[Senate Hearing 111-673, Volume 3]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 111-673



                               before the


                                 of the

                              COMMITTEE ON
                         HOMELAND SECURITY AND
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                             SECOND SESSION


                             VOLUME 3 OF 5


                             APRIL 23, 2010


       Available via http://www.gpoaccess.gov/congress/index.html

       Printed for the use of the Committee on Homeland Security
                        and Governmental Affairs


                             VOLUME 3 OF 5

57-321                    WASHINGTON : 2010
For sale by the Superintendent of Documents, U.S. Government Printing Office, 
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                                                        S. Hrg. 111-673




                               before the


                                 of the

                              COMMITTEE ON
                         HOMELAND SECURITY AND
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                             SECOND SESSION


                             VOLUME 3 OF 5


                             APRIL 23, 2010


       Available via http://www.gpoaccess.gov/congress/index.html

       Printed for the use of the Committee on Homeland Security
                        and Governmental Affairs


               JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan                 SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii              TOM COBURN, Oklahoma
THOMAS R. CARPER, Delaware           JOHN McCAIN, Arizona
MARK L. PRYOR, Arkansas              GEORGE V. VOINOVICH, Ohio
MARY L. LANDRIEU, Louisiana          JOHN ENSIGN, Nevada
CLAIRE McCASKILL, Missouri           LINDSEY GRAHAM, South Carolina
JON TESTER, Montana                  ROBERT F. BENNETT, Utah
PAUL G. KIRK, JR., Massachusetts

                  Michael L. Alexander, Staff Director
     Brandon L. Milhorn, Minority Staff Director and Chief Counsel
                  Trina Driessnack Tyrer, Chief Clerk
         Patricia R. Hogan, Publications Clerk and GPO Detailee


                     CARL LEVIN, Michigan, Chairman
THOMAS R. CARPER, Delaware           TOM COBURN, Oklahoma
MARK L. PRYOR, Arkansas              SUSAN M. COLLINS, Maine
CLAIRE McCASKILL, Missouri           JOHN McCAIN, Arizona
JON TESTER, Montana                  JOHN ENSIGN, Nevada
PAUL G. KIRK, JR., Massachusetts
            Elise J. Bean, Staff Director and Chief Counsel
                         David H. Katz, Counsel
                        Laura E. Stuber, Counsel
            Christopher J. Barkley, Minority Staff Director
               Anthony G. Cotto, Counsel to the Minority
                     Mary D. Robertson, Chief Clerk

                            C O N T E N T S

Opening statements:
    Senator Levin................................................     1
    Senator Kaufman..............................................     8
Prepared statements:
    Senator Levin................................................   105
    Senator Coburn...............................................   112

                         Friday, April 23, 2010

Frank L. Raiter, Former Managing Director, Residential Mortgage 
  Rating Group, Standard & Poor's................................    10
Richard Michalek, Former Vice President and Senior Credit 
  Officer, Structured Derivative Products Group, Moody's 
  Investors Services.............................................    12
Eric Kolchinsky, Former Team Managing Director, Structured 
  Derivative Products Group, Moody's Investors Service...........    14
Arturo Cifuentes, Ph.D., Former Moody's Senior Vice President, 
  Current Director, Finance Center, University of Chile, 
  Santiago, Chile................................................    16
Susan Barnes, Current Managing Director, Mortgage-Backed 
  Securities, Former North American Practice Leader, Residential 
  Mortgage-Backed Securities, Standard & Poor's..................    45
Yuri Yoshizawa, Group Managing Director, Structured Finance, 
  Moody's Investors Service......................................    47
Peter D'Erchia, Current Managing Director, U.S. Public Finance, 
  Former Global Practice Leader, Surveillance, Standard & Poor's.    48
Raymond W. McDaniel, Jr., Chairman and Chief Executive Officer, 
  Moody's Corporation............................................    76
Kathleen A. Corbet, Former President (2004-2007), Standard & 
  Poor's.........................................................    78

