
characteristics associated with a structured finance product 
differ from those of any other type of obligor or debt 
security. A NRSRO would not be required to attach that report 
if the rating symbol identifies the credit rating as relating 
to a structured finance product as distinct from a credit 
rating for any other type of obligor or debt security. 
Recognizing that market participants have a range of views on 
the symbology approach and whether it would be effective, 
particularly from a cost-benefit analysis, the Commission looks 
forward to the public's comments on this proposal.

Q.4. Chairman Cox, presently if an investor wants to compare 
the accuracy of the ratings of different rating agencies, could 
an investor easily obtain the necessary information? How would 
the proposals you outlined in your testimony, if adopted, make 
it easier for investors, analysts, and scholars to analyze the 
accuracy of ratings?

A.4. Currently making comparisons across NRSROs is difficult. 
For that reason, the Commission recently proposed new 
disclosure requirements designed to assist investors and others 
in comparing the performance of NRSROs. Under the proposed new 
rules a NRSRO would need to provide transition statistics for 
each asset class of credit ratings for which an applicant is 
seeking registration broken out over 1, 3, and 10 year periods. 
Both upgrades and downgrades would have to be included in these 
statistics. In addition, default statistics would show defaults 
relative to the initial rating and incorporate defaults that 
occur after a credit rating is withdrawn. These new rules would 
make it easier for academics, investors, and others to compare 
how different NRSROs initially rated a security, and whether 
they subsequently changed the rating.

Q.5.a. Chairman Cox, during our last hearing on rating 
agencies, this Committee heard testimony that the use of 
ratings by NRSROs in financial regulation creates artificial 
demand for NRSRO ratings. Because financial institutions must 
obtain NRSRO ratings to satisfy regulatory requirements, there 
is a demand for ratings even if they are inaccurate. Does 
demand for NRSRO ratings for regulatory purposes reduce the 
incentive for credit rating agencies to produce accurate 
ratings?

A.5.a. Not necessarily, but it could reduce the incentives of 
investors to be critical users of the ratings. Of course, 
ratings are used for a variety of purposes. One of the major 
uses of ratings is by issuers to give confidence to buyers that 
the debt instrument offered for sale is of high quality. The 
reputation of the rating agency is critical for that purpose. 
The Commission staff does not have any evidence to suggest that 
the coincident use of ratings for regulatory purposes reduces 
the NRSROs' incentive to protect their reputations by producing 
accurate ratings. To deal with the problem of regulatory over-
reliance on credit ratings as a shorthand for achieving other 
regulatory objectives, we will soon consider a rule proposal to 
provide alternative means of meeting those objectives.

Q.5.b. Should steps be taken to eliminate or reduce the use of 
NRSROs in financial regulation? If so, how could this be 
accomplished?

A.5.b. Yes. Financial regulators, including the SEC, should 
consider the extent to which the use of ratings for regulatory 
purposes induces investors to over-rely on ratings. The 
Commission is currently reconsidering the use of NRSRO ratings 
in its own rules. The Commission proposed new rules on June 25 
designed to ensure that the role assigned to ratings in 
Commission rules is consistent with the objective of having 
investors make an independent judgment of risks and of making 
it clear to investors the limits and purposes of credit ratings 
for structured products.

Q.6. Chairman Cox, NRSRO ratings are widely embedded in our 
economy. We heard testimony at the hearing about the great 
weight investors and regulators place on ratings. Do investors 
and regulators overly rely on ratings by NRSROs? Has over-
reliance on ratings reduced the amount of due diligence and 
risk assessment undertaken in our economy?

A.6. The fallout from the credit market turmoil indicates some 
investors relied too heavily on credit ratings for structured 
products rather than conducting their own assessment of the 
credit quality of the product. While, many of the financial 
institutions impacted in the turmoil had devoted substantial 
resources to establishing internal risk assessment functions 
(some of which ultimately failed to protect them), there is no 
question that there is a connection between over-reliance on 
ratings and the level of due diligence and risk assessment. The 
Commission proposed new rules on June 25 designed to ensure 
that the role assigned to ratings in Commission rules is 
consistent with the objective of having investors make an 
independent judgment of risks and of making it clear to 
investors the limits and purposes of credit ratings for 
structured products.

Q.7. Chairman Cox, the use of NRSRO ratings for financial 
regulation appears to multiply the impact inaccurate ratings 
can have on our economy. For example, NRSRO ratings are used in 
capital requirements and the SEC's money market rules. This 
means inaccurate ratings can allow financial institutions to 
hold too little capital, or force them to sell assets that no 
longer satisfy regulatory requirements. The need for financial 
institutions to raise more capital or re-allocate assets 
following large scale ratings downgrades could significantly 
affect the economy. If our financial regulatory system had 
relied less on NRSRO ratings, would our economy have been 
better prepared to weather the impact of the recent large scale 
ratings downgrades?

A.7. Yes, because the ratings for subprime-related securities 
were categorically wrong due to a variety of methodological 
factors that the agencies have since acknowledged. The large 
number of subsequent credit rating downgrades played a role in 
the credit market turmoil. However, as noted previously, 
issuers purchase credit ratings to make their securities 
marketable and many of the investors demanding that securities 
be rated are not subject to regulations that use credit 
ratings. The link between the use of credit ratings in 
Commission rules and investor over-reliance on credit ratings 
is difficult to quantify with precision.
    Chairman Cox, the Credit Rating Agency Reform Act of 2006 
sought to increase competition among rating agencies by making 
it easier for new firms to become NRSROs. The Act favors no 
particular business model. Two firms that use an ``investor 
pays'' model have registered as NRSROs. Some have argued that 
the ``investor pays'' model has fewer conflicts of interest 
than the ``issuer pays'' model because it makes the rating 
agency directly accountable to investors.

Q.8.a. How do we go about fostering innovation and further 
reducing the conflicts of interest in the credit rating 
industry?

A.8.a. The Rating Agency Reform Act of 2006 was designed to 
achieve these goals through requirements that promote 
accountability, transparency and competition in the credit 
rating agency industry. The Commission recently proposed new 
rules and rule amendments that are designed to further these 
goals in the context of structured finance, including by 
requiring more comparable performance statistics, the 
disclosure of ratings history, and greater disclosure of the 
assets underlying structured finance products and the 
methodologies used to determine and monitor structured finance 
ratings. The goal is to make it easier for the market to assess 
the quality of NRSRO ratings.

Q.8.b. What competitive barriers still entrench S&P and Moody's 
in their dominant market positions?

A.8.b. In the past, S&P and Moody's widespread market 
acceptance has given them an advantage because issuers and 
investors were familiar with their rating record and 
reputation. Issuers were inclined to use their services because 
they helped issuers sell their securities. Following the 
enactment of the Credit Rating Agency Act, it will be easier 
for competitor firms to become NRSROs and for the users of 
credit ratings to become comfortable with NRSROs other than S&P 
and Moody's. Ultimately, the test of their quality and value in 
the marketplace will be whether users are willing to pay for 
ratings from these other organizations. At the same time, S&P, 
Moody's, and the other NRSROs will need to provide 
significantly more information to the public to demonstrate the 
quality of their ratings and ratings processes. The Commission 
recently proposed new rules and rule amendments designed to 
require NRSROs to provide more information with which investors 
and other market participants could evaluate the NRSROs' 
performance record.
                                ------                                


    RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM 
                        CHRISTOPHER COX

                            RATING SHOPPING

    Without a doubt, one of the most worrisome practices that 
undercuts the accuracy and reliability of ratings is rating 
shopping. I am pleased to hear your proposal include 
improvements to disclosure, but I am concerned that it doesn't 
go far enough to ensure rating shopping cannot occur.
Q.1.a. Would the proposed rules eliminate rating shopping?

A.1.a. This is exactly what the proposed rules are intended to 
do. Specifically, the proposed new rules and rule amendments 
are designed to target the problem of rating shopping by making 
it easier to track the ratings of NRSROs, and by making it 
easier for competitor NRSROs to issue unsolicited ratings for 
structured products that would allow investors to compare these 
ratings. Currently, the information necessary to determine an 
initial rating for structured products typically is not made 
widely available. If this information were made available to 
all NRSROs, those that are not hired to determine the credit 
rating could nonetheless issue a credit rating. This approach 
is designed to eliminate the potential harm of rating shopping 
by promoting unbiased ratings.

Q.1.b. The fundamental problem is that people can still get a 
preliminary rating and then decide to go elsewhere. Would 
issuers have to disclose if they received a preliminary rating?

A.1.b. The agreement recently reached between the three largest 
NRSROs and the New York Attorney General to change the payment 
structure in the industry attacks this problem in a slightly 
different way, by ending the practice of free preliminary 
ratings. Now, issuers will have to pay even if they do not 
obtain a rating. The Commission staff believes this will also 
avoid the problem that arises if issuers forego approaching 
NRSROs in order to defeat a disclosure requirement.

Q.1.c. On the disclosure proposals you outlined--are you going 
to require issuers to share material non-public information 
with all NRSROs if they provided the same information to one 
NRSRO? Can you describe in detail the proposal for disclosure?

A.1.c. The Commission recently proposed new rules and rule 
amendments to require the disclosure of information about the 
assets underlying a structured finance product that are used by 
an NRSRO to determine a rating. The goal is to provide 
information to NRSROs that were not hired to determine the 
credit rating so they would have an opportunity to issue a 
credit rating. The details of this proposal are described in 
the attached rule release.

                              BEAR STEARNS

    The Bear Stearns collapse signaled a few problems in our 
system, one of which was that we seemed to have no idea how 
faulty Bear's assets were until it was too late.
Q.2.a. In the days and weeks leading up to Bear Stearns' 
collapse, it appears we received no signals from the ratings, 
which to my knowledge were unchanged until after the collapse. 
What does this say to you about the reliability of these 
ratings? Is this an example of a broader problem, in your mind?

A.2.a. Credit ratings issued by the NRSROs are intended to be 
an indicator of the credit risk associated with particular 
instruments or issuers. The extremely rapid deterioration of 
the financial position of Bear Stearns highlights the 
limitations of credit ratings and demonstrates the importance 
of considering the total mix of facts and circumstances in 
evaluating a firm, rather than relying on any single indicator 
of firm health.

Q.2.b. Shouldn't we be able to use the ratings as some sort of 
guide about the overall health and the risk of a firm's assets? 
Would you say that in the case of Bear, the ratings failed? 
Even if this was under extraordinary circumstances, shouldn't 
the ratings better reflect the actual risk at hand?

A.2.b. While the NRSROs would argue their definitions of credit 
risk reflected by their ratings accurately described the case 
of Bear Stearns even though it approached bankruptcy, you are 
right that users implicitly expect a correlation between 
ratings and performance. While the Credit Rating Agency Reform 
Act of 2006 prohibits the Commission from regulating the 
substance of credit ratings, our proposed new rules are 
intended to increase the accuracy of ratings through better 
disclosure, transparency, and competition. As noted previously, 
the events at Bear Stearns demonstrate the importance of 
considering the full range of information about a firm and 
broader market conditions in making judgments about the health 
of any firm.

Q.2.c. Is the SEC looking at the credit rating history for Bear 
Stearns, specifically the relationships between Bear Stearns 
and the rating agencies?

A.2.c. Yes, one of several areas covered by our examination of 
the three largest credit rating agencies is the relationship 
between issuers and the rating agencies. As a matter of 
enforcement policy, the Commission does not confirm or deny the 
existence of any ongoing enforcement investigation.

                            UPDATING RATINGS

Q.3.a. I'd like you to comment on a proposal by Professor 
Coffee for the rating agencies to periodically update ratings, 
as is done by securities analysts. Is this feasible? Do you 
think the SEC could require this within its existing authority?

A.3.a. The NRSROs generally have policies and procedures in 
place to monitor each rating and update it as necessary. The 
Commission has proposed new rules and rule amendments that 
would require greater disclosure about the NRSROs' procedures 
and methodologies for monitoring existing ratings including how 
frequently ratings are reviewed and whether different models 
are used in the initial rating and monitoring processes.

Q.3.b. Do you think the issue of ratings becoming ``stale'' is 
a concern? Could we argue that the ratings on Bear were in fact 
``stale''?

A.3.b. Yes, this is a concern. The Commission believes credit 
ratings should reflect current assessments of the credit 
worthiness of an obligor or debt security. As described above, 
our proposed new rules tackle this problem through new 
disclosure requirements. And although the Commission is 
statutorily prohibited from second guessing credit rating 
decisions made by the NRSROs, the Commission may evaluate 
whether an NRSRO followed its stated methodologies. We intend 
to do this through regular examinations.

Q.3.c. Will the proposed rules provide sufficient assurance to 
the markets that the ratings are current?

A.3.c. The proposed new rules that require greater disclosure 
about the NRSROs' procedures and methodologies for monitoring 
existing ratings such as how frequently ratings are reviewed 
and whether different models are used in the initial rating and 
monitoring processes are designed to provide the market with 
sufficient information on the surveillance processes of the 
NRSROs to allow for comparisons with respect to how frequently 
and actively they monitor and review existing ratings.

Q.3.d. Is the SEC looking at providing additional 
interpretation regarding what it means for a credit rating 
agency's ratings to be ``current assessments''? Is this an area 
the Commission should be looking at, in your opinion?

A.3.d. Yes. As part of the notice and comment process for our 
proposed new rules, we expect to receive useful information on 
this question. The Commission believes credit ratings should 
reflect current assessments of the credit worthiness of an 
obligor or debt security, and we will continue to explore ways 
to effectuate this principle. The Credit Rating Agency Act of 
2006 defines a ``credit rating'' as ``an assessment of the 
creditworthiness of an obligor as an entity or with respect to 
specific securities or money market instruments.'' Under this 
definition an ``assessment'' must reflect the NRSRO's current 
view of creditworthiness of the obligor or debt security.
                                ------                                


     RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM 
                        CHRISTOPHER COX

Q.1. Should Reg FD be amended to give all investors access to 
the same information that the rating agencies have so as to be 
able to judge for themselves whether the agency's opinions are 
valuable?

A.1. This is the purpose of the proposed new rules that would 
require the disclosure of information about the assets 
underlying the structured finance products that the NRSROs 
rate. This would allow market participants to better analyze 
the assets underlying structured securities, and reach their 
own conclusions about their creditworthiness. However, these 
new rules are not an amendment to Reg FD, which was designed to 
address the problem of issuers making selective disclosures of 
material nonpublic information to persons who were likely to 
use that information to their advantage in securities trading.

Q.2. Should Reg FD be amended to allow all NRSROs the same 
access to information if any NRSRO gets access to that 
information?

A.2. While not styled as an amendment to Reg FD, this is the 
purpose of the Commission's recently proposed new rules to 
require the disclosure of information about the assets 
underlying the structured finance products that the NRSROs 
rate. This data availability could particularly benefit 
subscriber-based NRSROs, who could use it to perform 
independent assessments of the validity of the ratings by their 
competitors who use the ``issuer pays'' model.

Q.3. If issuers pay the rating agencies for the ratings, how 
should investors be protected from rating shopping? Wouldn't it 
be better if the users of the ratings paid for them so that 
rating agencies that did a bad job and issued inflated ratings 
would be punished by the users in the form of lost market 
share? Doesn't the current structure reward the softest graders 
with increased business?

A.3. The issuer-pay and subscriber-pay models are subject to 
different types of potential conflicts. Consequently, I believe 
the users of credit ratings are served by having NRSROs that 
operate under both models as they serve as a check on the 
other. In addition, the Commission recently proposed new rules 
and rule amendments that would make it easier for NRSROs to 
provide unsolicited ratings for structured products. The goal 
is to create a mechanism to expose whether an NRSRO is 
employing less conservative methodologies than other NRSROs to 
determine ratings in order to increase market share.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM JOHN C. 
                          COFFEE, JR.

Q.1. If these reports are true, what duties would investment 
banks have violated under the securities laws?

A.1. In the case of an offering registered under the Securities 
Act of 1933, any investment banks that ignored warnings from 
their agents (i.e., the due diligence firms) would almost 
certainly face private liability under Sections 11 and 12 of 
the Securities Act of 1933 (plus, of course, liability in SEC 
enforcement actions based on Section 17 of that Act and Rule 
10b-5). The provisions of Section 11 entitle investors who 
purchased in the offering to sue for any material omission, 
unless the underwriter can establish its due diligence defense 
under Section 11(b)(3) that it ``had, after a reasonable 
investigation, reasonable ground to believe and did believe, at 
the time such part of the registration statement became 
effective, that the statements therein were true and that there 
was no omission to state a material fact required to be stated 
therein or necessary to make the statements therein not 
misleading.'' (Similar provisions are also found in Section 
12(a)(2) with only modest differences). I seriously doubt that 
either affirmative defense could be satisfied if the investment 
were on notice that a significant percentage of the loans in 
the structured finance product were outside usual lending 
guidelines and these facts were not clearly and specifically 
disclosed.
    In the case of offerings done by means of a private 
placement or other exemption from registration, the above 
sections will not apply, but the investment banks would still 
face liability under Rule 10b-5 if they made a materially false 
statement or omitted to make a statement necessary to be made 
in order to make the statement made, in light of the 
circumstances under which they were made, not misleading. 
Again, I think the investment banks who withheld material 
information will face a high risk of liability (but a variety 
of legal defenses are possible).

Q.2. Should credit rating agencies, as gatekeepers responsible 
for monitoring the quality of securities offered in our 
markets, conduct an independent assessment of asset-backed 
structured finance markets?

A.2. Ideally, yes, because this is what gatekeepers normally 
do. But logistically, it may be very difficult for the major 
ratings agencies to gear up to take such a step. Thus, a 
second-best alternative would be to require that ``NRSRO'' 
rating agencies not confer an ``investment grade'' rating on a 
structured finance product in the absence of receipt of a 
verification from an independent expert that the latter had 
conducted an investigation, using such sampling or similar 
procedures as the rating agency deemed reasonable for these 
purposes, and had reached specified conclusions about the 
quality of the collateral underlying the security. These 
specified conclusions might include that not more than a 
defined percentage of the loans were outside traditional 
lending criteria (i.e., such as that the borrower had an equity 
stake of at least [20] percent in the home).
    The point of this alternative is that the underwriters (and 
not the rating agency) could bear the cost of this ``due 
diligence'' investigation, but the rating agency would get an 
independent certification from an expert firm (which should 
have both civil and criminal liability for fraud for any 
knowing misstatements). Other techniques can also be imagined 
by which the rating agencies receive verification from parties 
other than the loan originators (and that is what is 
important--not that the rating agencies do it themselves).

Q.3. How often should ratings be reviewed and, if needed, 
updated by rating agencies?

A.3. All other gatekeepers on whom investors rely for 
evaluations--e.g., securities analysts and auditors--do 
regularly update their evaluators. With credit rating agencies, 
updates are the exception, not the rule. I would suggest two 
principles:
    First, debt ratings should be reviewed and updated at least 
annually. The rating agency could at this periodic moment re-
affirm, change or simply withdraw its rating. But such a 
withdrawal would be public and would alert investors not to 
continue to rely on a ``stale'' rating.
    Second, whenever the rating agency either (a) updates its 
model or methodology or (b) realizes that there has been an 
error in its model, it should promptly inform the market of the 
change that the new model (or the discovery of the error) would 
produce. Recent press reports have suggested that Moody's 
discovered a computer error in some ratings on European 
offerings that resulted in ratings that were three levels too 
high--and it did nothing! That is the kind of culpable omission 
that should be impermissible.

Q.4. If ratings were required to be updated more frequently, 
would it significantly increase the cost of ratings?

A.4. There would be an increase in the cost, which would be 
largely passed onto the issuer in all likelihood (given the 
weak level of competition in the ratings industry). But the 
costs of updating should not approach the cost of the original 
rating. In the typical case, the rating agency would already 
have developed its methodology and the issue would be largely 
whether any information input had changed (for example, had the 
default rate on mortgages in a particular location risen 
materially?). These will be relatively exceptional events. 
Where the agency changes its model, it should be able to 
generate all the implications for prior ratings in a single 
computer run (using the new methodology). Thus, while I 
acknowledge that there would be some cost increases, I do not 
believe they would approach the cost increases that Sarbanes-
Oxley imposed (justifiably) on the accounting profession.

Q.5. Would you please comment on Chairman Cox's testimony about 
the areas of rulemaking that the SEC is considering?

A.5. It is difficult to comment (and possibly unfair to do so) 
until proposed regulations are released. I did hear Chairman 
Cox testify that he favored rules restricting the currently 
pervasive conflicts of interest in this field, and that is 
desirable.
    Nonetheless, I do not yet believe that the SEC is 
considering rules to require increased verification of 
information in the rating process or to address the staleness 
problems. No ``solution'' can be adequate until these problems 
are addressed. Complex and sophisticated as any computer model 
may be, the first rule in this field is: ``GIGO: garbage in, 
garbage out.'' If loan originators are not subject to close 
scrutiny in terms of the data they provide, the process will 
inevitably produce distorted and optimistically biased 
conclusions.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM VICKIE A. 
                            TILLMAN

Q.1. Ratings Scoreboard. What are your views on the 
recommendation that has been made for the creation of a central 
website which investors could access and on which they could 
compare the accuracy of past ratings by the different NRSROs 
for the same types of securities?

A.1. We agree that rating agencies should work towards greater 
transparency and disclosure. At S&P, we are regularly 
considering new ways to do so. In our experience, the most 
effective way to measure ratings performance is through 
historical measures such as default and transition studies. 
These studies can demonstrate effectively the existence (or 
lack) of a correlation between ratings assigned by an NRSRO and 
the likelihood of default. At the same time, it is important to 
note the broad disparities in rating definitions, criteria and 
methodologies used by various rating agencies that help foster 
competition in the industry. Meaningful differences exist among 
rating agencies, not only in the way ratings are defined, but 
also in the way defaults and other relevant credit events are 
determined and measured, all of which can affect reported 
results. We would not object to having each rating agency make 
available--in a central repository--information about its 
performance history but would caution that such a repository 
must note these differentiations among rating agencies. 
Investors can then judge ratings performance and determine for 
themselves the value to them of a particular rating agency's 
opinions.

Q.2. Due Diligence. Did S&P undertake to verify the information 
it used to decide ratings on the structured finance products 
that were subsequently downgraded? In recent years, there has 
been widespread awareness, through the press and otherwise, 
about the proliferation of so-called ``liar loans''--mortgage 
loans with little or no documentation required and on which 
borrowers ultimately have stopped paying. Do you feel that 
NRSROs should have performed some investigation or due 
diligence on structured debt that contained these ``liar 
loans''?--Are there circumstances under which NRSROs should be 
required to perform some form of due diligence before issuing a 
rating?

A.2. The information concerning the collateral for the 
securitizations that we rate typically comes from the 
participants in the transaction being rated: the issuers and 
underwriters. S&P is very specific about the data it requires 
in its rating process. For example, with respect to U.S. 
Residential Mortgage-Backed Securities (``RMBS''), S&P 
publishes a detailed list of approximately 70 data points that 
it requires issuers to submit with respect to each loan in each 
pool that it is asked to rate. We also publish a detailed 
glossary of definitions that the issuer must utilize when 
providing data to S&P.
    S&P does not go on-site to review individual loan files 
held by originators and servicers, or perform an independent 
verification of the information provided to it in connection 
with its ratings analysis. As others at the hearing noted, we 
are not auditors and are generally not in the position to 
verify underlying data. The participants in the transactions we 
rate understand that S&P relies upon them for the accuracy of 
the data they provide. These participants issue representations 
and warranties in the operating documents for the transaction 
we are asked to rate with respect to the loan level data, 
regulatory compliance, and other issues and make disclosures 
about the collateral in the prospectus.
    However, in light of recent events, we determined that S&P 
can take steps on our own to improve disclosure of information 
on collateral underlying structured securities, and as I 
testified, S&P has announced and is implementing a 
comprehensive set of new measures designed to improve the 
ratings process. In addition, S&P has begun to implement 
procedures to collect more information about the processes used 
by issuers and originators to assess the accuracy and integrity 
of their data and their fraud detection measures so that we can 
better understand their data quality capabilities.

Q.3. Timeliness of Updates of Ratings. Professor Coffee in his 
testimony pointed out that major downgrades of CDO securities 
``came more than a year after the Comptroller of the Currency 
first publicly called attention to the deteriorating conditions 
in the subprime market and many months after the agencies 
themselves first noted problems in the markets.'' His testimony 
also states ``the gravest problem today may be the staleness of 
debt ratings.'' What is S&P doing to update ratings in a timely 
manner and eliminate stale ratings? What standards should 
NRSROs observe?

A.3. S&P continually strives to balance the twin goals of 
updating its ratings in a timely fashion while also adhering to 
its criteria and taking action when and only when it has the 
data to support a change in its rating opinion. In response to 
recent events, we have increased the frequency of our reviews 
of rated transactions. As part of our recently announced 
Actions (discussed at greater length in my testimony), we have 
undertaken several additional steps to improve the 
effectiveness and speed of our surveillance process. These 
include:

     increasing resources dedicated to surveillance;
      continuing to separate our new rating and rating 
surveillance functions;

     expanding our use of search and market based 
tools;

      incorporating new capabilities we have gained as 
part of our acquisition of iMake, a leading global provider of 
structured cash flow models and data; and
      developing an early warning indicator to 
investors that a key credit quality attribute (e.g., 
delinquencies or losses) of an issue or issuer differs from our 
expectations and has or may trigger a full review by S&P 
surveillance.

    We believe strongly that these steps will improve our 
surveillance process and help provide the market with timely 
and appropriate ratings updates.

Q.4. Separate Ratings from Business? Dr. Cifuentes' testimony 
contains a recommendation that a rating agency separate its 
rating business function from its rating analysis function. 
What are your views on how NRSROs should address this analyst 
independence concern?

A.4. S&P shares Dr. Cifuentes' belief in the importance of 
analyst independence and has long sought to protect the 
integrity of its ratings analysis and opinions through policies 
and procedures designed to promote that independence. For 
example, analysts are not involved in negotiating fees. Nor can 
S&P personnel who are responsible for negotiating fees vote in 
ratings committees. Additionally, we specifically structure our 
analysts' compensation so that it is not dependent on the 
revenue generated by the ratings they assign. Moreover, S&P's 
Analytic Firewalls Policy imposes numerous requirements and 
responsibilities on both ratings analysts and other employees 
of S&P and the McGraw-Hill Companies in order to ensure that 
ratings analysts ``have the freedom to express their respective 
opinions free from the improper influence of other Standard & 
Poor's/McGraw-Hill employees and free from the influence of the 
commercial relationships between Standard & Poor's/McGraw-Hill 
and third parties.''
    Additionally:

      ratings analysts are prohibited from 
participating in consulting or advisory services;

      ratings analysts are prohibited from cross-
selling of credit ratings or ancillary ratings products and 
services with any other S&P or McGraw-Hill product or service; 
and

      ratings employees are prohibited from joint 
selling or calling ratings customers with other S&P or McGraw-
Hill employees.

Q.5. Ratings Shopping. We have heard concerns about ``ratings 
shopping,'' where an underwriter or an issuer goes to the NRSRO 
that it feels will give it the highest rating, even if it is 
not necessarily the most accurate. Is ratings shopping a 
problem? How should the negative aspects of it be addressed?

A.5. We believe that ratings shopping is an issue to be 
considered by the markets as a whole. One suggested measure to 
address the concern is to require structured finance issuers to 
disclose whether they have approached rating agencies other 
than the ones providing a rating on the applicable transaction.

Q.6. Professional Analyst Organization. Dr. Cifuentes' 
testimony suggests ``the creation of a professional 
organization, independent of the rating agencies, to which 
ratings analysts must belong and which sets forth ethical, 
educational and professional standards.'' Please share your 
thoughts on the potential merits of such an organization.

A.6. At S&P, we believe that all rating agencies should have 
systematic procedures to help ensure that their analysts are 
able to identify, understand, and analyze information relevant 
to the issues and issuers they rate. In assessing the 
competence of analysts, S&P considers their level of education; 
experience within sectors, industries and geographic regions; 
experience with particular transactions and asset classes and 
other specialty areas; analytical ability; decision making; 
professionalism; time management ability; leadership; teamwork; 
and their written and verbal communication skills. S&P has 
adopted and continues to enhance policies and procedures 
designed to ensure that its analysts receive sufficient 
training and support to facilitate the generation of 
independent, objective and credible rating opinions. A major 
emphasis of the action plan that S&P announced in February is 
strengthening analyst training.
    However, given the importance of rating agency independence 
and the value of having a diversity of opinions in the market, 
we do not believe that Congress or the SEC should impose 
minimum standards for analyst training, background, experience, 
or other characteristics. Standards along these lines would 
replace independent judgments with those of the government. The 
result would be more homogeneity, and less innovation.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM VICKIE A. 
                            TILLMAN

Q.1. Ms. Robinson, Ms. Tillman, and Mr. Joynt, do you think 
that it is easy for investors to compare the accuracy of the 
ratings of the different credit rating agencies? If not, do 
S&P, Moody's, and Fitch favor the SEC issuing rules to require 
enhanced disclosure of ratings performance as Chairman Cox 
outlined in his testimony?

A.1. We have a long-standing tradition at Standard & Poor's 
(``S&P'') of publishing significant amounts of information 
about the default and transition history of our ratings. We 
believe the studies we publish assist issuers and investors in 
their evaluation of the quality of our rating opinions. And we 
are always open to considering new ways to inform the public 
about what we do and the excellent track record of S&P's 
ratings.
    We would support having each rating agency make available--
in a central repository--information about its performance 
history. Investors can then judge that performance and 
determine for themselves the value, to them, of a particular 
rating agency's views. I will note, however, that our rating 
opinions represent an analytic judgment based on a wide range 
of factors, many of which are assessments of future 
developments. Rating agencies employ different definitions of 
ratings and have different criteria. We believe that although 
this diversity of approaches is beneficial to the markets, it 
makes an ``apples to apples'' comparison of ratings difficult.

Q.2. Ms. Robinson, Ms. Tillman, and Mr. Joynt, would you please 
explain the process by which you obtain the information you use 
to rate structured finance securities?
    How much of the information is from issuers, underwriters, 
or other sources?
    Do you ever seek to verify the accuracy of the information 
you receive?

A.2. The information concerning the collateral for the 
securitizations that we rate typically comes from the 
participants in the transaction being rated: the issuers and 
underwriters. S&P is very specific about the data it requires 
in its rating process. For example, with respect to U.S. 
Residential Mortgage-Backed Securities (``RMBS''), S&P 
publishes a detailed list of approximately 70 data points that 
it requires issuers to submit with respect to each loan in each 
pool that it is asked to rate. We also publish a detailed 
glossary of definitions that the issuer must utilize when 
providing data to S&P.
    We at S&P are not auditors and are generally not in the 
position to verify underlying data. Currently, the participants 
in the transactions we rate understand that S&P relies upon 
them for the accuracy of the data they provide. These 
participants issue representations and warranties in the 
operating documents for the transaction with respect to the 
loan level data, regulatory compliance, and other issues and 
make disclosures about the collateral in the prospectus.
    As I testified, S&P has announced and is implementing a 
comprehensive set of new measures designed to further 
strengthen the ratings process, including steps to improve the 
quality and integrity of information we collect. We are working 
with market participants to improve disclosure of information 
on collateral underlying structured securities. Specifically:
    On transactions closing after May 1, 2008, we are 
requesting updated loan level performance data from issuers on 
a monthly basis, consistent with data customarily sent to 
Trustees and third party data vendors in the U.S. RMBS market.
    We are in the process of revamping criteria for assigning 
overall mortgage originator rankings based on operational 
process and procedures. New criteria should be established by 
mid-2008.
    We are evaluating various fraud tools and detection 
policies used by originators for improved data integrity and 
will be incorporating these evaluations in the criteria to be 
established by mid-2008.

Q.3. Do you have any reason to believe that inaccurate or 
fraudulent data contributed to the poor performance of your 
ratings on structured finance securities over the last few 
years? If yes, please provide supporting evidence.

A.3. Published reports indicate that data quality and fraud are 
among the factors that may have impacted loan performance for 
the vintages that have seen worse-than-expected performance, as 
well as a host of other potential factors. Certain published 
reports also suggest a significant increase in fraud with 
respect to recent vintages. For example, the Mortgage Asset 
Research Institute, commissioned by the Mortgage Bankers 
Association to conduct a mortgage fraud study in 2006, reported 
``findings of fraud were in excess of previous industry 
highs.'' It noted that key risk variables that have 
historically influenced default patterns, such as FICO, LTV and 
ownership status were proving less predictive.
    Ms. Robinson, Ms. Tillman, and Mr. Joynt, according to 
testimony provided by Chairman Cox, Moody's has downgraded 53 
percent and 39 percent of all its 2006 and 2007 subprime 
tranches; S&P has downgraded 44 percent of the subprime 
tranches it rated between the first quarter of 2005 and the 
third quarter of 2007; and Fitch has downgraded approximately 
34% of the subprime tranches it rated in 2006 and the first 
quarter of 2007.

Q.4. What steps have each of your companies taken during the 
past three years to hold accountable its executives and 
analysts for the poor performance of its ratings? Has your 
company dismissed or otherwise disciplined any of the 
executives or analysts responsible for overseeing or producing 
its ratings of structured finance products? Please provide a 
complete list of disciplinary actions.

A.4. Ratings transitions, even significant transitions, do not 
reflect errors in our initial analysis as they could be caused 
by a multitude of unforeseen factors such as the unprecedented 
market conditions we are currently experiencing. Moreover, the 
downgrades of our 2006 and 2007 subprime tranches do highlight 
the success of our surveillance procedures in place at S&P as 
we adapt to turbulent market conditions.
    Additionally, S&P considers personnel actions to be 
confidential and does not--as a rule--discuss publicly reasons 
for promotions/demotions/dismissals.
    We have been listening to and learning from the concerns 
and criticisms raised about our industry. We take very 
seriously our responsibility to implement whatever measures we 
can to improve the way we do business consistent with our role 
in the financial markets. As a result of our ongoing commitment 
to improve our rating process, we recently announced that we 
are adopting wide-ranging set of new measures to increase 
responsiveness and accountability at S&P from top to bottom.
    Among these numerous initiatives, we are increasing the 
annual training requirements for our analysts, expanding the 
scope and the course offerings of our training programs, 
including increasing our focus on policy requirements and 
compliance, and are establishing an analyst certification 
program in partnership with an academic institution. We also 
recently created and filled two new executive positions in the 
areas of risk oversight, criteria management and quality 
assurance. These changes add strength and depth to our ratings 
leadership and capabilities, and demonstrate S&P's commitment 
to serving the broad and growing needs of the global credit 
markets. Among other things, we named a new Executive Managing 
Director of Ratings Risk Management, who will be responsible 
for identifying, assessing and mitigating potential internal 
and external risk exposures in our ratings business. Also we 
split Quality and Criteria governance responsibilities into two 
separate functions to further strengthen their respective 
independence and effectiveness.
    Consistent with these Actions and with our ongoing efforts 
to do what is best both for our company and the financial 
markets we serve, we will continue to evaluate the performance 
of all of our employees and take action where we believe it to 
be appropriate.

Q.5.a. Ms. Robinson, Ms. Tillman, and Mr. Joynt, during the 
last 3 years, did your firm notice a decline in underwriting 
standards for mortgages being used to create residential 
mortgage-backed securities? If so, did you alter your ratings 
process in anyway to account for this decline in underwriting 
standards? Did you disclose to investors that there was a 
decline in underwriting standards?

A.5.a. S&P repeatedly and publicly voiced concerns about the 
subprime market and the deteriorating credit quality of RMBS 
transactions as far back as April 2005. These warnings included 
discussion of the various ``affordability'' mortgage products 
employed in the subprime market and the risks they entailed, 
including the risk of loosening underwriting standards. For 
example:
    In an April 4, 2005 article entitled S&P Comments On Risk 
In Newer Mortgage Products, As Discussed At Industry Event, we 
noted that ``there is growing concern around the increased 
usage of [interest-only, negative amortization, and 40-year 
amortization] mortgages in new RMBS securitization, which may 
pose significant credit risk. . . . [S]ome of the inherent 
risks that may arise include payment shock due to interest rate 
increases, coupled with the addition of principal repayment, 
undercollaterlization with regard to negative amortization, and 
home price depreciation.''
    In an April 20, 2005 article entitled Subprime Lenders: 
Basking in the Glow of a Still-Benign Economy, But Clouds 
Forming on the Horizon, we stated that we ``remain concerned 
about how these subprime lenders will perform in a prolonged 
rising interest rate environment.'' We observed that increased 
competition among subprime lenders threatened a relaxation in 
underwriting standards and warned that the growing popularity 
of ``affordability'' mortgage products ``suggests that Standard 
& Poor's concerns are justified.'' We singled out interest-only 
mortgages as ``[e]specially worrisome,'' noting that ``these 
loans are more likely to feature adjustable rates . . . setting 
borrowers up for potential problems should mortgage rates rise 
dramatically.''
    On July 10, 2006, in an article entitled Sector Report 
Card: The Heat Is On For Subprime Mortgages, we noted that 
downgrades of subprime RMBS ratings were outpacing upgrades due 
to ``collateral and transaction performance.'' The article also 
identified ``mortgage delinquencies'' as a ``potential hot 
button,'' and noted that such delinquencies ``may become a 
greater concern for lenders and servicers.''
    On February 14, 2007, we took the unprecedented step of 
placing on CreditWatch negative (and ultimately downgrading) 
transactions that had closed as recently as 2006. As we 
informed the market in the accompanying release: ``Many of the 
2006 transactions may be showing weakness because of 
origination issues, such as aggressive residential mortgage 
loan underwriting, first-time home-buyer programs, piggyback 
second-lien mortgages, speculative borrowing for investor 
properties, and the concentration of affordability loans.'' In 
a February 16, 2007 Los Angeles Times article, S&P's 
announcement was described as `` `a watershed event' because it 
means S&P is now actively considering downgrading bonds within 
their first year.'' See S&P to Speed Mortgage Warnings, Los 
Angeles Times, Feb. 16, 2007.
    In a February 28, 2007 article entitled RMBS Trends: U.S. 
Subprime Market Continues Correction As Issuers Strengthen 
Underwriting Standards, we observed that: ``Recent-vintage 
loans continue to pay the price for loosened underwriting 
standards and risk-layering in a declining home price 
appreciation market, as shown by early payment defaults and 
rising delinquencies. Lenders have reported tightened 
underwriting standards during the industry consolidation, with 
weaker players exiting the origination business or being 
acquired by larger entities, most prominently investment banks. 
Although evidence of improved underwriting standards has been 
represented in loan documentation data, other measures such as 
LTV have not fully supported the reports. However, as there is 
a lag between loan origination and securitization, we may begin 
to see more evidence in the coming quarters.''
    In an April 27, 2007 article entitled Special Report: 
Subprime Lending: Measuring the Impact, we stated: ``The 
consequences of the U.S. housing market's excesses, a topic of 
speculation for the past couple of years, finally have begun to 
surface. . . . Recent-vintage loans continue to pay the price 
for loosened underwriting standards and risk-layering in a 
declining home price appreciation market, as shown by early 
payment defaults and rising delinquencies.''
    In a July 25, 2007 teleconference, we observed that the 
``poor performance'' in U.S. RMBS ``results from a combination 
of factors including but not limited to an environment of loose 
underwriting standards, pressure on home prices, speculative 
borrowing behavior, risk layering, very high combined loan to 
value, financial pressure on borrowers resulting from payment 
increases on first-lien mortgages and questionable data 
quality.''

Q.5.b. Did you alter your ratings processes in any way to 
account for this decline in underwriting standards?

A.5.b. In response to deterioration in the sub prime mortgage 
market, which was attributable to a number of factors, we 
tightened our criteria through changes in our 
LEVELS' model targeted to increase the credit 
enhancement requirements for pools with subprime loans. As 
noted above, in February 2007, we also took the unprecedented 
step of placing on CreditWatch negative (and ultimately 
downgrading) transactions that had closed as recently as 2006. 
We continued taking downward action through as recently as this 
week. We increased the severity of the surveillance assumptions 
we use to evaluate the ongoing creditworthiness for RMBS 
transactions issued during the fourth quarter of 2005 through 
the fourth quarter of 2006 and downgraded those classes that 
did not pass our heightened stress test scenario within given 
time frames. In addition, we modified our approach for ratings 
on senior classes in transactions in which subordinate classes 
have been downgraded. We also announced that, with respect to 
transactions closing after July 10, 2007, we would implement 
changes that would result in greater levels of credit 
protection (collateral) for rated transactions and would 
increase our review of lenders' fraud-detection capabilities.
    No one can see the future. The point of these articles and 
actions, however, is to highlight our reaction to increasing 
subprime deterioration--looking, as we always do, to historical 
or paradigm-shifting behaviors to help analyze long-term 
performance. Consistent with our commitment to transparency we 
repeatedly informed the market of our view that the credit 
quality of subprime loans was deteriorating and putting 
negative pressure on RMBS backed by those loans. And, 
consistent with our commitment to analytical rigor, we revised 
our models, took action when we believed action was 
appropriate, and continue to look for ways to make our 
analytics as strong as they can be.