                     Alphabetical List of Witnesses

Barnes, Susan:
    Testimony....................................................    45
    Prepared statement...........................................   155
Cifuentes, Arturo, Ph.D.:
    Testimony....................................................    16
    Prepared statement with attachments..........................   144
Corbet, Kathleen A.:
    Testimony....................................................    78
    Prepared statement...........................................   210
D'Erchia, Peter:
    Testimony....................................................    48
    Prepared statement...........................................   173
Kolchinsky, Eric:
    Testimony....................................................    14
    Prepared statement...........................................   140
McDaniel, Raymond W., Jr.:
    Testimony....................................................    76
    Joint prepared statement with Yuri Yoshizawa.................   186
Michalek, Richard:
    Testimony....................................................    12
    Prepared statement...........................................   119
Raiter, Frank L.:
    Testimony....................................................    10
    Prepared statement...........................................   114
Yoshizawa, Yuri:
    Testimony....................................................    47
    Joint prepared statement with Raymond McDaniel...............   186

                              EXHIBIT LIST

 1.a. Memorandum from Permanent Subcommittee on Investigations 
  Chairman Carl Levin and Ranking Minority Member Tom Coburn to 
  the Members of the Subcommittee................................   220

   b. Excerpts from Documents Related to Credit Rating Agencies: 
  Competitive Pressures Affecting Ratings, chart prepared by the 
  Permanent Subcommittee on Investigations.......................   231

   c. Excerpts from Documents Related to Credit Rating Agencies: 
  Ratings Methodology, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   234

   d. Excerpts from Documents Related to Credit Rating Agencies: 
  Deteriorating Subprime Mortgages, chart prepared by the 
  Permanent Subcommittee on Investigations.......................   236

   e. Excerpts from Documents Related to Credit Rating Agencies: 
  Grandfathering, chart prepared by the Permanent Subcommittee on 
  Investigations.................................................   238

   f. Excerpts from Documents Related to Credit Rating Agencies: 
  Chronic Resource Shortages, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   240

   g. Revenue of the Three Credit Rating Agencies: 2002-2007. 
  Source: this matter.com/money..................................   242

   h. 2006 Originations and RMBS Issuance. Source: Standard & 
  Poor's Rating Services, U.S. Residential Mortgage Subprime 
  Market, March 29, 2007.........................................   243

   i. Percent of the Original AAA Universe Currently Rated Below 
  Investment Grade. Source: Blackrock Solutions as of February 8, 
  2010. Prepared by the Permanent Subcommittee on Investigations.   244

   j. Estimation of Housing Bubble: Comparison of Recent 
  Appreciation vs. Historical Trends, chart prepared by Paulson & 
  Co, Inc........................................................   245

   k. Biggest Clients of the Credit Rating Agencies. Source: 
  Anna Katherine Barnett-Hart, ``The Story of the CDO Market 
  Meltdown,'' March 2009.........................................   246

   l. Cash Flow & Hybrid Mezzanine SF CDOs of ABS: Exposure to 
  Subprime RMBS Collateral by Cohort. Source: Standard & Poor's, 
  ``Overview and Impact of the Residential Subprime Market,'' 
  March 2007.....................................................   247

  m. Typical Structure of a Residential Mortgage Backed 
  Security. Source: Standard & Poor's data. Prepared by the 
  Permanent Subcommittee on Investigations.......................   248

      Documents Related to Competitive Pressures Affecting Ratings

Standard & Poor's Documents:

 2. Standard & Poor's internal email, dated May 2004, re: 
  Competition with Moody's (We just lost a huge Mizuho RMBS deal 
  to Moody's. . . . *** Losing one or even several deals due to 
  criteria issues, but this is so significant that it could have 
  an impact in the future deals.)................................   249

 3. Standard & Poor's internal email, dated August 2004, re: SF 
  CIA: CDO methodology invokes reactions (We are meeting with 
  your group this week to discuss adjusting criteria for rating 
  CDOs of real estate assets this week because of the ongoing 
  threat of losing deals. *** Lose the CDO and lose the base 
  business - a self reinforcing loop.)...........................   250

 4. Standard & Poor's internal email, dated November 2004, re: 
  APB Meeting - Nov 4 (I think the criteria process must include 
  appropriate testing and feedback from the marketplace.)........   254