Q.6. Ms. Robinson, Ms. Tillman, and Mr. Joynt, when each of 
your companies tries to attract new customers, how do you 
distinguish your ratings from the ratings of other rating 
agencies?
    Do you have empirical data that demonstrates that your 
ratings are better than the ratings of other companies? If yes, 
please provide documentation supporting your answer.
    Do you compete more on price or ratings accuracy? Please 
provide documentation supporting your answer.

A.6. S&P began its credit rating activities 90 years ago, and 
today is a global leader in the field of credit ratings and 
credit risk analysis. We vigorously protect our reputation and 
we believe--recent criticism notwithstanding--that our 
excellent historical track record of providing the market with 
independent and rigorous rating opinions and information is 
widely recognized in the market. Investors attach value to our 
ratings because of this track record, and this is and of itself 
diminishes any leverage that underwriters may be perceived to 
have over the process. It is also this track record, along with 
our commitment to innovation and improvement, that we sometimes 
discuss with potential new customers. We believe, as well, that 
S&P's proven role as a market leader will continue to 
distinguish us from our competitors even as the credit rating 
industry expands.

Q.7. Ms. Robinson, Ms. Tillman, and Mr. Joynt, what are the 
idealized default rates for each of your ratings?

A.7. There are no idealized default rates for our ratings, 
since ratings are not mapped to particular expected default 
rates. Instead, we arrive at our rating opinions by applying 
our published assumptions, methodologies and criteria to the 
best available information in our possession.
    Over the last 30 years (through May 16, 2008), S&P's 
cumulative default rate by original rating class for all 
structured finance ratings has been as follows:

------------------------------------------------------------------------
                Initial rating                     Percent of default
------------------------------------------------------------------------
AAA...........................................                     0.14
AA............................................                     0.60
A.............................................                     1.46
BBB...........................................                     3.53
BB............................................                     5.21
B.............................................                     4.78
------------------------------------------------------------------------

Q.8. Ms. Robinson, Ms. Tillman, and Mr. Joynt, in his written 
testimony, Professor Coffee notes that because only a limited 
number of investment banks underwrite structured finance 
products, they have leverage over the rating agencies. If they 
don't like the ratings they get from one agency, they can go to 
another with lower standards.
    Has your firm ever felt pressure to lower your rating 
standards in order to attract business?
    How do you attract customers if your ratings use the most 
stringent standards? Will issuers and underwriters simply go to 
other firms with less demanding standards?

A.8. At S&P, we do not permit issuers to dictate any aspect of 
our analytical process. Our analytics are driven by our 
criteria, and we do not compromise that criteria to meet a 
particular issuer's needs or agenda. We have refused to rate 
whole categories of transactions that do not meet our criteria 
and we believe that we have lost numerous RMBS deals for this 
reason.
    As noted, we believe our reputation and integrity are our 
most valuable long-term assets. It would be contrary to our 
best interests to sacrifice these qualities by providing 
anything other than what we believe to be our best opinion of 
creditworthiness. In some instances, this may mean that an 
issuer will take its business elsewhere, but that is a risk we 
are willing to take in order to preserve the far more valuable 
asset that is our reputation for independence.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM VICKIE 
                           A. TILLMAN

Q.1. During the hearing, I asked you for specifics on the 
ratings your agency provided on Bear Stearns in the months 
leading up to the collapse. Please provide the Committee with a 
detailed explanation of the ratings for Bear Stearns from 
November 2007 and March 2008. In addition, please answer the 
following questions.

A.1. On November 15, 2007, S&P downgraded the Bear Stearns 
Companies' (``Bear'') long-term counterparty credit rating from 
``A+'' to ``A'' and affirmed the short-term rating of ``A-1''.
    This action followed our decision on August 3, 2007 to 
revise our outlook on Bear from stable to negative based in 
part on the reputational harm suffered by Bear in the wake of 
problems with its managed hedge funds, as well as its material 
exposure to holdings of mortgages and MBS, the valuations of 
which, we said, remained under ``severe pressure.'' We further 
noted on August 3 that Bear had exposure to debt it had taken 
up as a result of unsuccessful leveraged finance underwritings 
and had significant further underwriting commitments. We 
observed that Bear had a relatively high degree of reliance on 
the U.S. mortgage and leveraged finance sectors, and its 
revenues and profitability would be especially affected if 
there were an extended downturn in those markets. We continued 
this negative outlook in our November 15 rating action.
    The November 15 rating action followed Bear's announcement 
that it would take a fourth-quarter writedown on its CDO and 
subprime exposure of $1.2 billion. We considered the writedown 
to be comparatively less than that of its peers, particularly 
given Bear's substantial business concentration in the U.S. 
mortgage market. We noted that the potential for further 
writedowns remained given continued dislocation in the mortgage 
market but considered the company's remaining CDO and subprime 
exposure to be manageable. Nevertheless, we warned that 
additional writedowns could further impair the company's future 
earnings performance, particularly in light of Bear's 
relatively greater revenue reliance on fixed income markets, 
which were experiencing a general slowdown.
    The negative outlook on the ratings reflected our 
continuing concern that the general slowdown in Bear's core 
fixed income businesses could have a negative impact on its 
earnings performance in the near to medium term. We also 
remained concerned that long-term lingering effects (including 
litigation) of the widely publicized problems in the company's 
managed hedge funds would have a negative impact on performance 
in the company's asset management unit. We noted that the 
ratings could be lowered if earnings failed to stabilize at a 
satisfactory level beyond the next few quarters, which we 
expected to be difficult ones for the firm. We observed that in 
contrast, if Bear were able to overcome current challenges and 
affect a more rapid earnings recovery than we currently 
anticipated, the outlook could be revised to stable.
    On March 14, 2008, S&P downgraded Bear's long-term 
counterparty credit rating from ``A'' with negative outlook to 
``BBB'' and its short-term rating from ``A-1'' to ``A-3''. At 
the same time, we placed the long- and short-term ratings on 
CreditWatch with negative implications.
    This rating action followed Bear's announcement that its 
liquidity position had substantially deteriorated in the two 
days prior to the rating action. The severe impairment of 
Bear's liquidity had resulted in the negotiation of a 28-day, 
Fed-backed secured loan facility with JP Morgan Chase 
(``JPMC'') that was designed to ease Bear's liquidity pressures 
until it could implement a longer term funding structure.
    We noted that Bear had been experiencing significant stress 
during the week of March 10 because of concerns regarding its 
liquidity position. Although the firm's liquidity at the 
beginning of the week had held steady with excess cash of $18 
billion, ongoing pressure and anxiety in the markets resulted 
in significant cash outflows toward the week's end, leaving 
Bear with a significantly deteriorated liquidity position at 
end of business on Thursday, March 13, 2008.
    We observed that our ratings were based on our expectation 
that Bear would find an orderly solution to its funding 
problems. We noted, however, that although we viewed the 
liquidity support to Bear as positive, we considered it a 
short-term solution to a longer term issue that did not 
remediate Bear's confidence crisis. We also remained concerned 
about Bear's ability to generate sustainable revenues in an 
ongoing volatile market environment.
    Finally, we stated that we expected to resolve the 
CreditWatch in the coming weeks, as more concrete, longer term 
solutions to Bear's liquidity and confidence crisis were 
fleshed out. We warned that the ratings could be lowered 
further if there were a failure to stabilize liquidity or to 
achieve a satisfactory longer term funding structure.
    On March 17, 2008, we placed our ``BBB'' long- and ``A-3'' 
short-term counterparty credit ratings on Bear on CreditWatch 
with developing implications.
    This rating action followed the announcement that JPMC had 
agreed to acquire Bear in an all-stock transaction.
    We noted that we considered the acquisition of Bear by JPMC 
as positive, as it would permit Bear to meet its obligations 
through funding sources obtained directly from its new parent. 
We observed that we expected that JPMC would assume all of 
Bear's obligations when the transaction closed. We stated that 
we would resolve the CreditWatch placement when details about 
the integration of Bear's activities became tangible.
    We warned that if the acquisition by JMPC were not to close 
as expected, the ratings on Bear would come under renewed 
pressure. Conversely, if the acquisition was to proceed as 
expected and Bear's businesses were successfully integrated 
into JPMC, the ratings on Bear could be equalized with those on 
its new parent.
    On March 24, 2008, we raised the counterparty credit 
ratings on Bear to ``AA-/A-1+'' and removed them from 
CreditWatch Developing where they had been placed on March 17. 
We determined that the outlook for the ratings was stable.
    This rating action recognized the strengthened immediate 
guarantee by JPMC of all of Bear's counterparty obligations. We 
noted that JPMC was also to assume Bear's debt obligations upon 
completion of the acquisition.
    We observed that in our view, the price increase for the 
transaction and the anticipated increase in the amount of 
shares controlled by JPMC raised the probability that the deal 
would be completed. We warned that on its own, Bear's viability 
was uncertain, and that if the deal were to be amended in any 
way, we would review the circumstances at that time.
    We stated that we expected the acquisition by JPMC to be 
completed under the revised terms by mid-May. In light of the 
guaranty and our expectation that Bear's debt would be assumed 
by JPMC, we believed that Bear's creditors benefited from 
JPMC's creditworthiness and participated in the outlook for 
JPMC. Therefore we equalized the ratings and outlook with those 
on JPMC.
    Our press releases for each of these ratings actions are 
attached.

Q.2. Were any of the ratings downgraded between December 2007 
and March 14, 2008?

A.2. As noted, on November 15, 2007, S&P downgraded Bear's 
long-term counterparty credit rating from ``A+'' to ``A,'' 
which followed our decision in August 2007 to change our 
outlook on Bear from stable to negative.
    On March 14, 2008, S&P downgraded Bear's long-term 
counterparty credit rating from ``A'' with negative outlook to 
``BBB'' and its short-term rating from ``A-1'' to ``A-3.'' At 
the same time, we placed the long- and short-term ratings on 
CreditWatch with negative implications.

Q.3. Were any of the ratings downgraded during the week of the 
collapse (March 10-14)?

A.3. As noted, on March 14, 2008, S&P downgraded Bear's long-
term counterparty credit rating from ``A'' with negative 
outlook to ``BBB'' and its short-term rating from ``A-1'' to 
``A-3.'' We also placed Bear's long- and short-term ratings on 
CreditWatch with negative implications.

Q.4. Can you explain from your agency's point of view how 
Bear's collapse unfolded and the role the ratings may have 
played?

A.4. While we are continuing to review the factors that led to 
the sudden and severe weakening of Bear's liquidity situation, 
a number of factors are clear at this time. As noted in our 
published reports, Bear faced (i) material exposure to CDOs and 
subprime investments, as well as the general slowdown in its 
fixed income businesses; (ii) significant dislocation in the 
mortgage market; and (iii) severe, ongoing reputational harm 
that eventually led to a crisis in confidence. The damage to 
Bear was hastened, in our view, by its inability to effect a 
rapid earnings recovery in the face of these challenges.
    As noted, Bear's situation deteriorated rapidly in March 
2008 when it announced that its liquidity position had 
substantially and rapidly deteriorated over a two-day period, 
which resulted in part from significant cash outflows, as well 
as ongoing pressure and anxiety in the markets. It was also 
reported that some hedge funds suddenly withdrew billions of 
dollars in assets from Bear, which was unexpected and would 
have contributed to the bank's rapid decline. The sudden loss 
in confidence in Bear was critical in our view, and was widely 
unexpected. It became clear that Bear required a long term 
solution to its liquidity problems, which eventually arose in 
the form of JPMC's announced acquisition.
    We do not believe that S&P's ratings had a role in causing 
these events to occur. Rather, consistent with our long-
standing reputation for independence and objectivity, our 
ratings simply reflected our current opinion of the 
creditworthiness of Bear based on the best facts available to 
us at the time.

Q.5. Do you think the lack of changes to the Bear Stearns' 
ratings is an example of a unique event in the markets or an 
indication of larger flaws in the structure of the ratings?

A.5. We believe the speed with which Bear deteriorated was a 
unique event in the market and broadly unanticipated.

Q.6. Under ideal circumstances, would you agree that the 
ratings should have been downgraded to more accurately reflect 
Bear's risk?

A.6. As with all of our ratings, we downgraded Bear's rating 
when we concluded that the data available supported such a 
move. It is always easy in hindsight to look back and question 
whether certain ratings should have or could have been 
different if we knew then what we know now. That, however, is 
different than the reality of our work, which is to take the 
information available to us at the time and try as best we can 
to project what is likely to happen in the future. That is what 
we did with our ratings on Bear.

Q.7. What lessons do you think we should take from the Bear 
Stearns collapse as it relates to the credit ratings?

A.7. As noted, our rating on Bear was based on the best 
information available to us at the time, including statements 
by management and regulatory filings. We had concerns about 
Bear's exposure to CDOs and subprime investments, as well as 
the consequences of continued harm to its reputation, among 
other things, and made those concerns public. Of course, we are 
always looking for ways to refine our analytical processes and, 
in this case, are continuing to assess the factors that led to 
Bear's rapid decline.

Q.8. What are your thoughts on a proposal Professor Coffee 
discussed at the hearing for rating agencies to periodically 
update ratings?

A.8. At S&P we believe that timely monitoring of our rating 
opinions is a key component of the value we bring to investors 
and the market. We are constantly looking for ways to enhance 
our surveillance process and have made improvements--including 
increasing the frequency of our reviews of rated transactions 
and the amount of resources dedicated to the process--response 
to recent events.
    While we believe that credit ratings should be ``current'' 
assessments of creditworthiness, we do not believe a mandated 
fixed schedule of periodic reviews in the manner that Professor 
Coffee suggests would improve the surveillance process. Ratings 
are subjective in nature and are typically formulated and 
disseminated after deliberation of whatever duration is 
appropriate to assess the particular issue or issuer being 
considered. The necessary frequency and scope of any ratings 
review may vary considerably based on issue and issuer-specific 
factors as well as the original method of analysis. Any rule 
attempting to impose a specific, fixed period during which 
ratings must be updated would divert attention away from 
surveillance based on risk identification and assessment, and 
would by its nature be arbitrary, burdensome and, we believe, 
ineffective.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

  RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM CLAIRE 
                            ROBINSON

Q.1. Ratings Scoreboard. What are your views on the 
recommendation that has been made for the creation of a central 
website which investors could access and on which they could 
compare the accuracy of past ratings by the different NRSROs 
for the same types of securities?

A.1. Moody's would support the establishment of a centralized 
repository, such as an industry portal, for rating performance 
studies. Indeed, we believe such a repository could enhance the 
ability of users of credit ratings to compare and contrast 
rating agency performance in a more efficient manner. We also 
would support a centralized repository that lists the ratings 
of each NRSRO for a particular security, so long as such 
requirements do not intrude on our rating methodologies or the 
content of our ratings.

Q.2. Timeliness of Updates of Ratings. Professor Coffee in his 
testimony pointed out that major downgrades of CDO securities 
``came more than a year after the Comptroller of the Currency 
first publicly called attention to the deteriorating conditions 
in the subprime market and many months after the agencies 
themselves first noted problems in the markets.'' His testimony 
also states ``the gravest problem today may be the staleness of 
debt ratings.'' What is Moody's doing to update ratings in a 
timely manner and eliminate stale ratings? What standards 
should NRSROs observe?

A.2. Our initial ratings on these securities reflected our 
expectation of the asset performance in the pools. As always, 
we monitored our published ratings and took rating actions 
accordingly and when warranted by performance data and when our 
expectation of future performance changed due to changes in 
market conditions.
    Professor Coffee's comments seem to suggest that rating 
actions on a security should be taken as soon as any 
significant changes in market conditions are observed. Based on 
our ongoing conversations with investors, issuers and 
regulators, many market participants have a strong preference 
for credit ratings that are not only accurate but stable. They 
want ratings to reflect enduring changes in credit risk because 
rating changes have real consequences--due primarily to 
ratings-based portfolio governance rules and rating triggers--
that are costly to reverse. Market participants, moreover, do 
not want ratings that simply track market-based measures of 
credit risk. Rather, ratings should reflect independent 
analytical judgments that provide counterpoint to often 
volatile market-based assessments.
    However, we do believe that there are additional steps that 
can be taken to enhance the quality and efficiency of our 
surveillance activities. For example:

      Further enhancing our surveillance function: We 
are continuing to expand the resources allocated to wholly 
separate monitoring teams within our Structured Finance Group. 
This initiative began before the RMBS and CDO downgrades. More 
recently, as part of our commitment to enhancing surveillance, 
Moody's created and filled the position of Global Structured 
Finance Surveillance Coordinator. The executive in this role is 
working with the surveillance managers and departmental heads 
throughout our global Structured Finance Department to enhance 
our surveillance processes and make them more efficient.

      Enhancing the automated review of data: Moody's 
has also been implementing a number of automated processes and 
systems, including proprietary applications, to routinely sift 
through entire databases of transactions, updating performance 
statistics and flagging rating outliers. The rollout of these 
initiatives began before the RMBS and CDO downgrades.

      Enhancing market communication: Moody's has 
allocated more resources to the function of communicating our 
monitoring activities to the market.

      Enhancing review of internal process and market 
trends: As part of the CRA industry initiative, Moody's has 
committed to evaluating our internal processes and market 
trends regularly so that we maintain the operational 
flexibility to enable us to dedicate the resources needed to 
monitor existing ratings and conduct reviews on a timely basis.

    Q.3. Separate Ratings from Business? Dr. Cifuentes' 
testimony contains a recommendation that a rating agency 
separate its rating business function from its rating analysis 
function. What are your views on how NRSROs should address this 
analyst independence concern?

    A.3. Moody's would not object to a clearer distinction 
between the business arm of a credit rating agency and the 
analytical work that it conducts. For our part, Moody's Code 
sets forth our policies that govern the roles and 
responsibilities of our rating agency employees, with the 
primary goal of ensuring that our analytical activities remain 
appropriately distanced from the commercial management of our 
business. In particular, the following provisions are relevant:

    2.11  Reporting lines for Employees and their compensation 
arrangements will be organized to eliminate or effectively 
manage actual or potential conflicts of interest. Analysts will 
not be compensated or evaluated on the basis of the amount of 
revenue that [Moody's] derives from Issuers that the Analyst 
rates or with which the Analyst regularly interacts.

    2.12  [Moody's] will not have analysts who are directly 
involved in the rating process initiate, or participate in, 
discussions regarding fees or payments with any entity they 
rate.

    Implementation of these and other standards in the Moody's 
Code is subject to oversight by our internal Compliance 
Department as well as external examination by authorities such 
as the SEC.
    Furthermore, while we believe that we operate with a high 
degree of independence and clarity around analytical 
remuneration, greater clarity regarding our policies and 
practices to protect analysts' independence may be beneficial 
for the market. We recently have implemented, or are in the 
process of implementing, several other measures to further 
demonstrate the independence of our rating process. These 
include:

      Formalizing the separation of ratings-related 
businesses: Moody's recently reorganized its operating 
businesses to formalize the separation of our ratings-related 
and non-rating activities into two different business units.

      Enhancing the Credit Policy function: The Credit 
Policy function at Moody's has long been independent from those 
parts of the rating agency with revenue-generating 
responsibility, and we have taken steps to further separate 
this function. The Chairman of Credit Policy now has a 
reporting responsibility to the President of Moody's. The 
performance incentives for Credit Policy personnel are based 
exclusively on the effectiveness of the rating process and the 
analytical quality of their oversight. The measurement of the 
unit's performance is wholly independent of the financial 
performance of the company or any business unit.

      Codifying the existing policies about analyst 
communication with issuers: In order to enhance market 
confidence in the appropriateness of communications between 
Moody's analysts and issuers or advisors, we are codifying our 
existing practice that such communications are limited to 
communications about credit issues.

      Implementing ``look-back'' reviews to confirm 
integrity of analysis: Moody's has adopted a new policy related 
to employees who leave Moody's to work for another market 
participant. When we learn that an issuer or a financial 
intermediary representing the issuer has hired a Moody's 
employee who has served as lead analyst for that issuer, we 
will now review the analyst's work related to the issuer and 
its securities over a six-month ``look-back'' period to confirm 
the integrity and rigor of that analyst's work.

    Also, as part of the CRA industry initiative, we have 
committed to conduct formal and periodic, internal reviews of 
compensation policies and practices for analysts and other 
employees who participate in rating committees to ensure that 
these policies do not compromise the rating process.

Q.4. 4. Ratings Shopping. We have heard concerns about 
``ratings shopping,'' where an underwriter or an issuer goes to 
the NRSRO that it feels will give it the highest rating, even 
if it is not necessarily the most accurate. Is ratings shopping 
a problem? How should the negative aspects of it be addressed?

A.4. Ratings shopping occurs in the structured finance market 
because there is relatively little information available 
publicly about the transactions prior to their issuance. 
Arguably, market disciplinary forces and transparency around 
NRSRO methodologies already operate to some extent to address 
the negative aspects of rating shopping. For example, because 
rating methodologies are published, market participants can 
compare various CRA's different approaches to the same sectors 
or asset classes. A potential user of an NRSRO's credit ratings 
can decide for itself whether or not the NRSRO's methodology is 
more or less stringent than another NRSRO's methodologies and 
take this into account in deciding whether to attach any weight 
to the NRSRO's ratings. On the other hand, this same 
transparency allows issuers to assess the conservatism of a 
particular NRSRO and ratings shop at the outset of the rating 
process.
    We believe that the appropriate way to deal with the 
negative aspects of ratings shopping in the structured finance 
market is to have issuers publicly disclose in a comprehensive 
and standardized manner:

      the characteristics of each asset in the asset 
pool;

      the structure of the transaction and performance 
data for each asset in the asset pool;

      the validation process used to verify the quality 
of the information provided and all pertinent representations 
and warranties; and

      Servicer and Trustee reports prepared after the 
issuance of the transaction.

    Presently, because of the generally limited data in the 
public market about structured securities prior to their 
issuance, neither investors nor CRAs that have not had 
sufficient contact with the issuer are able to formulate an 
informed opinion on the securities. However, if robust 
information about structured finance products were publicly 
available once the details of the transaction had been 
finalized,\10\ both the investors and credit rating agencies 
could form higher quality opinions, regardless of whether or 
not an issuer has directly contacted them. As a result, in many 
circumstances market participants would have the benefit of 
multiple and potentially diverse opinions about the same 
transaction. Finally, and most importantly, having the 
underlying data published by the issuers or originators would 
allow investors to form their own opinions about the strengths 
and weaknesses of a particular transaction, which could support 
authorities' efforts to discourage the use of ratings for 
purposes other than an objective opinion about relative credit 
risk.
---------------------------------------------------------------------------
    \10\ Given their complex and mutable nature, structured finance 
products may not lend themselves to unsolicited ratings before that 
time.
---------------------------------------------------------------------------
    Some policymakers and market commentators have suggested 
that ratings shopping can be addressed by requiring CRAs to 
disclose the names of issuers who provide data to a credit 
rating agency and ask for a preliminary assessment but then 
choose to publish the rating of another credit rating agency. 
We believe that such a solution would be unworkable and likely 
would fail to resolve concerns about the practice because:

      The CRA would not necessarily know if the issuer 
contracted with another CRA for a final rating of the same 
structure.

    Even if the CRA tried to monitor the conduct of an issuer, 
the CRA could not know with certainty that it had identified 
all cases requiring disclosure under such a provision because 
it might not have access to all relevant information. Moody's 
believes it is inappropriate to impose a disclosure obligation 
on an entity that cannot, as a practical matter, control the 
means by which it acquires information that triggers that 
obligation.
      Ratings shopping would simply occur at an earlier 
point in time.

    Moody's believes that requiring credit rating agencies to 
disclose cases of ratings shopping might change the nature of 
the practice but would not eliminate it. Some originators, 
underwriters and sponsors of structured securities who wished 
to avoid being identified by CRAs as ratings shoppers likely 
would get around the disclosure trigger by withdrawing earlier 
in the process. Others might simply refrain from approaching 
CRAs that were believed to have more conservative methodologies 
or were less-well established, and whose methodologies were not 
well-understood or well-tested in the market.

Q.5. Professional Analyst Organization. Dr. Cifuentes in his 
testimony suggested ``the creation of a professional 
organization, independent of the rating agencies, to which 
ratings analysts must belong and which sets forth ethical, 
educational and professional standards.'' Please share your 
thoughts on the potential merits of such an organization.

A.5. In evaluating the necessity of a ``professional analyst 
organization'', we believe the following points should be 
considered.

      We believe that a rigorous credit ratings process 
involves the expertise of a combination of professionals--
including lawyers, MBAs, accountants and others--who bring 
their respective and possibly divergent points of view to bear 
upon an analysis. Consequently, establishing a single body that 
establishes one set of standards for credit analysts, in our 
view, may diminish some of the advantage of having employees 
with different educational and professional credentials.

      Many of our professionals already belong to 
professional organizations, such as state bars. These 
organizations impose continuing education requirements and 
ethical standards. Establishing yet another professional 
organization may be overly burdensome on the analysts.

      Moody's Code already has extensive provisions 
dealing with, among other things, the quality, integrity and 
independence of the rating process. There are provisions 
directed specifically to analysts.

      Moody's also has an extensive professional 
development and training program that has been designed to 
enhance the quality of Moody's rating analysis and analysts' 
understanding of relevant policies and procedures, including 
those relating to ethics. Moody's analysts are required to meet 
annual continuing education requirements by completing Moody's 
courses or approved, external courses.

      As part of the CRA industry initiative, we intend 
to incorporate into the Moody's Code an explicit commitment to 
adopt and maintain a continuing education program appropriate 
to the nature of our business. Doing so will make our policies 
and practices in this area subject to monitoring by the SEC.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM CLAIRE 
                            ROBINSON

Q.1. Ms. Robinson, Ms. Tillman, and Mr. Joynt, do you think 
that it is easy for investors to compare the accuracy of the 
ratings of the different credit rating agencies? If not, do 
S&P, Moody's, and Fitch favor the SEC issuing rules to require 
enhanced disclosure of ratings performance as Chairman Cox 
outlined in his testimony?

A.1. We agree that new ``requirements for enhanced disclosures 
about ratings performance'' is an important area for 
consideration as the Securities and Exchange Commission 
(``SEC'') contemplates new rules for our industry. We believe 
that consideration of ratings performance data would create 
objective criteria for assessing whether a credit rating 
agency's (``CRA's'') ratings are suitable for use in 
regulation.
    For Moody's part, we publish and make freely available a 
wealth of data on ratings performance so that users of our 
ratings, as well as regulators, can judge the performance of 
our ratings. For your information, we have provided in this 
packet our ``Guide to Moody's Default Research: March 2008 
Update'', which lists our performance, default, transition and 
loss severity research reports in reverse chronological order 
and broken down by topic. Moody's believes there is substantial 
value in encouraging agencies to present their analysis of 
their ratings performance in the ways they believe to be most 
relevant, since there is no single agreed upon approach.
    One reason why there is no unique way to measure ratings 
performance is that different users of ratings place different 
value on different characteristics of the relationship between 
ratings and credit risk and as such different rating agencies 
seek to measure different attributes. For example, users may be 
concerned with one or more of the following:

      the relationship between ratings and defaults;

      the relationship between ratings and expected 
credit losses (which are the product of default probabilities 
and loss severity rates in the event of default);

      ratings stability;

      the relationship between ratings and ``mark-to 
market'' risk;
      the information in rating outlooks rather than 
just the ratings alone;

      the ability of ratings to rank relative credit 
risk at a point of time; and

      the ability of ratings to rank relative credit 
risk over time.

    We agree in concept that presenting data in a standardized 
format would facilitate ratings performance comparisons. We 
believe, however, that such a standard may be difficult to 
implement in practice for a number of reasons, including:

      There may be differences of opinion on the most 
meaningful way to present the data. Any given presentation may 
advantage or disadvantage one rating agency compared with 
another.

      Rating agencies do not all define their ratings 
in the same way, which may result in standardized performance 
reports not being perfectly comparable. For example, Moody's 
ratings are intended to be opinions of expected loss whereas 
some other rating agencies may intend their ratings to measure 
other indicators of credit risk, such as just probability of 
default. Therefore, a standardized format that focuses on 
default experience alone may not effectively capture the 
overall predictive content of a Moody's rating.

      Rating agencies have different approaches to 
dating defaults on structured finance securities because events 
of default are more subjective in structured finance than in 
corporate finance. In particular, many securitizations are 
structured as pass-through securities and, as such, are not at 
risk of payment defaults in a strict contractual sense until 
they reach their legal final maturity dates (in perhaps 30 
years) even though cash flows to investors may cease many years 
prior to maturity.

Q.2. Ms. Robinson, Ms. Tillman, and Mr. Joynt, would you please 
explain the process by which you obtain the information you use 
to rate structured finance securities?

A.2. At Moody's, the analyst or analysts assigned to a 
particular structured finance transaction begin the credit 
analysis by assembling relevant information on the transaction. 
Information about the specific transaction may come from the 
originator or a market intermediary in meetings or other 
communications with the analyst(s). Our analysts compare this 
transaction-specific information with data we have regarding 
past transactions, deals effected by other market participants, 
thematic research generated by Moody's analysts regarding 
industry trends, credit research generated in other rating 
departments (e.g., regarding the creditworthiness of the 
financial institutions participating in the securitization) and 
macro-economic trend research generated by Moody's 
Analytics.\1\
---------------------------------------------------------------------------
    \1\ Moody's Analytics is a subsidiary of our corporate parent, 
Moody's Corporation. It is legally and operationally separate from 
Moody's Investors Service, the rating agency, and is a provider of 
research, data, analytic tools and related services that are distinct 
from credit ratings.
---------------------------------------------------------------------------
    We have provided in this packet the Moody's Investors 
Service Code of Professional Conduct (``Moody's Code''), which 
presents the various policies that we have in place to address 
issues of (1) quality and integrity of the rating process; (2) 
independence and management of conflicts of interest; (3) 
responsibilities to investors and issuers; and (4) enforcement 
and disclosure of the Code of Professional Conduct and 
communication with market participants. Of particular relevance 
to this question is the following provision:

    1.4  Credit Ratings will be determined by rating committees 
and not by any individual Analyst. Credit Ratings will reflect 
consideration of all information known, and believed to be 
relevant, by the applicable [Moody's] Analyst and rating 
committee, in a manner generally consistent with [Moody's] 
published methodologies. In formulating Credit Ratings, 
[Moody's] will employ Analysts who, individually or 
collectively, have appropriate knowledge and experience in 
developing a rating opinion for the type of credit being 
analyzed.

    Our primary contact for transaction-specific information is 
typically the intermediary (``Arranger'' ``Underwriter'' or 
``Investment Banker'') that chooses the assets to be included 
in the transaction and sets up the structure of the 
transaction, divides the structure into different classes of 
securities (``tranches'') and markets the tranches. We may also 
deal with and obtain information from:

      one or more ``Originators'', which either 
originate the underlying assets in the course of their regular 
business activities or source them in the open market;

      the ``Servicer'', which collects payments and may 
track pool performance;

      in managed transactions, an ``Asset Manager'', 
which may assemble the initial pool and may subsequently buy 
and sell assets in the transaction; q
      the ``Trustee'', who oversees cash distributions 
to investors and monitors compliance with transaction 
documentation;

      a ``Financial Guarantor'', who may provide 
guarantees on principal and/or interest payments to, or may 
sell credit default swaps on, particular tranches; and

      in asset-backed commercial paper (``ABCP'') 
programs, an ``Administrator'' of the ABCP conduit that funds 
several asset pools.

    In addition, it is not unusual for the Arranger to ask us 
to communicate directly with the transaction lawyer in order 
for us to get a better understanding of the transaction 
structure.

Q.2.a. How much of the information is from issuers, 
underwriters, or other sources?

A.2.a. The relative proportions of the information we obtain 
from the different sources vary depending on the asset class 
and the transaction in question. In general terms, our primary 
source of transaction-specific information is the Arranger (or 
its agents). As noted above, however, our analysts compare this 
transaction-specific information with data we have regarding 
past transactions, deals effected by other market participants, 
thematic research generated by Moody's analysts regarding 
industry trends, credit research generated in other rating 
departments (e.g. regarding the creditworthiness of the 
financial institutions participating in the securitization) and 
macro-economic trend research generated by Moody's Analytics.

Q.2.b. Do you ever seek to verify the accuracy of the 
information you receive?

A.2.b. Our analysis takes into consideration and compares data 
from a variety of sources. Moody's Code of Professional Conduct 
Provision 1.7 states:

    1.7  [Moody's] will invest resources sufficient to carry 
out high-quality credit assessments of Issuers or obligations. 
When deciding whether to rate or continue rating an obligation 
or Issuer, [Moody's] will assess whether it is able to devote 
sufficient personnel with appropriate skills to make a proper 
rating assessment, and whether its personnel likely will have 
access to sufficient information needed in order to make such 
an assessment.

    When rating a corporate issuer, we receive audited 
financial data and regulatory filings. When rating a structured 
finance product, the Originator and/or Arranger of the 
structured product make representations and warranties to the 
other parties in the transaction as to the quality of the loan 
level data describing the collateral. With respect to the 
publicly offered securities in the structured finance market, 
the prospectus also contains information that must be provided 
to investors in accordance with U.S. securities laws. The named 
underwriter performs due diligence on the security being issued 
to help verify the accuracy of information in the prospectus. 
These underwriters frequently hire a due diligence firm to 
examine the underlying loans. Accounting firms also are 
frequently hired by underwriters to verify that the summary 
information about the loan pools matches the information in the 
related loan files.
    As part of the credit rating process, we do consider, among 
other factors:

    (a)  the source of the data we receive;

    (b)  the track record of the source in providing quality 
data;

    (c)  the predictive powers associated with the data; and

    (d)  whether or not the data (such as financial 
information) has been subject to review by a third party.

    In addition, as noted in our response to the preceding 
question, we also assess the transaction-specific information 
in the context of the much broader and deeper data sets and 
other information we possess as a result of our credit rating 
and credit-related research activities. However, others in the 
market (e.g. auditors, issuers and underwriters) are far better 
positioned--given their expertise and resources--to certify the 
accuracy of data.
    Our experience over the decades that we have been rating 
structured securities has been that most of the issuers 
operated in good faith and provided reliable information to us, 
and we have relied upon them to do so. Nevertheless, our 
analysts seek to exercise skepticism in our analysis of 
information provided to us. Furthermore, if we believe we have 
inadequate information to provide an informed credit opinion to 
the market, we will exercise our editorial discretion and 
either refrain from publishing an opinion or withdraw our 
published credit rating.
    In light of recent market difficulties, we believe that the 
due diligence process conducted by the parties who originate, 
arrange, and/or service residential mortgage backed securities 
(``RMBS'') needs to be further strengthened. We have proposed a 
series of measures to improve transparency, data integrity and 
accountability in U.S. residential mortgage securitizations, 
including \2\:
---------------------------------------------------------------------------
    \2\ For more information, please see the enclosed ``Moody's 
Proposed Enhancements to U.S. Residential Mortgage Securitizations: 
Call for Comments''.

---------------------------------------------------------------------------
      Stronger representations and warranties;

      Independent third-party pre-securitization review 
of underlying mortgage loans;

      Standardized post-securitization forensic review;

      Expanded loan-level data reporting of initial 
mortgage pool and ongoing loan performance; and

      More comprehensive originator assessments.

    We believe that these measures taken together will provide 
more standard and reliable information on RMBS transactions 
than currently available.

Q.3. Do you have any reason to believe that inaccurate or 
fraudulent data contributed to the poor performance of your 
ratings on structured finance securities over the last few 
years? If yes, please provide supporting evidence.

A.3. While the sharp decline in home prices and contraction of 
mortgage credit availability across the U.S. have been key 
factors contributing to the current market turmoil, numerous 
market sources have identified certain market practices--
including lenient lending practices by mortgage originators and 
misrepresentations by certain mortgage brokers, appraisers and 
some borrowers themselves--as also contributing to the 
unexpectedly poor payment performance of recent subprime 
mortgage loans. This is why we are supporting the strengthened 
due diligence measures noted in our response to question 2a 
above.

Q.4. Ms. Robinson, Ms. Tillman, and Mr. Joynt, according to 
testimony provided by Chairman Cox's testimony, Moody's has 
downgraded 53 percent and 39 percent of all its 2006 and 2007 
subprime tranches; S&P has downgraded 44 percent of the 
subprime tranches it rated between the first quarter of 2005 
and the third quarter of 2007; and Fitch has downgraded 
approximately 34% of the subprime tranches it rated in 2006 and 
the first quarter of 2007.
    What steps have each of your companies taken during the 
past three years to hold accountable its executives and 
analysts for the poor performance of its ratings? Has your 
company dismissed or otherwise disciplined any of the 
executives or analysts responsible for overseeing or producing 
its ratings of structured finance products? Please provide a 
complete list of disciplinary actions.

A.4. Moody's is committed to providing the most accurate, 
objective and independent credit assessments available in the 
global credit markets. As in any company, Moody's regularly 
evaluates the performance of its employees, including its 
executives and analysts. The assessment of the performance of 
each employee, which is measured by the ability of the employee 
to perform his/her job function, is an assessment that is 
distinct from ratings performance. Moody's does make 
disciplinary decisions, including employment termination 
decisions, based on poor performance in a job function. Moody's 
individual personnel decisions, however, are confidential and 
the Company is therefore not in a position to provide more 
detailed information on specific personnel actions.
    Also, as you know, the Securities and Exchange Commission 
(``SEC'') has been conducting a non-public examination of 
certain NRSORs, including Moody's. Under the Credit Rating 
Agency Reform Act of 2006 (``Reform Act'') and related rules 
the SEC is entitled to inspect Moody's books and records, 
including those relating to Moody's compliance function, credit 
policy function and human resources function. Moody's has been 
cooperating fully with this extensive examination.
    We recognize that the unprecedented financial turmoil that 
has developed in the past year has caused a great deal of 
anxiety and uncertainty in the markets. While examination of 
the root causes of the situation reveals multiple points of 
market failure, we believe the speed and extent of rating 
downgrades have been one contributor to the loss of confidence 
in the credit markets and undermined the credibility of credit 
rating agencies.
    For Moody's part, we have been and will continue working 
hard to respond quickly and sensibly to rapidly changing market 
conditions, and we continue to refine our practices to improve 
our performance in the future, based on what we have observed 
from this confluence of events. We can and must always strive 
to improve the quality of our work. Lessons from the recent 
market turmoil highlight opportunities for improvements in 
assessing the quality of information used in our rating 
process, the modeling and explanation of risk factors, and the 
application of multi-disciplinary analysis to even the most 
highly specialized instruments.

Q.5. Ms. Robinson, Ms. Tillman, and Mr. Joynt, during the last 
3 years, did your firm notice a decline in underwriting 
standards for mortgages being used to create residential 
mortgage-backed securities? If so, did you alter your ratings 
process in any way to account for this decline in underwriting 
standards?

A.5. Yes. Beginning in 2003, Moody's observed an increase in 
the risk profile of subprime mortgage portfolios that we were 
asked to review prior to assigning ratings and adjusted our 
ratings standards accordingly. Our response to these increased 
risks can be categorized into three broad sets of actions:

    (1) We began warning the market starting in 2003.

    We provided early warnings to the market, commenting 
frequently and pointedly over an extended period on the 
deterioration in origination standards and inflated housing 
prices. We frequently published reports on these issues 
starting in July 2003 and throughout 2004, 2005 and 2006.\3\ In 
January 2007, we published a special report highlighting the 
rising defaults on the 2006 vintage subprime mortgages \4\ and 
we have continued to publish on similar trends in the 
market.\5\
---------------------------------------------------------------------------
    \3\ Please see Annex I, which sets out in a table excerpts from our 
publications on this issue. We have also provided you with all of the 
documents referenced in Annex I.
    \4\ Please see ``Early Defaults Rise in Mortgage Securitization,'' 
Moody's Special Report, January 18, 2007. We have included this 
document in Annex II, which also provides a list of the updates we 
provided to the market as well as the actual published research for 
your information.
    \5\ Please see Annex II.

---------------------------------------------------------------------------
    (2) We tightened our ratings criteria.