 5. Standard & Poor's internal email, dated March 2005, re: 
  LEVELS 5.6(c) (Version 6.0 could've been released months ago 
  and resources assigned elsewhere if we didn't have to massage 
  the sub-prime and Alt-A numbers to preserve market share. *** 
  We have known for some time (based upon pool level data and 
  LEVELS 6.0 testing) that--Subprime: B and BB levels need to be 
  raised--ALT A: B, BB and BBB levels need to be raised (we have 
  had a disproportionate number of downgrades)...................   258

 6. Standard & Poor's internal email, dated June 2005, re: 
  Privileged Criteria Deliberations: CWHEQ 2005-C (Why these 
  questions come up every month is obvious--issuers don't like 
  the outcome. However, the right thing to do is to educate all 
  the issuers and bankers and make it clear that these are the 
  criteria and that they are not-negotiable. If this is clearly 
  communicated to all then there should be no monthly questions. 
  . . . *** Screwing with criteria to ``get the deal'' is putting 
  the entire S&P franchise at risk--it's a bad idea.)............   261

 7. Standard & Poor's internal email, dated February 2006, re: 
  EMC Compares (I don't think this is enough to satisfy them. 
  What's the next step?).........................................   263

 8. Standard & Poor's internal email, dated February 2006, re: 
  comstock (If our current structure, which we have been 
  marketing to investors and the mgr, (and which we have been 
  doing prior to the release of the beta cash flow assumptions) 
  doesn't work under the new assumptions, this will not be good. 
  Happy to comply, if we pass, but will ask for an exception if 
  we fail . . .).................................................   267

 9. Standard & Poor's internal email, dated May 2006, re: 
  Privileged & Confidential Committee Deliberations - Madaket 
  Funding (I submit for your consideration the banker's argument 
  to waive the one failing run.).................................   269

10.a. Standard & Poor's internal email, dated May 2006, re: 
  Broadwick Funding (It was a known flaw not only in that 
  particular ABACUS trade, but in pretty much all ABACUS trades . 
  . .)...........................................................   271

   b. Standard & Poor's internal email, dated April 2006, re: 
  ABACUS 2006-12 - Writedowns immediately prior to Stated 
  Maturity (Don't even get me started on the language he cites . 
  . . which is one of the reasons I said the counterparty 
  criteria is totally messed up.)................................   275

   c. Standard & Poor's internal email, dated May 2005, re: 
  Adirondack CDO (. . . this is exactly the kind of backroom 
  decision-making that leads to inconsistent criteria, confused 
  analysts, and pissed-off clients.).............................   279

11. Standard & Poor's internal email, dated May 2006, re: 
  Confidential - Criteria Changes in LEVELS 5.7 (We certainly did 
  intend to do anything to bump us off a significant amount of 
  deals. *** [H]eard your ratings could be 5 notches back of 
  moddys [sic] equivalent. [G]onna kill your resi biz.)..........   287

12. Standard & Poor's internal email, dated June 2006, re: 
  question on impact to CDOs (We assume this scenario to be 
  negative for the corporate business because Moody's will be 
  giving out higher ratings on secured loans so issuers will be 
  less likely to ask for an S&P rating on the issue.)............   288

13. Standard & Poor's internal email, dated August 2006, re: Can 
  you call me? Have left you numerous messages (How many millions 
  does Morgan Stanley pay us in the greater scheme of things? How 
  many times have I accommodated you on tight deals?)............   290

14. Standard & Poor's internal email, dated August 2006, re: 
  Loss severity vs gross/net proceeds (They've become so beholden 
  to their top issuers for revenue they have all developed a kind 
  of Stockholm syndrome which they mistakenly tag as Customer 
  Value creation . . .)..........................................   293

Moody's Documents:

15. Moody's internal email, dated December 2003, re: Noel Kirnon 
  (The Derivatives team has achieved a year to date 96% market 
  share compared to a target share of 95%.)......................   295

16. Moody's internal email, dated January 2006, re: BES and PEs 
  (Top Achievements in ``05: 1. Protected our market share in the 
  CDO corporate cash-flow sector . . .)..........................   296

17. Moody's internal email, dated April 2006, re: Jay Siegel 
  Exit Interview (He described RMBS as the worst team to work on 
  at Moody's. It is difficult to maintain market share in a 
  market that has become commoditized and where Moody's expected 
  loss analysis means higher cost for issuers.)..................   297