    In response to the increase in the riskiness of loans made 
during the last few years and the changing economic environment, 
Moody's steadily increased its loss projections and levels of credit 
protection for each rating level we looked for on pools of subprime 
loans. Our loss projections and credit protection (or ``enhancement'') 
levels rose by about 30% over the 2003 to 2006 time period, and as a 
result, bonds issued in 2006 and rated by Moody's had significantly 
more credit protection than bonds issued in earlier years.

    (3) We took rating actions as soon as warranted by the 
performance data.

    As illustrated by Figure 1, the earliest loan delinquency 
data for the 2006 mortgage loan vintage was largely in line 
with the performance observed during 2000 and 2001, at the time 
of the last U.S. real estate recession. Thus, the loan 
delinquency data we had in January 2007 was generally 
consistent with the higher loss expectations that we had 
already anticipated. As soon as the more significant collateral 
deterioration in the 2006 vintage became evident in May and 
June 2007, we took prompt and deliberate action on those 
transactions with significantly heightened risk.
    Figure 2 shows the significantly higher loan delinquencies 
in the 2006 vintage, as of July 2007. For example, at 10 months 
of seasoning, 8.6% of the underlying loans in the 2006 vintage 
were seriously delinquent, nearly twice the level of 
delinquencies of the 2001 vintage 10 months after closing.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 



    Moody's observed the trend of weakening conditions in the 
subprime market and adjusted our rating standards to address 
the increased risk. Along with most other market participants, 
however, we did not anticipate the magnitude and speed of the 
deterioration in mortgage quality (particularly for certain 
originators), the rapid transition to restrictive lending that 
subsequently occurred or the virtually unprecedented national 
decline in home prices.

Q.5.a. Did you disclose to investors that there was a decline 
in underwriting standards?

A.5.a. Yes. Please see Annex I, including in particular, the 
excerpts quoted from the following publications:

    (1) 2003 Review and 2004 Outlook: Home Equity ABS (January 
20, 2004);

      ``Moody's expects relatively high defaults and 
losses for these mortgage types and has set credit enhancement 
levels to offset the risks.'' (Page 5)

      ``Potentially indicating deteriorating credit 
quality, the percentage of full documentation loans in subprime 
transactions continues to decline as borrowers choose more 
expensive low and no doc alternatives to minimize the time and 
scrutiny taken by lenders to underwrite new loans.'' (Page 6)

      ``Not only are borrowers susceptible to payment 
shock in a rising interest rate environment, but at the end of 
the TO period borrowers will again suffer payment shock with 
the introduction of principal in their monthly payment. Because 
of the shorter amortization period, that principal amount will 
also be significantly higher.'' (Page 6)

    (2) 2004 Review and 2005 Outlook: Home Equity ABS (January 
18, 2005); and

      ``Because these loans are generally underwritten 
based on lower initial monthly payments, many subprime 
borrowers may not be able to withstand the payment shock once 
their loans reset into their fully indexed/amortizing schedule. 
The resulting higher default probability, which may be 
exacerbated with slowing home price appreciation, could have a 
very negative effect on home equity performance in the 
future.'' (Page 3)

      ``The increase in reduced documentation in the 
subprime sector is particularly worrisome because for borrowers 
with weaker credit profiles the need for establishing repayment 
capability with stronger asset and income documentation becomes 
even more important.'' (page 6)

      ``Moody's increases credit enhancement on such 
loans to account for the lower borrower equity and the higher 
borrower leverage'' (page 6)

    (3) 2005 Review and 2006 Outlook: Home Equity ABS (January 
24, 2006).

      ``Full documentation levels fell by almost 10 
percent on average per transaction from the beginning of 2004 
to the end of 2005. Therefore, in 2005 not only did we see a 
proliferation of riskier 'affordability' products, but also a 
gradual weakening of underwriting standards.'' (Page 5)

      ``Moody's loss expectations on the interest-only 
mortgages are about 15%-25% higher than that of fully 
amortizing mortgages.'' (Page 6)

      ``In Moody's view, credit risk for this product 
is approximately 5% higher than the standard 30 year fully 
amortizing product, all other credit parameters being equal.'' 
(Page 6)

      ``Moody's considers hybrid ARM loans to be 
riskier than equivalent fixed-rate loans primarily because of 
the risk of payment shock associated with adjustable-rate 
products.'' (Page 6)

Q.6. Ms. Robinson, Ms. Tillman, and Mr. Joynt, when each of 
your companies tries to attract new customers, how do you 
distinguish your ratings from the ratings of other rating 
agencies?

A.6. When endeavoring to attract new customers for our credit 
rating services, Moody's seeks to distinguish our rating 
services from those of other CRAs on the basis of a number of 
factors, including the following:

      Moody's overall reputation for trustworthiness 
and credibility in the market place, based on the aggregate 
performance of our ratings over time, our objectivity and 
independence, the depth and breadth of our research and ratings 
coverage, transparency and the quality of services.

      The analytical capabilities of the rating teams 
that cover the particular sector or asset class in question.

      The transparency and analytical rigor of our 
rating methodologies for the sectors or asset classes in 
question.

      The depth and breadth of our research and ratings 
coverage for the particular sector, geographic region and/or 
asset class in question.

      The quality of the services we provide to users 
of our credit ratings, as well as to issuers and their agents 
in the credit rating process. We believe that both users of our 
credit ratings and issuers and their agents appreciate the 
efficiency, effectiveness, accessibility, and courtesy of our 
rating teams, issuer relations teams and investor services 
teams.

      The ability of Moody's analysts to access and use 
the research, data and analytic tools produced by Moody's 
Analytics, an operationally and legally separate business unit 
within Moody's Corporation.

      Moody's credit ratings seek to opine on 
``expected loss'', which reflects an assessment of both 
probability of default and loss given default. This approach is 
a distinctive feature of our credit ratings and differs from 
our competitors.

Q.6.a. Do you have empirical data that demonstrates that your 
ratings are better than the ratings of other companies? If yes, 
please provide documentation supporting your answer.

A.6.a. No. We do not possess the comprehensive, comparative 
ratings data histories for each CRA that would be needed to 
undertake such analyses. Moreover, we believe performance 
comparisons should be made by others, not the ratings agencies 
themselves, because ratings agencies naturally have an interest 
in the subject matter of such comparisons. However, if we were 
to become aware of performance comparisons made by others that 
we believed were incorrect or subject to misinterpretation, we 
would try to correct the resulting misunderstandings.
    Having said that, we would also note that credit default 
studies show that our ratings have been remarkably consistent 
and reliable predictors of default over many years and across 
many economic cycles. The predictive quality of credit ratings 
is empirically verifiable and has been evaluated by Moody's and 
independent third parties. We would refer you to our Guide to 
Default Research, which is attached. Examples of rating 
performance reports that we publish include:

      Quarterly global and regional reports on 
corporate bond rating performance, both with respect to rating 
accuracy and rating stability.

      Semi-annual reports on global structured finance 
rating performance, both in the aggregate and disaggregated by 
asset class sub-sectors.

      Annual reports on corporate and structured 
finance default rates, loss given default rates and rating 
transitions.

      Periodic reports on default and loss 
characteristics of bonds, bank loans and preferred stocks for 
specific company sectors and regions.

    In addition to publishing issuer or obligation-specific 
rating actions and credit opinions, Moody's also publishes our 
rating methodologies and various studies relating to the 
historical, aggregate performance of our credit ratings. These 
and other publications facilitate the assessment of our 
ratings' relevance and usefulness by potential users of our 
credit ratings as well as other third parties.
    As noted in question 6 above, however, our credit ratings 
seek to offer an opinion on expected loss, which differs from 
what some of our competitors attempt to address, which 
consequently makes direct comparison difficult. We believe that 
we serve users of our credit ratings best by being as 
transparent as possible about our rating methodologies, the 
reasoning in support of our credit opinions and the aggregate 
performance of our ratings.

Q.6.b. Do you compete more on price or ratings accuracy? Please 
provide documentation supporting your answer.

A.6.b. Moody's seeks to compete on the basis of the quality of 
our products (including credit ratings and related research), 
the trustworthiness of our reputation, and the quality of the 
services we provide to users of credit ratings and the people 
and firms with which we interact as part of the credit rating 
process. We believe that the aggregate performance of our 
credit ratings over time is a very important factor in the 
assessment of the quality of our work. In this regard, we refer 
you to our Guide to Default Research.

Q.7 Ms. Robinson, Ms. Tillman, and Mr. Joynt, what are the 
idealized default rates for each of your ratings?

A.7 Moody's does not target specific default or loss rates for 
its ratings.\6\ That is to say, Moody's credit rating scale 
does not measure ``absolute'' credit risk; rather it provides 
an ordinal ranking of credit risk.
---------------------------------------------------------------------------
    \6\  Moody's primary objective for its ratings is to provide an 
informative ordinal ranking of credit risk at each point in time. As 
such, in our view the most appropriate measure of Moody's accuracy is 
the ``power'' of its ratings, the information content of their rank 
orderings at specific points in time with respect to expected credit 
losses (the product of default probability and expected loss severity) 
as realized over a long horizon. Credits that have low ratings today 
should on average prove to be more risky than credits that have high 
ratings today.
    In addition to a relative ranking of risk at a point in time, some 
investors desire a consistent relative ranking of credits across time, 
so that the riskiness of a credit today can be compared to similarly 
rated debt instruments in the past. To measure the accuracy of Moody's 
ratings across time, the most appropriate metric is the ``power'' of a 
pool of ratings assigned to multiple credits, and possibly even the 
same credits, observed at different points over time.
    Moody's believes that as a consequence of its relative rating 
approach, the meaning of its ratings should be highly consistent over 
time. Since the relative creditworthiness of bond issuers does not, on 
average, change rapidly, there should not generally be any need to 
change average rating levels sharply over time. As a practical matter, 
therefore, Moody's does not manage its ratings to achieve cardinal 
accuracy or to maintain constant default rates by rating category. 
Doing so would require Moody's to change its ratings en masse in 
response to changes in cyclical conditions. Rather, ratings are changed 
``one-at-a-time'' as needed in order to improve the current rank 
ordering of credit risk.
---------------------------------------------------------------------------
    When, however, we need to associate specific default or 
loss rates with ratings for quantitative modeling purposes, we 
refer to a table of idealized expected credit loss rates. 
(Expected credit loss rates are the products of default 
probabilities and expected amounts of loss suffered if defaults 
occur.) These idealized loss rates are broadly consistent with 
the long-term average historical loss rates of securities that 
carry the same ratings and are used for associating modeled 
expected losses of both structured and corporate securities 
with corresponding ratings.
    Some models require default rates, rather than expected 
loss rates, as inputs. In those cases, we are able to derive 
idealized default rates from the idealized loss rates simply by 
dividing every value in the idealized loss table by an 
appropriate expected loss severity rate. To derive an idealized 
default rate for senior unsecured corporate bonds, for example, 
we could assume an average expected loss severity of 55%. For 
secured bonds and loans, we would typically assume a lower 
severity rate, and for subordinated bonds a higher severity 
rate. For structured securities, expected loss severity rates 
(and hence idealized default rates) have varied by asset class 
and potentially other features of the security.
    Since Moody's first began rating municipal securities in 
1920, municipal securities have been rated on a separate scale 
that places greater weight on default risk than expected loss 
severity. This rating scale has been associated with lower 
overall credit risk by rating category than comparably rated 
corporate and structured securities. For municipal securities, 
we have developed a similar idealized default rate table that 
is sometimes used to model expected portfolio defaults on a 
pool of municipal securities. Given the very limited number of 
defaults in the municipal sector and secular changes in credit 
risk profiles in the sector, the derivation of this table is 
less closely tied to historical data and is more likely to be 
reviewed from time to time.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 


Q.8. Ms. Robinson, Ms. Tillman, and Mr. Joynt, in his written 
testimony, Professor Coffee notes that because only a limited 
number of investment banks underwrite structured finance 
products, they have leverage over the rating agencies. If they 
don't like the ratings they get from one agency, they can go to 
another with lower standards.
    Has your firm ever felt pressure to lower your rating 
standards in order to attract business?

A.8. Issuers, arrangers, underwriters, investors and other 
users of credit ratings naturally have strong incentives to try 
to influence CRAs' credit rating analysis and decisions, both 
when a credit rating is first issued and over the lifetime of 
the securities in question. It is not surprising, therefore, 
that from time to time, various members of these groups try to 
exert pressure on us, e.g. to: (a) change our methodologies, 
models or assumptions; (b) reach a decision on a rating that 
favors their interests; and/or (c) make a rating decision 
faster or slower than we consider appropriate in light of the 
information available. Since various market participants and 
users of credit ratings often have diverging interests, we are 
accustomed to our actions being unpopular with one group or 
another.
    However, Moody's reputation and long-term success are 
critically dependent on the market's confidence in our ethics, 
objectivity and credit judgments. Consequently, we have long 
had in place strong policies and procedures to ensure the 
independence and objectivity of our ratings. (For a more 
detailed descriptions in Section 2 of Moody's Code and our 
annual reports on implementation of the Moody's Code.\7\) For 
example:
---------------------------------------------------------------------------
    \7\ We make these documents publicly available on the Regulatory 
Affairs webpage at moodys.com and have included them in Annex III to 
this response.

      ratings are decided on by committees, not 
individuals;
      analyst compensation is unconnected to either 
ratings or fees;
      a separate surveillance team reviews the 
performance of most structured transactions;
      a separate and independent credit policy group 
within Moody's is responsible for reviewing and vetting 
methodologies and models; and,
      perhaps most significantly, our methodologies, 
models and processes are publicly available and transparent so 
all market participants can assess our integrity and rigor.

Q.8.a. How do you attract customers if your ratings use the 
most stringent standards? Will issuers and underwriters simply 
go to other firms with less demanding standards?

A.8.a. In our view, the best mechanism to discourage rating-
shopping is investor confidence in our ratings. If investors 
believe that our ratings are thoughtful opinions about the 
credit quality of a security, they ultimately will demand that 
issuers seek our ratings. Alternately, if investors believe 
that the models, assumptions and methodologies from Moody's or 
another CRA are inappropriately conservative or lax and 
therefore fail to produce predictive ratings, over time, we 
believe investors, issuers and their agents will prefer the 
ratings of another CRA whose ratings appear to be better 
predictors of credit quality.
    As noted above, Moody's long-term success is critically 
dependent on the market's confidence in our ethics, objectivity 
and credit judgments.

Q.9. Ms. Robinson, in your written testimony you stated that 
Moody's tracks debt for more than 11,000 corporate issuers, 
26,000 public finance issuers, and 110,000 structured finance 
obligations.
    How often does Moody's review and, if necessary, update 
each rating?

A.9. The frequency with which Moody's periodically reviews the 
creditworthiness of issuers and obligations varies across 
sectors and asset classes based on the unique characteristics 
of each.\8\ In very general terms, the frequency of our 
regular, periodic reviews typically is associated with the 
frequency with which new information about the issuer or 
obligation is made available. (Ratings may also be reviewed 
between these regular, periodic reviews when information 
indicates that the creditworthiness of a security could be 
materially affected.)
---------------------------------------------------------------------------
    \8\ See Moody's Code of Professional Conduct. Provision 1.9 states 
our policy regarding monitoring of credit ratings:

    ``Except for Credit Ratings that clearly indicate that they do not 
entail ongoing surveillance, once a Credit Rating is published, Moody's 
will monitor the Credit Rating on an ongoing basis and update it by:

    1.9.1  periodically reviewing the creditworthiness of the Issuer or 
other relevant entity or debt or debt-like securities;
    1.9.2  initiating a review of the status of the Credit Rating upon 
becoming aware of any information that might reasonably be expected to 
result in a Credit Rating action (including termination of a Credit 
Rating), consistent with the applicable rating methodology; and
    1.9.3  updating on a timely basis the Credit Rating, as 
appropriate, based on the results of such review.
---------------------------------------------------------------------------
    For example, the frequency of our regular, periodic reviews 
for structured finance securities typically is determined by 
the scheduled payment dates for the rated securities. This is 
the case for two reasons. First, the receipt of transaction 
underlying asset performance information from the Trustee or 
the Servicer is driven by these payment dates. Second, until 
the performance information is received, it will not be clear 
whether there has been any deterioration in underlying asset 
performance and thus whether a rating adjustment needs to be 
considered. Consequently, Moody's structured finance monitoring 
process typically occurs either monthly or quarterly, depending 
on the frequency with which the trustees or servicers generate 
and provide information to us. If we receive performance data 
or other information between scheduled payment dates that 
indicates material deterioration or improvement in the 
creditworthiness of securities, we would take appropriate 
action. The transaction performance data is further informed by 
Moody's analysis of macroeconomic conditions.
    With corporations and financial institutions, analysts for 
the issuer in question typically conduct periodic reviews that 
are timed to coincide with the publication of financial 
statements and other key, periodic filings with authorities 
(e.g. on a quarterly, semiannual or annual basis, depending on 
the filing and jurisdiction in question). They may also listen 
to investor briefings organized by the issuer, monitor the 
business and specialized industry press and relevant 
authorities' websites. In addition, if they identify 
information from the issuer or other sources that would 
indicate material deterioration or improvement in the 
creditworthiness of securities, they take appropriate action at 
that time. Furthermore, rating teams conduct regular (e.g. 
annual) portfolio reviews. In a portfolio review, all of the 
analysts involved in rating issuers or securities belonging to 
a particular sector, together with their supervisors, credit 
officers for the sector and possibly related sectors, and 
relevant specialists (e.g. corporate governance, accounting and 
risk management analysts) are invited to participate in a 
meeting where the credit ratings of all issuers in a sub-sector 
are considered relative to each other and in light of Moody's 
methodology for the sector and outlook for the industry as a 
whole.
    Within a given sector or sub-sector, there can be 
differences in the frequency with which issuers are brought to 
a committee for review. For example, all things being equal, an 
issuer whose ratings are under review for possible upgrade or 
downgrade likely will be brought to a rating committee within a 
shorter period of time than an issuer to whom Moody's has 
assigned a ``stable'' outlook.

Q.9.a. Does Moody's review municipal ratings as often as it 
reviews corporate and structured finance ratings?

A.9.a. As indicated above, the frequency of our review will 
depend upon the specific characteristics of each sector and 
asset class. In our public finance group the level of issuance 
activity in a particular sector, the level of issuance activity 
by a particular issuer, the rating level of a particular issuer 
(lower rated credits are reviewed more frequently) and the 
overall volatility in that issuer's sector are important 
factors in determining the frequency of reviews. There are 
certain issuers in the public finance sector who are very 
active in the debt market, who are not highly rated and who are 
in a more credit-sensitive sector. These issuers generally will 
have their ratings reviewed on a more frequent basis than those 
who, in contrast, are small issuers in less volatile sectors 
who access the market very infrequently and whose credit 
characteristics are not as complex as some of the larger 
issuers.
    Consequently, the frequency of our review is directly 
linked to the complexity of the credit, the volatility of the 
sector, and the susceptibility of the credit to change.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM CLAIRE 
                            ROBINSON

Q.1. During the hearing, I asked you for specifics on the 
ratings your agency provided on Bear Stearns in the months 
leading up to the collapse. Please provide the Committee with a 
detailed explanation of the ratings for Bear Stearns from 
November 2007 and March 2008.

A.1.

      November 14, 2007: Moody's placed the long-term 
ratings of The Bear Stearns Companies Inc. (``Bear'') and its 
subsidiaries on review for possible downgrade. This rating 
action was taken in response to Bear's announcement that it 
expected to post a net loss in the fourth quarter of 2007, 
resulting from $1.2 billion in net market valuation losses on 
its exposures to subprime mortgage-related assets and CDOs. The 
loss also followed weak third quarter 2007 earnings. Moody's 
stated in its rating action that it ``expected that on a go-
forward basis, Bear's exposure to these specific assets would 
pose only modest downside risk but that during its review 
Moody's would evaluate Bear's firm-wide exposures and 
valuations in other asset classes.'' Moody's also expressed the 
opinion that Bear's performance through the market inflection 
and dislocation was more challenged than some competitors, 
which reflected not only tough markets, but certain risk and 
strategic decisions made by the firm. Specifically, we stated 
that ``[A]lthough Bear had improved its earnings 
diversification over the past five years, its level and scale 
of product and geographic diversification still lagged that of 
its peers and had not provided a sufficient buffer to offset 
write-downs in mortgages and leveraged lending.''

      December 20, 2007: Moody's lowered the long-term 
senior debt rating of Bear to A2 from A1 and changed the rating 
outlook to stable, ``concluding the review for downgrade that 
was initiated on November 14, 2007'' (see above). Factors 
considered included the sizeable write-downs on its mortgage 
and CDO portfolios, Bear's elevated risk appetite at the time, 
and Moody's ongoing concern regarding Bear's corporate 
governance, including board oversight of management's strategic 
risk decisions and leadership succession planning. The A2 
rating and stable outlook factored in Moody's expectations at 
that time for the future risk of loss posed by Bear's net 
exposures, as well as Moody's expectations for a reduced, but 
acceptable, level of operating profitability in 2008. Moody's 
also indicated that Bear's ratings benefited from an ample 
capital position and strong liquidity profile. Bear had 
recently announced a partnership agreement with CITIC 
Securities Co. Ltd., which included a $1 billion preferred 
stock investment in Bear, further bolstering its capital 
position.

      March 14, 2008: Moody's lowered the long-term 
senior debt rating of Bear two notches to Baa1 from A2 and its 
short-term ratings to Prime-2 from Prime-1, and placed the 
company's long-term and short-term ratings on continued review 
for a possible downgrade. The rating action was in response to 
the rapidly deteriorating liquidity position of Bear, which 
necessitated an emergency secured funding line from JPMorgan 
Chase & Co. (``JPMorgan'') back-stopped by the Federal Reserve 
Bank of New York. The 28-day funding facility represented a 
temporary liquidity respite for Bear as it looked to identify a 
long-term resolution to its liquidity problems.

    The rating action reflected Moody's opinion that Bear's 
customer franchise had been hurt by the crisis, and would 
continue to erode if a long-term stabilizing solution was not 
quickly achieved. The review would focus on the financial and 
strategic alternatives under consideration by Bear and the 
likelihood for a timely resolution.
    Given the fluidity of the situation, Moody's stated that it 
would re-address its ratings within 7-10 days. Importantly, 
Moody's indicated that Bear had a number of attractive 
franchises that could facilitate a strategic solution.

      On March 17, 2008: Moody's placed Bear's ratings 
on review for possible upgrade in response to the announcement 
by JPMorgan that it would acquire Bear with assistance from the 
Federal Reserve.

      March 28, 2008: Moody's announced it was 
continuing its review for possible upgrade of Bear's Baa1 
ratings and those of its rated subsidiaries. This rating action 
followed revisions to the original March 16, 2008 merger 
agreement and operating guaranty from JPMorgan.

    In addition, please answer the following questions.

Q.1.a. Were any of the ratings downgraded between December 2007 
and March 14, 2008?

A.1.a. Response: Yes.

      December 20, 2007: Moody's downgraded the 
following ratings of Bear Stearns and its subsidiaries:

          --  long-term senior unsecured debt to A2 from A1

          --  issuer rating to A2 from A1

          --  subordinated debt to A3 from A2

          --  trust preferred stock to A3 from A2

          --  preferred stock to Baa1 from A3

      March 14, 2008: Moody's downgraded the following 
ratings of Bear Stearns and its subsidiaries, and placed the 
ratings on review for possible further downgrade:

          --  long-term senior unsecured debt to Baa1 from A2

          --  commercial paper to Prime-2 from Prime-1

          --  issuer rating to Baa1 from A2

          --  subordinated debt to Baa2 from A3

          --  trust preferred stock to Baa2 from A3

          --  preferred stock to Ba1 from Baa1

Q.1.b. Were any of the ratings downgraded during the week of 
the collapse (March 10-14)?

A.1.b. Yes. Please see our response to the above question. On 
March 14, 2008, Moody's lowered Bear's long-term senior debt 
rating two notches to Baa1 from A2, and placed the company on 
review for further downgrade. We expressed the opinion that the 
liquidity crisis was the result of sudden diminishing market 
confidence in Bear by its counterparties and customers, 
compounded by persistently negative market conditions. The 
downgrade also reflected our opinion that Bear's franchise had 
been hurt by the liquidity crisis and would continue to erode 
if a long-term, stabilizing solution was not quickly achieved. 
Moody's also noted that Bear had a number of attractive 
franchises that could facilitate a strategic solution--which is 
what ultimately occurred.

Q.1.c. Can you explain from your agency's point of view how 
Bear's collapse unfolded and the role the ratings may have 
played?

A.1.c. During the week of March 10, 2008, the market was 
flooded with rumors about liquidity problems at Bear. Although 
Bear did not face any sizeable net writedowns or credit losses, 
and the bulk of its franchises were intact, rampant rumors 
about its liquidity position, compounded by persistently 
negative market conditions, further eroded confidence in Bear 
by its counterparties and customers. Investor concerns over the 
impact that the failure of the Peloton and Carlyle hedge funds 
would have on Bear added to the pressure.
    Because market participants value both accuracy and 
stability in credit ratings, Moody's manages its ratings so 
that they are changed only in response to changes in relative 
credit risk that we believe will endure, rather than in 
response to market rumors, transitory events or shifts in 
market sentiment. We recognize, however, that rumors about 
liquidity problems at a financial institution can, in and of 
themselves, contribute to liquidity problems and that liquidity 
problems for such an institution can have an enduring impact on 
creditworthiness. Consequently, Moody's analysts were actively 
reviewing Bear's evolving liquidity position on a daily basis 
throughout the week.
    It is our understanding that Bear's liquidity situation 
declined precipitously between March 12 and March 14, 2008. 
What was originally market perception and rumors had become 
reality. This sudden erosion in liquidity severely constrained 
Bear's financial and operating flexibility. Prime brokerage 
clients pulled cash and investment balances out of the firm, 
haircut requirements rose on Bear's short-term collateralized 
funding and an increasing amount of short-term collateralized 
funding failed to roll at maturity. As a result, Bear's 
liquidity pool, which had started the week at about $18 
billion, rapidly declined to around $5 billion by the end of 
Thursday, March 13. On March 14, we downgraded Bear's long-term 
senior unsecured debt ratings from A2 to Baa1 and short-term 
debt ratings from Prime-1 to Prime-2 and left those ratings on 
review for further downgrade. We expressed the opinion that the 
liquidity crisis was the result of diminishing market 
confidence in Bear by its counterparties and customers, 
compounded by persistently negative market conditions. The 
downgrade also reflected our opinion that Bear's franchise had 
been hurt by the liquidity crisis and would continue to erode 
if a long-term, stabilizing solution was not quickly achieved. 
Moody's also noted that Bear had a number of attractive 
franchises that could facilitate a strategic solution--which is 
what ultimately occurred.

Q.1.d. Do you think the lack of changes to the Bear Stearns' 
ratings is an example of a unique event in the markets or an 
indication of larger flaws in the structure of the ratings?

A.1.d. Moody's believes that our credit ratings of Bear and its 
securities were appropriate in light of the information 
available to us throughout the relevant time period. Moreover, 
although the company's equity suffered a dramatic loss in value 
as a result of this crisis, Moody's maintained our credit 
rating on Bear's debt at investment grade, in part because Bear 
had a number of attractive franchises that could facilitate a 
strategic solution--which is what ultimately occurred. As noted 
earlier, Moody's ratings speak to whether a debt investor who 
holds the securities to maturity will be made whole, and not 
whether a company's equity will retain its value.
    Ultimately, the issue with Bear was a severe and extreme 
crisis of confidence based on a liquidity problem that arose 
suddenly and materialized in a matter of days. This crisis of 
confidence denied Bear's access to short-term secured 
financing, even when the collateral consisted of agency 
securities with a market value in excess of the funds to be 
borrowed. Confidence sensitivity was expected to be less of an 
issue in the secured funding markets, particularly where 
franchise impairment was limited. (Notably, Bear had survived 
prior crises utilizing many of the same tools that were at its 
disposal this time.) However, access to the secured funding 
markets, which had operated smoothly throughout many previous 
market crises, evaporated over the span of week. The market 
dislocation was so extreme that Bear could not borrow against 
high-grade collateral. This is a situation that Bear--or any 
other securities firm--would find difficult to protect against, 
and as a result the Federal Reserve was prompted on March 16, 
2008 to provide liquidity to the securities firms.\9\
---------------------------------------------------------------------------
    \9\ Specifically, by the implementing the primary dealer credit 
facility.
---------------------------------------------------------------------------
    Our analysis suggested that Bear was more vulnerable than 
the other major securities firms because it had slightly weaker 
liquidity, was less diversified and had concentrations in 
stressed asset classes. Bear's long-term ratings were lower 
than those of its peers, reflecting this risk. However, it also 
appears to us that a high degree of risk avoidance by market 
participants (due to persistently negative market conditions 
and market-wide opacity with respect to counterparty exposures) 
may have led to the very unusual situation where market 
participants refused to accept high-grade collateral at any 
haircut. In addition, during the week of March 10 the departure 
of client balances that had financed prime brokerage lending 
contributed to Bear's liquidity difficulties.

Q.1.e. Under ideal circumstances, would you agree that the 
ratings should have been downgraded to more accurately reflect 
Bear's risk?

A.1.e. We believe that our credit ratings of Bear and its 
securities appropriately reflected the credit risks of which we 
were aware in light of the information available to us at the 
time. It is important to note that while Bear Stearns suffered 
a severe crisis of confidence, it has not defaulted on any of 
its debt instruments, and its ratings are currently on review 
for upgrade in connection with its pending acquisition by 
JPMorgan. In hindsight, a lower rating on such instruments 
would have overstated the risk of default.

Q.1.f. What lessons do you think we should take from the Bear 
Stearns collapse as it relates to the credit ratings?

A.1.f. Moody's credit ratings intend to offer an opinion on the 
risk of default and severity of loss in the event of default. 
As stated above, we believe that our credit ratings of Bear and 
its securities appropriately reflected the risks of which we 
were aware given the information available to us at the time. 
We also believe that, more generally, Moody's long-term credit 
ratings strike the appropriate balance between accuracy and 
stability. Our conversations with investors, issuers and 
regulators have led us to conclude that they have a strong 
preference for credit ratings that are both accurate and 
stable. They want ratings to reflect enduring changes in credit 
risk because rating changes have real consequences--due 
primarily to ratings-based portfolio governance rules and 
rating triggers--that are costly to reverse. Market 
participants, however, do not want us to provide ratings that 
simply track market-based measures of credit risk (although 
such measures can be a useful supplementary source of 
information in the investment decision-making process). They 
want our credit ratings to reflect independent analytical 
judgments that provide a counterpoint to often volatile market-
based assumptions.
    Having said that, the recent market turmoil has highlighted 
a vulnerability of securities firms, namely the loss of access 
by a solvent firm to secured funding, even when secured by high 
quality collateral. This scenario had not previously occurred 
in the history of the industry. The SEC is also now more 
focused on this vulnerability, as SEC Chairman Cox recently 
noted: ``We are discussing with each of the firms various 
stress scenarios that include not only impairment of unsecured 
funding but also of secured funding. We now live in a post Bear 
Stearns reality.'' (Reuters, May 26) In addition, the increased 
complexity of these firms and of the financial instruments in 
which they deal have elevated the analytic challenge. Moody's 
is and will continue to evaluate the appropriateness of our 
rating methodology for securities firms in light of the recent 
events.

Q.1.g. What are your thoughts on a proposal Professor Coffee 
discussed at the hearing for rating agencies to periodically 
update ratings?

A.1.g. Moody's believes that credit rating announcements should 
be made when the credit rating agency has new or relevant 
information to share with the market. Generally, these 
instances are either: a change in rating (the rating opinion 
has changed); or a rating affirmation (there is a significant 
event in the market and investors are unsure whether the rating 
remains unchanged).
    Moody's does not believe that publishing rating 
announcements according to a prescribed timetable or schedule 
would prevent mass downgrades or improve the appropriateness of 
existing ratings for the following reasons:

      Ratings are already monitored on an ongoing basis 
and Moody's changes our ratings when our opinion about the 
fundamental creditworthiness of the obligation changes.

      A requirement to announce on a quarterly, semi-
annual or annual basis that our rating has not changed would 
saturate the market with redundant and potentially confusing or 
obfuscating information.

      Arbitrary review dates could inappropriately 
focus investor and issuer attention on those dates, rather than 
on credit-relevant events and thereby inadvertently conceal 
significant rating actions.

      Paradoxically, publishing more information could 
reduce the usefulness of the rating and impair transparency.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM STEPHEN W. 
                             JOYNT

Q.1. Ratings Scoreboard. What are your views on the 
recommendation that has been made for the creation of a central 
website which investors could access and on which they could 
compare the accuracy of past ratings by the different NRSROs 
for the same types of securities?

A.1. In our Joint Response to the Technical Committee of the 
International Organization of Securities Commissions' 
(``IOSCO'') Consultation Report on the Role of Credit Rating 
Agencies in Structured Finance Markets, dated April 25, 2008, 
the participating rating agencies (Fitch, AM Best, DBRS, 
Moody's and Standard & Poor's) stated our commitment to create 
a centralized, industry portal to house our ratings performance 
studies and other relevant data.
    I note that the SEC will soon publish its recently 
announced proposed rules (the ``Proposed Rules''), which will 
include a requirement that certain performance statistics be 
made publicly available to facilitate comparisons among rating 
agencies. Fitch looks forward to working with the SEC in the 
context of the Proposed Rules to enhance the availability of 
performance data for users of ratings.

Q.2. Due Diligence. Did Fitch undertake to verify the 
information it used to decide ratings on the structured finance 
products that were subsequently downgraded? In recent years, 
there has been widespread awareness, through the press and 
otherwise, about the proliferation of so-called ``liar 
loans''--mortgage loans with little or no documentation 
required and on which borrowers ultimately have stopped paying. 
Do you feel that NRSROs should have performed some 
investigation or due diligence on structured debt that 
contained these ``liar loans''? Are there circumstances under 
which NRSROs should be required to perform some form of due 
diligence before issuing a rating?

A.2. The principal contacts at the initial stages of the rating 
process are with the originator, the issuer and/or the 
arranger. Fitch will also receive information and documentation 
from the transaction lawyers. These parties will typically 
provide an overview of the transaction and the originator, as 
well as a detailed term sheet setting out the main features of 
the legal and financial structure. The arranger often acts as 
the conduit between Fitch and the originator for information on 
the underlying assets and their historic performance. It may 
also act as a conduit for outside opinions from other experts, 
such as accountants.
    Where relevant, Fitch will meet the originator to conduct 
an on-site servicer review, the purpose of which is to 
understand the asset origination process, the way the assets 
are administered and what steps are undertaken in the event of 
non-performance (e.g., of individual loans within a consumer 
loan portfolio). This also represents an opportunity for Fitch 
to resolve any outstanding questions about the data that it has 
already received. Following this review any further questions 
on the origination, underwriting or administration process are 
addressed directly to the originator or via the arranger.
    Fitch's own lawyers (internal or external) may discuss 
legal and structural aspects of the transaction with 
transaction counsel, to better understand the transaction and 
whether and how legal risks relevant to our credit analysis 
have been mitigated. However, in all cases, these reviews are 
not designed to supplant or replace the legal analysis 
performed by transaction counsel, and are instead undertaken 
simply to understand the legal analysis provided by transaction 
counsel. In cases where Fitch receives reports and information 
from other external advisors or experts, such as auditors, 
actuaries and consultants, we may discuss these reports and 
information with such third parties to understand their impact 
on our credit analysis. Fitch also utilizes data gathered from 
servicers, trustees and data services in the course of 
monitoring existing transactions to evaluate new transactions.
    As part of this process, we consider, among other factors, 
(a) the source of the data we receive; (b) the track record of 
that source in providing quality data; (c) the predictive 
powers associated with any one piece of data; and (d) whether 
or not the data (such as financial information) has been 
subject to review by a third party.
    However, as we make clear in our Code of Conduct and other 
documents and publications, Fitch does not audit or verify the 
truth or accuracy of any information provided or available to 
it. This responsibility is not one which it is feasible or 
appropriate for rating agencies to discharge, and one that, in 
a clear, statutory context, already exists for other parties. 
We do agree with the SEC's position, in the Proposed Rules, 
that it would be very helpful to users of our ratings for us to 
disclose the extent to which we rely on the due diligence of 
others to verify the assets underlying structured products. In 
addition, we will be amending our Code of Conduct, in line with 
IOSCO's recently amended Code of Conduct Fundamentals for 
Credit Rating Agencies, to state that we will adopt reasonable 
steps to assess that the information provided to us for use in 
ratings is of sufficient quality to support credible ratings.
    Indeed, we have already introduced additional measures 
aimed at reviewing the plausibility of data used in the rating 
process. In November 2007, we announced a reassessment of the 
risk management processes of originators, conduits and/or 
issuers for product being securitized going forward. Beginning 
in January 2008, our RMBS rating process has incorporated a 
more extensive review of mortgage origination/acquisition 
practices, including a review of originator/conduit/issuer due 
diligence reports, and a sample of mortgage origination files. 
Additionally, Fitch is studying how a more robust system of 
representation and warranty repurchases could help to provide 
more stable RMBS performance. Fitch will not rate subprime RMBS 
without completion of the review process.

Q.3. Timeliness of Updates of Ratings. Professor Coffee in his 
testimony pointed out that major downgrades of CDO securities 
``came more than a year after the Comptroller of the Currency 
first publicly called attention to the deteriorating conditions 
in the subprime market and many months after the agencies 
themselves first noted problems in the markets.'' His testimony 
also states ``the gravest problem today may be the staleness of 
debt ratings.'' What is Fitch doing to update ratings in a 
timely manner and eliminate stale ratings? What standards 
should NRSROs observe?

A.3. We believe that a number of recent steps will improve our 
timeliness.
    In order to better signal concerns about potential ratings 
pressure, Fitch is rolling out the use of Rating Outlooks for 
all structured finance securities. Outlooks indicate those 
securities for which the risk of rating actions is heightened, 
but has not yet reached the level of Rating Watch.
    Additionally, Fitch has made substantial investments in 
automation to provide for more frequent in-depth analysis of 
the large portfolios of rated RMBS, CDO and other structured 
products. This allows for the ability to more quickly 
communicate the impact of fast-moving events on large 
portfolios.
    More broadly, as with many other market participants, we 
have learned lessons from the precipitous changes in 
performance and environment for several asset classes and are 
adding additional review steps to the process by which criteria 
assumptions are determined. These will not guarantee that 
future assumptions will always be replicated in actual events--
no process could realistically assure this--but they will 
incorporate recent experience regarding origination standards, 
product correlation and risk-layering.
    We have introduced structural changes to a number of 
groups, from senior management rotation down to increased 
resources devoted to dedicated surveillance work. We have also 
added Credit/Risk Officers to each of the ratings groups, to 
bring enhanced analytical oversight, experience and training to 
these groups. The Credit and Risk Officers will work with each 
group to identify important trends and to ensure that Fitch's 
analytical process is both rigorous and balanced.
    At the same time, we are conscious of the need to manage 
expectations of the degree to which the timing of rating 
actions will ever meet universal acclaim. Ratings are a 
``single-point'' representation which inevitably will be 
subject to change as different risks crystallise and others 
recede. Particularly when market conditions are volatile, 
rating efficacy can also be measured in terms of the swiftness 
with which the ratings are revised to reflect a change in 
circumstances, rather than their absolute ability to have 
predicted a series of unexpected events. It is in this spirit 
that we continue to place significant focus on the timeliness 
of our continued surveillance.

Q.4. Separate Ratings from Business? Dr. Cifuentes' testimony 
contains a recommendation that a rating agency separate its 
rating business function from its rating analysis function. 
What are your views on how NRSROs should address this analyst 
independence concern?

A.4. Fitch acknowledges and addresses the potential conflicts 
of being an issuer-paid rating agency in four primary ways. 
One, we have separated business development from credit 
analysis, to keep each group focused on its core task. Two, we 
have relocated all of our non-rating operations into a separate 
division, Fitch Solutions, which operates behind a firewall. 
Three, we have established and enforce a Code of Conduct and 
related policies to address these conflicts. Four, no analyst 
or group of analysts is directly compensated on the revenues 
related to their ratings. To that end, we are in agreement with 
the SEC's Proposed Rule that would prohibit anyone who 
participates in determining a rating from negotiating the fee 
that is paid for such rating.

Q.5. Ratings Shopping. We have heard concerns about ``ratings 
shopping,'' where an underwriter or an issuer goes to the NRSRO 
that it feels will give it the highest rating, even if it is 
not necessarily the most accurate. Is ratings shopping a 
problem? How should the negative aspects of it be addressed?