18. Moody's internal email, dated April 2006, re: MGIC Home Re 
  2006-1 Committee#3 (At this point, I would feel comfortable 
  keeping the previously committeed levels since such a large 
  adjustment would be hard to explain to Bear, . . .)............   299

19. Moody's internal email, dated May 2006, re: Magnolia 2006-5 
  Class Ds (I am worried that we are not able to given these 
  complicated deals the attention they really deserve, and that 
  they (CS) are taking advantage of the ``light'' review and the 
  growing sense of ``precedent''.)...............................   302

20. Moody's internal email, dated October 2006, re: managing 
  expectations: 2 different stories (I mention this to reinforce 
  the expectation that concessions we make in the interest of 
  getting the deal(s) rated will be used against us.)............   307

21. Moody's internal email, dated December 2006, re: legal 
  points outstanding (Have been speaking to Plamen and my feeling 
  is that the only way we'll maybe get Taberna to agree to the 
  covenants is if you rate down to Aa2 on the B Notes at the same 
  levels as the other agencies.).................................   308

22. Moody's internal email, dated March 2007, re: DQ Hit for 
  Jake's ACE Deal (I just spoke with Sue Valenti at Deutsche 
  regarding this deal and she is resisting the changes to the LC 
  levels. She is pushing back dearly saying that the deal has 
  been marketed already and that we came back ``too late'' . . .)   312

23. Moody's internal email, dated June 2007, re: Rating 
  application for Belden Point CDO (We are okay with the revised 
  fee schedule for this transaction. We are agreeing to this 
  under the assumption that this will not be a precedent for any 
  future deals and that you will work with us further on this 
  transaction to try to get to some middle ground with respect to 
  the ratings.)..................................................   315

24.a. Moody's internal email, dated October 2007, re: 3Q Market 
  Coverage-CDO (Market share by deal count dropped to 94%, though 
  by volume it's 97%. It's lower than the 98+% in prior quarters. 
  Any reason for concern, are issuers being more selective to 
  control costs (is Fitch cheaper?) or is it an aberration.).....   318

   b. Moody's internal email, dated October 2007, attached copy 
  of Moody's internal memorandum, Credit Policy issues at Moody's 
  suggested by the subprime/liquidity crisis, prepared by the 
  Moody's Chief Risk Officer.....................................   319

                Documents Related to Ratings Methodology

Standard & Poor's Documents:

25. Standard & Poor's internal email, dated March 2005, re: 
  Wachovia Report Cites Questions Of S&P's Integrity (I would 
  like to discuss how we plan on ultimately ``spinning'' our 
  revised correlation assumptions . . .).........................   324

26. Standard & Poor's internal email, dated May 2006, re: an 
  error in the new correlation assumptions? (I have already 
  brought this issue up and it was decided that it would be 
  changed in the future, . . .)..................................   326

27. Standard & Poor's internal email, dated December 2006, re: 
  Synthetic CDO-2 of ABS (both Cash and Synthetic) (Rating 
  agencies continue to create and [sic] even bigger monster - the 
  CDO market. Let's hope we are all wealthy and retired by the 
  time this house of cards falters.).............................   328

28. Standard & Poor's internal email, dated January 2007, re: 
  Summary of Conference Call (Can anyone give me a crash course 
  on the ``hidden risks in CDO's of RMBS''?).....................   330

29. Standard & Poor's internal email, dated March 2007, re: 
  Proposed plan for review of criteria (This is because our 
  published criteria as it currently stands is a bit too unwieldy 
  and all over the map in terms of being current or 
  comprehensive. . . . our SF rating approach is inherently 
  flexible and subjective, while much of our written criteria is 
  detailed and prescriptive.)....................................   332

30.a. Standard & Poor's instant message, dated April 2007, (we 
  rate every deal . . . it could be structured by cows and we 
  would rate it).................................................   337

   b. Standard & Poor's instant message, dated May 2007, (no 
  body gives a straight answer about anything around here anyway 
  *** how about we come out with new criteria or a new stress and 
  actually have clear cut parameters on what the hell we are 
  supposed to do)................................................   338