A.5. We understand the concerns surrounding ``rating 
shopping'', which have arisen most recently in the context of 
structured finance ratings. To address these concerns, Fitch 
has consistently advocated greater transparency regarding 
transaction data.
    As it stands today, generally there is limited data in the 
public market about structured securities prior to their 
issuance such that neither investors nor rating agencies who 
lack direct contact with the issuer are able to formulate an 
informed opinion on structured securities. However, if robust 
information about structured finance products were publicly 
available once the details of the transaction had been 
finalized, agencies could provide ratings, regardless of 
whether or not an issuer requested a preliminary rating.
    The dissemination of unsolicited ratings, where possible, 
likely would reduce the frequency of rating shopping, since 
rating opinions could be disseminated into the market 
regardless of whether the issuer specifically contracted with 
the agency or not. As a result, in many circumstances market 
participants would have the benefit of multiple and potentially 
diverse opinions about the same transaction.
    Additionally, and most importantly, as mentioned above 
under Response I, having the underlying data published by the 
issuers or originators would allow investors to form their own 
opinions about the strengths and weaknesses of a particular 
transaction, which could support authorities' efforts to 
discourage the use of ratings for purposes other than an 
objective measure of relative credit risk. Voluntary efforts 
currently in progress being coordinated by the American 
Securitization Forum will potentially provide much more 
standardized data to all participants in the U.S. RMBS market.

Q.6. Professional Analyst Organization. Dr. Cifuentes in his 
testimony suggested ``the creation of a professional 
organization, independent of the rating agencies, to which 
ratings analysts must belong and which sets forth ethical, 
educational and professional standards.'' Please share your 
thoughts on the potential merits of such an organization.

A.6. Fitch typically is sympathetic to any industry initiative 
which seeks to support analysts from rating agencies, and other 
institutions, in their professional development. At the same 
time, we note that recent market feedback to the Committee of 
European Securities Regulators (``CESR''), with which CESR 
concurred,\1\ was that there was no need to impose educational 
and professional qualifications upon the staff of rating 
agencies.
---------------------------------------------------------------------------
    \1\ Paragraph 165 of CESR's Second Report to the European 
Commission on the compliance of credit rating agencies with the IOSCO 
Code and The role of credit rating agencies in structured finance, May 
2008.
---------------------------------------------------------------------------
    Membership of such an organization would also have to be 
voluntary--it is unlikely we could compel membership by our 
employees. Equally, it would be important for operational, 
compliance, and regulatory reasons that the formal, mandatory 
policies of each individual agency, including our policies on 
the management of conflicts of interest, be understood as the 
standard by which employee behavior is judged.
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATORS SHELBY FROM STEPHEN 
                            W. JOYNT

Q.1. Ms. Robinson, Ms. Tillman, and Mr. Joynt, do you think 
that it is easy for investors to compare the accuracy of the 
ratings of the different credit rating agencies? If not, do 
S&P, Moody's, and Fitch favor the SEC issuing rules to require 
enhanced disclosure of ratings performance as Chairman Cox 
outlined in his testimony?

A.1. In our Joint Response to the Technical Committee of the 
International Organization of Securities Commissions' 
(``IOSCO'') Consultation Report on the Role of Credit Rating 
Agencies in Structured Finance Markets, dated April 25, 2008, 
the participating rating agencies (Fitch, AM Best, DBRS, 
Moody's and Standard & Poor's) stated our commitment to create 
a centralized, industry portal to house our ratings performance 
studies and other relevant data.
    I note that the SEC will soon publish its recently 
announced proposed rules (the ``Proposed Rules''), which will 
include a requirement that certain performance statistics be 
made publicly available to facilitate comparisons among rating 
agencies. Fitch looks forward to working with the SEC in the 
context of the Proposed Rules to enhance the availability of 
performance data for users of ratings.

Q.2. Ms. Robinson, Ms. Tillman, and Mr. Joynt, would you please 
explain the process by which you obtain the information you use 
to rate structured finance securities?

      How much of the information is from issuers, 
underwriters, or other sources?

      Do you ever seek to verify the accuracy of the 
information you receive?

A.2. The principal contacts at the initial stages of the rating 
process are with the originator, the issuer and/or the 
arranger. Fitch will also receive information and documentation 
from the transaction lawyers. These parties will typically 
provide an overview of the transaction and the originator, as 
well as a detailed term sheet setting out the main features of 
the legal and financial structure. The arranger often acts as 
the conduit between Fitch and the originator for information on 
the underlying assets and their historic performance. It may 
also act as a conduit for outside opinions from other experts, 
such as accountants.
    Where relevant, Fitch will meet the originator to conduct 
an on-site servicer review, the purpose of which is to 
understand the asset origination process, the way the assets 
are administered and what steps are undertaken in the event of 
non-performance (e.g., of individual loans within a consumer 
loan portfolio). This also represents an opportunity for Fitch 
to resolve any outstanding questions about the data that it has 
already received. Following this review any further questions 
on the origination, underwriting or administration process are 
addressed directly to the originator or via the arranger.
    Fitch's own lawyers (internal or external) may discuss 
legal and structural aspects of the transaction with 
transaction counsel, to better understand the transaction and 
whether and how legal risks relevant to our credit analysis 
have been mitigated. However, in all cases, these reviews are 
not designed to supplant or replace the legal analysis 
performed by transaction counsel, and are instead undertaken 
simply to understand the legal analysis provided by transaction 
counsel. In cases where Fitch receives reports and information 
from other external advisors or experts, such as auditors, 
actuaries and consultants, we may discuss these reports and 
information with such third parties to understand their impact 
on our credit analysis. Fitch also utilizes data gathered from 
servicers, trustees and data services in the course of 
monitoring existing transactions to evaluate new transactions.
    As part of this process, we consider, among other factors, 
(a) the source of the data we receive; (b) the track record of 
that source in providing quality data; (c) the predictive 
powers associated with any one piece of data; and (d) whether 
or not the data (such as financial information) has been 
subject to review by a third party.
    However, as we make clear in our Code of Conduct and other 
documents and publications, Fitch does not audit or verify the 
truth or accuracy of any information provided or available to 
it. This responsibility is not one which it is feasible or 
appropriate for rating agencies to discharge, and one that, in 
a clear, statutory context, already exists for other parties. 
We do agree with the SEC's position, in the Proposed Rules, 
that it would be very helpful to users of our ratings for us to 
disclose the extent to which we rely on the due diligence of 
others to verify the assets underlying structured products. In 
addition, we will be amending our Code of Conduct, in line with 
IOSCO's recently amended Code of Conduct Fundamentals for 
Credit Rating Agencies, to state that we will adopt reasonable 
steps to assess that the information provided to us for use in 
ratings is of sufficient quality to support credible ratings.
    Indeed, we have already introduced additional measures 
aimed at reviewing the plausibility of data used in the rating 
process. In November 2007, we announced a reassessment of the 
risk management processes of originators, conduits and/or 
issuers for product being securitized going forward. Beginning 
in January 2008, our RMBS rating process has incorporated a 
more extensive review of mortgage origination/acquisition 
practices, including a review of originator/conduit/issuer due 
diligence reports, and a sample of mortgage origination files. 
Additionally, Fitch is studying how a more robust system of 
representation and warranty repurchases could help to provide 
more stable RMBS performance. Fitch will not rate subprime RMBS 
without completion of the review process.

Q.3. Do you have any reason to believe that inaccurate or 
fraudulent data contributed to the poor performance of your 
ratings on structured finance securities over the last few 
years? If yes, please provide supporting evidence.

A.3. The very high delinquency and default performance of 
recent vintage subprime RMBS and Alternative-A RMBS has a 
variety of causes, including declining home prices and the 
prevalence of high-risk mortgage products such as stated-income 
loans and 100% combined-loan-to-value loans. However, as 
indicated in your question, these factors do not fully account 
for the large number of early defaults that are occurring. Many 
industry observers have noted that poor underwriting, together 
with borrower/broker fraud, also appear to be playing a role in 
high defaults.
    For example, for an origination program that relies on 
owner occupancy to offset other risk factors, a borrower 
fraudulently stating intent to occupy will dramatically alter 
the probability of the loan defaulting. When this scenario 
happens with a borrower who purchased the property as a short-
term investment, based on the anticipation that the value would 
increase, the layering of risk is greatly multiplied. If the 
same borrower also misrepresented his income, and cannot afford 
to make the payments, the loan will almost certainly default 
and result in a loss, as there is no type of loss mitigation, 
including modification, which can rectify these issues.
    It is not possible to confidently make a broad statement of 
how pervasive these problems are across the range of 
originators and issuers in Fitch's rated portfolio. However, 
given the combination of our review of historical loan 
performance, the level of problems identified in recent Fitch 
studies and the findings of third-party reviews, Fitch believes 
that poor underwriting quality and fraud may account for as 
much as one-quarter of the underperformance of recent vintage 
subprime RMBS. More details on this can be found in our 
November 28, 2007 report ``The Impact of Poor Underwriting 
Practices and Fraud in Subprime RMBS Performance'', a copy of 
which is attached to this letter.

Q.4. Ms. Robinson, Ms. Tillman, and Mr. Joynt, according to 
testimony provided by Chairman Cox's testimony, Moody's has 
downgraded 53 percent and 39 percent of all its 2006 and 2007 
subprime tranches; S&P has downgraded 44 percent of the 
subprime tranches it rated between the first quarter of 2005 
and the third quarter of 2007; and Fitch has downgraded 
approximately 34% of the subprime tranches it rated in 2006 and 
the first quarter of 2007.
    What steps have each of your companies taken during the 
past three years to hold accountable its executives and 
analysts for the poor performance of its ratings? Has your 
company dismissed or otherwise disciplined any of the 
executives or analysts responsible for overseeing or producing 
its ratings of structured finance products? Please provide a 
complete list of disciplinary actions.

A.4. Like all of the major rating agencies, our structured 
finance ratings have not performed well and have been too 
volatile, but we have found no evidence of violations of our 
policies or procedures which would indicate disciplinary action 
is either warranted or appropriate.
    We have, however, seen merit in making a number of changes 
to the senior management team to introduce additional 
perspectives into the work of our structured finance groups. On 
January 22, 2008, Fitch appointed successors to the positions 
of Global Head of Structured Finance Ratings, responsible for 
all structured finance ratings globally, and Global Head of 
Structured Credit Ratings, responsible for all CDO ratings 
globally. In making these and other appointments, we have 
reflected a belief that adding senior managers with experience 
of corporate and financial sector assets is an important 
addition to the robustness of the rating process.

Q.5. Ms. Robinson, Ms. Tillman, and Mr. Joynt, during the last 
3 years, did your firm notice a decline in underwriting 
standards for mortgages being used to create residential 
mortgage-backed securities? If so, did you alter your ratings 
process in any way to account for this decline in underwriting 
standards?
    Did you disclose to investors that there was a decline in 
underwriting standards?

A.5. Some degree of decline was apparent in the migration to 
higher risk products such as ``no-money-down'' and ``no 
documentation'' loans. The rating process accounted for these 
factors by assuming higher default and loss rates for these 
mortgages than for other, less risky mortgages. We described to 
investors the risks of various mortgage products in our 
criteria reports, and we discussed the trends to higher risk 
products in numerous investor presentations and special 
reports, e.g., the 2006 and 2007 Global Structured Finance 
Outlook reports.
    Fitch did not change the rating process until it became 
apparent that not only the underwriting standards, but the 
underwriting processes and controls, had become so weak that 
RMBS became exposed to very high-risk loans, in many instances 
exhibiting evidence of borrower and broker fraud. In response 
to these developments Fitch announced an enhanced originator 
review process described in Response B above.

Q.6. Ms. Robinson, Ms. Tillman, and Mr. Joynt, when each of 
your companies tries to attract new customers, how do you 
distinguish your ratings from the ratings of other rating 
agencies?

      Do you have empirical data that demonstrates that 
your ratings are better than the ratings of other companies? If 
yes, please provide documentation supporting your answer.

      Do you compete more on price or ratings accuracy? 
Please provide documentation supporting your answer.

A.6. While we can point to occasions where we believe our 
methodologies and rating actions have demonstrated greater 
prescience than those of our competitors, at a very high level, 
it is difficult to argue conclusively that one set of ratings 
is demonstrably ``better'' than another. Our aim has always 
been to provide a valid, independent opinion that investors can 
use as one additional data point to include in their own 
analysis, and that can be judged on its own merits, based on 
the quality of our rating commentary, accompanying research and 
the published performance data.
    The decision by an entity as to which CRA to approach is 
based on a variety of factors, including the efficiency of the 
rating process, the quality of the analysis and the 
accompanying research reports, the relative cost and, most 
importantly, the reputation of the agency with investors. 
Ultimately, the long-term success or failure of an agency is 
measured in terms of the latter, which, in Fitch's case, has 
resulted in investors--voluntarily and at their own 
initiative--incorporating Fitch in their investment guidelines 
over the past five years, on an equal footing with the two 
larger agencies. This greater recognition--based on the quality 
of our work and not the level of our ratings--has been the 
greatest spur to increased business opportunities for our 
agency.

Q.7. Ms. Robinson, Ms. Tillman, and Mr. Joynt, what are the 
idealized default rates for each of your ratings?

A.7. Given the ordinal nature of ratings--that is, ratings are 
a relative ranking, rather than a specific percentage 
prediction--Fitch has not historically benchmarked individual 
ratings to cardinal default expectations. In our public 
transition and default studies, we have measured our 
performance using a variety of traditional measures, including 
comparisons of cumulative default rates, Gini coefficients and 
Lorenz curves.

Q.8. Ms. Robinson, Ms. Tillman, and Mr. Joynt, in his written 
testimony, Professor Coffee notes that because only a limited 
number of investment banks underwrite structured finance 
products, they have leverage over the rating agencies. If they 
do not like the ratings they get from one agency, they can go 
to another with lower standards.

      Has your firm ever felt pressure to lower your 
rating standards in order to attract business?

      How do you attract customers if your ratings use 
the most stringent standards? Will issuers and underwriters 
simply go to other firms with less demanding standards?

A.8. We do not view the nominal concentration of investment 
banks active in the capital markets as representing increased 
leverage such as to threaten the objectivity of our work. The 
banks in question operate across multiple asset classes, in 
dozens of geographies. In this work, the decision on which 
rating agency to approach and ultimately to engage is not 
steered centrally by any one individual, or any one group of 
individuals within any of the banks. The decision to hire or 
not hire a given agency is based on the variety of factors 
outlined above in Response F, rather than a narrow 
consideration of the treatment of that bank's prior 
transaction.
    Where the level of credit enhancement is also used by banks 
as a determining factor, we believe that our track record amply 
demonstrates many segments where our market share was lower in 
part because of the credit view which Fitch took. We understand 
this as a natural part of the business of being an independent 
rating agency, and believe, as noted above in Response F, that 
ultimately the long-term success or failure of our agency will 
be measured relative to our reputation with investors, not 
short-term gains in market share.

Q.9. Mr. Joynt, Chairman Cox outlined in his testimony the 
rulemaking areas the SEC is considering.
    The outline contains several ideas for improving 
competition in the ratings industry.
    Are there any additional measures the SEC should consider 
to foster competition?

A.9. Fitch supports competition in the marketplace and has been 
working diligently to provide an alternative global, full-
service rating agency capable of successfully competing with 
Moody's and S&P across all products and market segments. We 
believe that one of the Proposed Rules--requiring the public 
disclosure of the information a rating agency uses to determine 
a rating on a structured product--would be very constructive in 
furthering competition. Such disclosure would also have the 
added benefit of assisting investors in conducting their own 
investment analysis process. However, it may be most practical 
that this disclosure requirement should apply to the sources of 
the information--i.e., originators, arrangers and issuers--
rather than the receivers of the information.

Q.10. Mr. Joynt, Chairman Cox indicated in his testimony that 
the SEC may consider rules that would require all NRSROs to 
have access to the information underlying credit ratings.
    Would this make it easier for your company and the other 
smaller rating agencies to compete against S&P and Moody's?

A.10. Fitch supports competition in the marketplace and has 
been working diligently to provide an alternative global, full-
service rating agency capable of successfully competing with 
Moody's and S&P across all products and market segments. We 
believe that one of the Proposed Rules--requiring the public 
disclosure of the information a rating agency uses to determine 
a rating on a structured product--would be very constructive in 
furthering competition. Such disclosure would also have the 
added benefit of assisting investors in conducting their own 
investment analysis process. However, it may be most practical 
that this disclosure requirement should apply to the sources of 
the information--i.e., originators, arrangers and issuers--
rather than the receivers of the information.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM STEPHEN 
                            W. JOYNT

Q.1. During the hearing, I asked you for specifics on the 
ratings your agency provided on Bear Stearns in the months 
leading up to the collapse. Please provide the Committee with a 
detailed explanation of the ratings for Bear Stearns from 
November 2007 and March 2008. In addition, please answer the 
following questions.

      Were any of the ratings downgraded between 
December 2007 and March 14, 2008?

      Were any of the ratings downgraded during the 
week of the collapse (March 10-14)?

      Can you explain from your agency's point of view 
how Bear's collapse unfolded and the role the ratings may have 
played?

      Do you think the lack of changes to the Bear 
Stearns' ratings is an example of a unique event in the markets 
or an indication of larger flaws in the structure of the 
ratings?

      Under ideal circumstances, would you agree that 
the ratings should have been downgraded to more accurately 
reflect Bear's risk?

      What lessons do you think we should take from the 
Bear Stearns collapse as it relates to the credit ratings?

      What are your thoughts on a proposal Professor 
Coffee discussed at the hearing for rating agencies to 
periodically update ratings?

A.1. The ``A+'' long-term Issuer Default and senior debt 
ratings reflected Fitch's view that Bear Stearns' capacity for 
payment of financial commitments was strong, but more 
vulnerable to changes in circumstance or economic conditions 
than higher rated obligors. Positive rating considerations 
included leading franchises in clearing and securities 
settlement and fixed income and equities securities sales and 
trading. The company had a conservative market and credit risk 
culture as regards proprietary trading and investment banking 
relative to peers. Senior executives at Bear Stearns had 
established a culture of no surprises and accountability which 
had served them well, demonstrated by a very long history of 
good and steady profits. There was minimal turnover at high 
ranks and material employee ownership indicated a degree of 
alignment of the firm's interests with those of its customers.
    Fitch analysts meet with broker dealer issuers several 
times a year to assess business risk and strategies as well as 
review principal ratings factors already listed above. We also 
maintain an open dialogue through regular conversations, pre-
earnings calls and regular information requests on business and 
balance sheet conditions.
    Fitch published a special analysis on liquidity in August 
2007, following market liquidity pressures in July and August. 
Information requests also increased once the volatile markets 
began in earnest in August 2007. Bear Stearns and other issuers 
provide us with updates on exposures and commitments to 
leveraged loans, commercial real estate, ABS CDOs, mortgage 
inventory, counterparty credit relationships to financial 
guarantors and hedge funds. We also obtain regular updates on 
liquidity and market volatility trends.
    Bear Stearns' funding structure was similar to peers 
although net adjusted leverage was slightly lower. Bear Stearns 
assumed significant operational and reputation risk from its 
global clearing and prime brokerage business but had managed 
this risk very well historically. Strategic expansion was 
thoughtful and carefully balanced against its expenses 
resulting in reduced revenue diversification as compared to 
peers. Product expansion typically lagged industry trends. 
Diversification was limited by this both geographically and on 
the product side. The firm had more limited revenues outside 
the U.S. The firm had recently been investing in its asset 
management business to build higher fee revenues often seen as 
ballast against trading results. Its support of a managed hedge 
fund in June 2007 was a marked departure for Bear Stearns.
    On November 14, 2007, Fitch downgraded a number of Bear 
Stearns' ratings. Full rating histories are attached. At the 
parent company level, the Short-term Issuer Default Rating of 
BSC was lowered to ``F1'' and the Individual rating (a measure 
of standalone financial strength) was lowered to ``B/C''. 
Additionally, the rating outlook was revised to ``Negative'' 
from ``Stable''. The downgrades reflected Fitch's view that 
Bear Stearns' near term profitability was expected to be weak, 
pressured by its exposure to the U.S. mortgage market as a 
whole. Its global clearing and equities businesses were 
performing well, however; Fitch believed financial performance 
in 2008 would remain challenging given the scale of Bear 
Stearns' fixed income business and more limited international 
scope. Liquidity had been managed well and remained adequate 
but deteriorating conditions in the capital markets were 
considered a potential threat to Bear Stearns' financial 
flexibility. Fitch highlighted that future downgrades could 
result from declines in earnings, severe negative valuation 
adjustments, an increased risk profile, diminished liquidity, 
rising leverage and/or tangible equity erosion.
    In December, Fitch continued the Negative Outlook following 
Bear Stearns' earnings release of FY07 results in a published 
press release. Bear Stearns posted its first quarterly loss in 
its history and was mildly profitable for FY07. The firm took 
$1.9 billion in mortgage inventory write-downs. Liquidity 
measures had improved during the last half of 2007. Ratings 
were not downgraded further during the period March 10-13, 
2008.
    On March 14, 2008, Fitch lowered all ratings on Bear 
Stearns and its subsidiaries rated by Fitch. The parent company 
Long-term Issuer Default Rating was lowered to ``BBB'' from 
``A+'' and the Short-term Issuer Default Rating was lowered to 
``F3'' from ``F1''. The Individual rating was lowered to ``C/
D'' from ``B/C''. All issue ratings were also placed on Rating 
Watch Negative. The Support rating was raised from ``5'' to 
``3'', reflecting the secured loan agreement concluded with JP 
Morgan Chase.
    Bear Stearns suffered a rapid decline in liquidity over a 
24-hour period. In February and early March, there was 
unprecedented spread widening in all credit and particularly in 
mortgage products as the failure of several high profile hedge 
funds pressured prices. Liquidity had dried up in almost the 
entirety of the domestic mortgage-backed securities market, 
including unprecedented credit spread widening in ``AAA''-rated 
US Agency paper.
    Bear Stearns had a capital base that was the smallest of 
the bulge bracket and had the highest percentage of its 
securities inventory in mortgage based assets. It was the 
lowest rated broker dealer at Fitch. As indicated above, Fitch 
had downgraded its Short-term ratings to ``F1'' in November and 
the Negative Outlook indicated a probability that its rating 
may face further downgrades. Bear Stearns also possessed a high 
market share in providing financing to fixed income hedge 
funds. Fitch believes these factors all led to increasing 
reluctance by investors to hold its paper, particularly as 
their quarter end was approaching.
    Fitch believes that market conditions were highly volatile 
for several weeks preceding the Bear Stearns' failure. Unique 
elements include the unprecedented spread widening in products 
that had been highly liquid for years and through multiple 
stress scenarios. While similarities can be drawn between this 
period and market conditions in the fall of 1998, there are 
numerous unique elements including the turmoil in domestic RMBS 
markets, the absence of Fannie Mae and Freddie Mac in active 
purchases of mortgages due to portfolio caps, the existence of 
the mortgage-based ABX indexes allowing greater speculation and 
accumulation of short positions, and the increase in hedge fund 
and statistically-based program trading in fixed income and 
equities. Fitch believes these market conditions likely 
resulted in the acceleration of the rate of deterioration.
    It is very difficult to attribute ``what if'' scenarios to 
the operations of financial markets since human reaction can be 
so unpredictable. Ratings consider the diversification of 
sources, tenor and types of unsecured funding as well as its 
reliance and ability to withstand periods of illiquidity. 
Treasury management is an integral part of the culture and 
management of these firms and risk mitigation takes multiple 
forms including short term limits to rollover risk, investor 
concentrations and availability of unencumbered assets. 
Contingency funding plans are detailed and make various 
assumptions on the firm's ability to shift from an unsecured to 
a secured environment.
    Fitch noted a shift in industry trends since 1998. The 
industry and Bear Stearns, in particular, reduced reliance on 
unsecured credit sources, emphasizing the extension of long-
term funds, the use of bank charters to support certain 
businesses and increased reliance on secured bank funding 
agreements to support the growing inventory of illiquid assets.
    Bear Stearns' liquidity ratios were on target with peers. 
Its funding coverage of less liquid assets was the strongest of 
peers having limited credit granted to investment banking 
clients, merchant bank and private equity funds and generally 
conservative posture in expanding its balance sheet. It also 
maintained a relatively conservative capital structure with 
minimal levels of hybrid capital issuances versus peers.
    While we strive to incorporate a prospective view in our 
ratings, Fitch believes that the evolving credit stress has 
elements of great severity and rapidity not previously 
foreseen. We are evaluating this scenario, as well as the 
recent programs modified by the U.S. Federal Reserve in the 
ongoing ratings assessment of the other U.S. based brokers. 
Three of the remaining four are presently assigned a Rating 
Outlook of Negative.
    Our ratings are subject to continuous review, other than 
where expressly disclosed as point-in-time in nature. This 
means that any material event can cause a rating action for any 
rating at any time. Fitch is staffed to ensure that sufficient 
analysts of appropriate experience are available to attend 
whenever committees need to be called.
    The topic of ``bunching'' actual rating actions to meet 
pre-determined dates has also recently been discussed in the 
context of regulatory consultations in Europe, and we 
understand that the overwhelming majority of rating users do 
not see a benefit in such an idea.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ARTURO 
                        CIFUENTES, PH.D.

Q.1. Dr. Cifuentes, in your testimony you point out that rating 
agencies were originally created to provide investors with 
information about credit risk. Later, ratings were used by 
regulators for a variety of other purposes including 
determining capital requirements and establishing investment 
guidelines for financial institutions.
    Would you please elaborate on your view that ratings that 
are useful for investors may not be necessarily as useful for 
regulators?

A.1. A regulator is mostly concerned with the soundness 
(solvency) of financial institutions; to be precise, whether a 
financial institution has enough capital. In that sense, a 
regulator prefers conservative ratings (that is, ratings that 
err in the direction of ``safety'') and stability (that is, 
ratings that do not change frequently for nobody wants to check 
the solvency of an institution on a daily basis).
    An investor or portfolio manager, on the contrary, benefits 
from accurate (that is, neither conservative not aggressive) 
and unbiased ratings. Moreover, to the extent that investors 
trade securities, they would benefit from timely changes in 
ratings. These objectives lend themselves to ratings that 
should be more ``dynamic'' (change more frequently).
    Therefore, the needs of these two constituencies (stable 
versus dynamic ratings; conservative versus accurate and 
unbiased ratings) are not one-hundred per cent aligned.
    A final observation: Some naive commentators think that the 
ratings agencies secretly welcome the use of ratings by 
regulators because this would help the agencies to secure a 
reliable and steady source of revenue. Actually, the opposite 
is true. In fact, T. J. McGuire, a former Moody's Executive 
Vice President, gave a speech to the SEC in 1995 in which he 
expressed the view that this practice would eventually erode 
the integrity and objectivity of the ratings system. (See T. J. 
McGuire speech delivered on April, 1995 at the Fifth Annual 
International Institute for Securities Market Development, U.S. 
Securities and Exchange Commission, available from 
www.Moodys.com.)

Q.2. Dr. Cifuentes, the credit rating industry is highly 
concentrated with S&P and Moody's each rating more than 90 
percent of rated corporate bonds. Fitch is the only other firm 
that has significant market share. Chairman Cox has indicated 
that the SEC is considering rules to require disclosure about 
the performance of the ratings of each rating agency.
    Do you believe that disclosure of ratings performance data 
would help new credit rating agencies compete with more 
established firms?

A.2. No. I don't think so. Ratings performance data are 
available already and have done little to help potential new 
agencies to compete with the existing ones.
    In my opinion, the most significant obstacles faced by a 
new agency are a bit different: (i) the three-year ``waiting'' 
period (essentially, they need to survive for three years while 
selling ratings that are not accepted by regulators: an 
incredibly tough barrier to entry); (ii) the fact that the 
existing rating agencies have not been sanctioned for their bad 
performance; and (iii) the fact that the new agencies do not 
have access to historical data (bond default frequencies, 
recovery values for defaulted securities, etc.) that Moody's 
and S&P have.

Q.3. Would this disclosure also make rating agencies more 
accountable to investors?

A.3. I don't believe so. Rating agencies, to the extent that 
they can protect themselves under the First Amendment, are 
accountable to nobody. And worse, whether they are accountable 
to investors or not, it is in a sense an academic issue: being 
approved by the SEC is the only thing that matters.
              Additional Material Submitted for the Record
                  As Housing Boomed, Moody's Opened Up
            The Wall Street Journal, Friday, April 11, 2008
                           By AARON LUCCHETTI
    Bond-rating agency Moody's Investors Service used to be an ivory 
tower of finance. Analysts were discouraged from having a drink with a 
client. Phone calls from bankers went unanswered if they rang during 
intense, almost academic debates about credit ratings.
    A decade ago, as the housing market was just beginning to take off, 
Moody's was a small player in analyzing complex securities based on 
home mortgages. Then, Moody's joined Wall Street and many investors in 
partaking of the punch bowl.
    A firm once known for a bookish culture began to focus on the 
market share that affected its own revenue and profit. The rating firm 
became willing, on occasion, to switch analysts if clients complained. 
An executive overseeing mortgage ratings went skydiving with a client. 
By the height of the mortgage-securities frenzy in 2006, Moody's had 
pulled even with its largest competitor, rating nine out of every 10 
dollars raised in these instruments. It gave many of the bonds its 
coveted triple-A rating.
    Profits at the 99-year-old firm, which John Moody started to rate 
railroad bonds, rose 375 percent in six years. The share price 
quintupled.
    Now, Moody's and the other two major rating firms, the Standard & 
Poor's unit of McGraw-Hill Cos. and the Fitch Ratings unit of Fimalac 
SA, are under fire for putting top ratings on securities that 
ultimately collapsed in value. Investors, many of whom relied on 
ratings to signal which securities were safe to buy, have lost more 
than $100 billion in market value. The credibility of the ratings 
system is in tatters as new downgrades of mortgage securities come 
almost weekly. Investigators from Congress, the Securities and Exchange 
Commission and several state attorneys general are examining the rating 
firms' practices.
    Moody's acknowledges it sometimes got things wrong in judging 
mortgage bonds, but says these were honest mistakes and not the result 
of efforts to garner market share. It says it has maintained its rigor 
and objectivity in a rating process that is still adversarial toward 
big investment banks.
    Of the three big rating agencies, Moody's underwent the deepest 
cultural change amid the housing boom. At the heart of the firm's 
gradual transformation into a player in the mortgage game was Brian 
Clarkson, 51 years old, who joined the company as an analyst in 1991 
and became president last August. Mr. Clarkson maintains that his focus 
on making Moody's friendlier to Wall Street was what the company needed 
early this decade. ``We're in a service business,'' he says. ``I don't 
apologize for that.''
    When Mr. Clarkson first joined Moody's, the agency was known as a 
place where analysts often didn't even promptly pick up their phones, 
much less talk extensively to companies whose bonds they were rating. A 
magazine story in the mid '90s attempted to answer the question ``Why 
Everyone Hates Moody's.''
    Mr. Clarkson himself had dealt with Moody's as an outsider, and 
been frustrated with its manner. As he began to rise within the firm, 
he set out to make it more client-friendly and focused on market share. 
Firms like Moody's are hired by companies, governments and other 
organizations that seek to sell bonds. The firms rate bonds based on 
the likelihood they'll default and, in Moody's case, also based on how 
much of their principal bondholders are likely to get back.
    Top-rated triple-A bonds rarely miss payments, and even if they do, 
investors can expect to get nearly all of their money back. Bonds rated 
B and C are more likely to lose money for their owners. To compensate 
for the added risk, they pay higher interest rates. Bond buyers depend 
heavily on the ratings, and conservative investors often buy only 
triple-A bonds.
    Bond issuers, knowing that a higher rating means they pay a lower 
interest rate, have an incentive to shop around among rating agencies. 
And they have clout as they shop: They're the ones paying the bill. 
Moody's toughness gave issuers reason to go elsewhere, and back in the 
mid-1990s, Fitch and S&P were both rating more mortgage bonds than 
Moody's, in large part because their standards were considered easier. 
For instance, in commercial mortgage-backed securities, Moody's trailed 
its two main competitors by 30 percentage points in market coverage in 
1996.
    That year, Mr. Clarkson took over the group at Moody's that 
analyzed such securities. The firm added new analysts and overhauled 
its ratings approach, allowing for higher ratings in the area. Within a 
year, Moody's moved ahead of both Fitch and S&P in the sector. Rivals 
said Moody's had cut its standards. Mr. Clarkson was quoted as calling 
this ``sour grapes.'' He says now that the change in the ratings 
approach was the right call.
    In 1999 Mr. Clarkson took over the part of the firm's ``structured 
finance'' business that oversaw bonds and complex securities based on 
home mortgages. Moody's rated just 14 percent of high-quality ``prime'' 
bonds in that area in the year before he took over, compared with 51 
percent that Fitch rated and 89 percent that S&P rated, as calculated 
by the publication Asset-Backed Alert. (The same bond often gets a 
rating from two different firms.)
    Moody's top home-mortgage analyst at the time, Mark Adelson, took a 
cautious approach that resulted in fewer triple-A ratings. Mr. Clarkson 
shook things up, firing or reassigning about two dozen analysts and 
hiring new ones who started giving higher grades under a new 
methodology. Mr. Adelson left for an investment bank. In 2001, Moody's 
market coverage was up to 64 percent. Mr. Adelson says ``the world 
thought differently than I did'' about mortgage bonds in 1998 and 1999. 
He isn't critical of Mr. Clarkson's management. Mr. Clarkson ``is what 
Moody's needs,'' Mr. Adelson says. ``He's very smart, capable and 
driven.''
    By 2001, Moody's was an independent company. It had long been 
tucked inside financial publisher Dun & Bradstreet Corp., but D&B spun 
it off as a new public company in 2000. Just before it did so, Warren 
Buffett saw the growth and profitability of Moody's business and had 
his Berkshire Hathaway Inc. raise its stake in D&B. Berkshire is now 
Moody's biggest shareholder, with a 19 percent interest. In some areas, 
Moody's continued to make it hard to get a high rating, with the result 
that it didn't do much business in those areas; these areas included 
the riskier part of home-mortgage bonds and products known as net-
interest margin securities.
    Mr. Clarkson encouraged his people to be more responsive picking up 
the phone when in the office and to find ways deals could get done 
within Moody's methodologies. Customer-service coaches gave sessions on 
improving relationships with bond issuers and investors.
    ``Brian (Clarkson) created a dialogue between Moody's and the 
Street that was good,'' says Paul Stevenson, a former Moody's executive 
who now works at BMO Financial Group. But ``the most recent problem,'' 
he says, ``is that the rating process became a negotiation.''
    Consider a Bank of America mortgage deal in early 2001. As in most 
such deals, the vast majority of the securities based on the pool of 
mortgages would be rated triple-A. The question was how big a chunk 
would be rated lower paying a higher interest rate and bearing the 
brunt of any defaults that occurred.
    A rating committee at Moody's voted to require that the issuer put 
about 4.25 percent of the deal's value in the lower-rated section, to 
provide extra protection for buyers of the top-rated section. But after 
Bank of America complained and said it might go with a different rating 
firm, Moody's reduced the size of the lower-rated chunk slightly saving 
the issuer some interest costs according to people with knowledge of 
the matter.
    Linda Stesney, a Moody's managing director who was then co-head of 
mortgage-backed securities, says she doesn't recall the deal. She says 
Moody's reconsidered its view on deals when issuers presented new 
information affecting credit quality. She adds that Moody's mortgage 
ratings at the time held up well.
    In 2002, Mr. Clarkson's realm extended to the fast-growing business 
of CDOs. In this complex product, already-sliced-up bonds are further 
sliced into new pieces, based on risk and potential return. Moody's was 
already rating 90 percent of the dollar value of CDOs. Mr. Clarkson 
told an analyst he didn't want bad service to cause that to slip, say 
people familiar with the matter.
    ``There was never an explicit directive to subordinate rating 
quality to market share,'' says Mark Froeba, a former Moody's analyst 
who recently started a bond valuation company that may compete with 
rating firms.
    ``There was, rather, a palpable erosion of institutional support 
for rating analysis that threatened market share.'' An example would be 
raising too many legal issues on deals, slowing them down 
unnecessarily.
    Mr. Clarkson says the goal was maintaining consistency about the 
issues Moody's raised on deals. ``I have no problem losing deals for 
the right reasons,'' he says. ``We don't change methodology to garner 
market share.''
    Some supporters say that while Mr. Clarkson cared about market 
share, he cared more about the quality of Moody's ratings. Bill May, a 
Moody's managing director, recalls Mr. Clarkson warning him in 2002 
about the things that could get a managing director fired. He says 
inaccurate ratings topped the list, followed by ``arrogant or rude'' 
behavior toward market participants.
    On occasion, Moody's agreed to switch analysts on deals after 
bankers complained. Among banks that requested that a different analyst 
look at their deals were Credit Suisse Group, UBS AG and Goldman Sachs 
Group Inc., according to a person familiar with the matter. The banks 
declined to comment. Mr. May says analysts were switched on ``rare'' 
occasions to accommodate such a request.
    Mr. Clarkson stressed relationships, in a break with tradition at 
the firm, whose office in Lower Manhattan is adorned with sepia-toned 
pictures of its founder. John Bohn, Moody's president from 1989 to 
1996, says he used to tell recruits that Moody's was a ``special 
business'' where ``you can't go out for beers'' with friends who worked 
for investment banks.
    Mr. Clarkson's view is that ``it's important to socialize.'' The 
onetime mountain climber and recreational weightlifter met with 
investment-bank officials and gave speeches at industry conferences 
peppered with movie quotes and references to television shows like 
``Survivor.''
    When Moody's sought to rate more deals for GMAC's residential-
finance unit in the late 1990s, Moody's officials traveled to the 
company's Minneapolis offices several times. Mr. Clarkson and several 
others from Moody's accepted an invitation to go skydiving with 
officials of the GMAC unit. ``We paid our own way,'' Mr. Clarkson 
recalls.
    Some analysts say they occasionally would attend the dinners that 
celebrated the launch of a new CDO Moody's had just rated. Moody's says 
it has rules to prevent conflicts, including a $50 limit on gifts, and 
that building better relationships with Wall Street officials was part 
of its effort to be more transparent in its rating methodologies.
    As Moody's staff grew to accommodate the surging mortgage market, 
Mr. Clarkson arranged off-site meetings for employees to get to know 
each other better. At one, he sung as a Blues Brother, while at 
another, two Moody's executives entertained by wrestling in fat suits.
    Mr. Clarkson's structured-finance group grew to account for about 
43 percent of Moody's revenue in 2006, up from 28 percent in 1998. By 
2006, the firm had more revenue from structured finance $881 million 
than its entire revenue had been in 2001.
    Employees, though paid a fraction of what they could earn on Wall 
Street, sometimes grew wealthy from Moody's surging share price and 
their stock options. According to a regulatory filing, Mr. Clarkson's 
compensation totaled $3.8 million in 2006. The firm's chief executive, 
Raymond McDaniel, earned $8.2 million that year, more than twice what 
his predecessor made in 2000. Moody's says the rise in their 
compensation reflected growth in the overall business, not just the 
mortgage area, and that much of the rise came from the increasing value 
of stock options that had been granted years before.
    By early 2007, some Moody's analysts were growing worried about the 
market for securities backed by subprime mortgages. But Mr. McDaniel 
told a group of investors in May 2007: ``The good-news story for us'' 
includes ``very strong growth coming out of our largest business, which 
is the structured-finance business. It is both large and a significant 
growth engine for the company.''
    Despite some analysts' concerns, Moody's rated about 94 percent of 
the $190 billion in mortgage-related and other structured-finance CDOs 
issued in 2007, the second busiest year ever. Many of those CDOs have 
since been downgraded, some from triple-A to levels that suggest 
investors will have significant losses. Moody's says some bonds it 
rated were backed by fraudulent loans. It also notes that it wasn't 
alone in being surprised by the depth of the housing decline. ``We were 
preparing for a rainstorm and it was a tsunami,'' Mr. Clarkson says.
    Since becoming Moody's president in August, he is spending up to 
half of some weeks dealing with regulators. ``They want the same things 
we do,'' he says. Some options that Moody's is considering to improve 
its process such as adding new labels to structured-finance ratings to 
convey the products' unique attributes and risks were earlier raised by 
regulators.
    Mr. Clarkson says analysts have kept their ``adversarial'' 
approach, but adds, ``One of the things we have to do going forward is 
be more skeptical.''