31. Standard & Poor's internal email, dated May 2007, re: 
  Modelling of some spread compression on Static CDOs (. . . the 
  cash-flow criteria from 2004 . . . actually states that . . . 
  in the usual vague S&P's way . . . Still, consistency is key 
  for me and if we decide we do not need that, fine but I would 
  recommend we do something. Unless we have too many deals in US 
  where this could hurt.)........................................   340

32. Standard & Poor's internal email, dated July 2007, re: 
  Weekly RMBS/CDO Surveillance performance update (It remains to 
  been [sic] seen if S&P is really prepared to witness drastic 
  rating actions, just to avoid the slower ``notching'' process 
  and public criticism.).........................................   344

33. Standard & Poor's internal email, dated September 2007, re: 
  SIFMA Rating Agency Panel October 4 (I have tried to stay away 
  from underlying rating performance and place the issue more on 
  the newness of the underwriting standards that defied all 
  common sense.).................................................   351

34. Standard & Poor's internal email, dated November 2007, re: 
  Resi Mortgage Operations - Conduit & Originator Reviews (We 
  believe our analytical process and rating opinions will be 
  enhanced by an increased focus on the role third parties can 
  play in influencing loan default and loss performance. . . . 
  Should have been doing this all along.)........................   357

Moody's Documents:

35. Moody's internal email, dated January 2006, re: 2006 
  Priorities for M3 team (Not recalibrating the Prime model and 
  not fixing the simulation will create a growing number of 
  inconsistencies (problems) in the existing models as was the 
  case through most of 2004.)....................................   359

36. Moody's internal email, dated April 2006, re: Goldman CES 
  Deal: Building OC with Cap (I am getting serious pushback from 
  Goldman on a deal that they want to go to market with today. . 
  . . oldman needs more of an explanation (I do not know how to 
  get around this without telling them we were wrong in the 
  past).)........................................................   361

37. Moody's internal email, dated October 2006, re: Pro-rata 
  modeling criteria (Our problem here is that nobody has told us 
  about the changes that we are later expected to adhere to. 
  Since there is no published criteria outlining the change in 
  methodology how are we supposed to find out about it?).........   362

38. Moody's internal email, dated April 2007, (If in our opinion 
  15% of the ratings are inflated, the impact to the cdo note 
  ratings would be significant.).................................   366

39. Moody's internal email, dated June 2007, re: Please READ M-1 
  sign off (Over time, different chairs have been giving 
  different guidelines at different point of time on how much 
  over-enhancement we need for a bond to be notched up to Aaa, . 
  . .)...........................................................   367

40. Moody's internal email, dated August 2007, re: Seasoning 
  benefit in Alt-A model is fully functional now (. . . maybe 
  this is more like rearranging the deck chairs on the Titanic . 
  . .)...........................................................   368

41. Moody's internal email, dated August 2007, re: UBS CDO 
  Research (This is depressing: ``In our skewed sample of 111 
  mezzanine ABS CDOs, collateral losses extend into senior AAA 
  tranches. We predict that 10% of senior AAA tranches we 
  examined will default. Overall, the expected loss of senior AAA 
  tranches is 1%. For BBB tranches, 55% will default and expected 
  losses are 65%. This is horrible from a ratings and risk 
  management point of view; perhaps the biggest credit risk 
  management failure ever.'')....................................   370

42. Moody's internal email, dated August 2007, re: Deal 
  Management (. . . each of our current deals is in crisis mode. 
  This is compounded by the fact that we have introduced new 
  criteria for ABS CDOs. Our changes are a response to the fact 
  that we are already putting deals closed in the spring on watch 
  for downgrade. This is unacceptable and we cannot rate the new 
  deals in the same away [sic] we have done before. . . . bankers 
  are under enormous pressure to turn their warehouses into CDO 
  notes.)........................................................   372

43. Moody's internal email, dated November 2007, re: Fitting a 
  default model on 2006 Alt-A data (My staff is sensitive to both 
  priorities and the risks associates with demands to do 
  something ``quick and dirty'' that then becomes part of a 
  rating process. The reason Ahish pushed back was that the 
  proposed use of the data would quite likely lead to false 
  conclusions that might be used for rating decisions.)..........   373

44. Moody's internal email, dated November 2007, re: Moody's 
  Follow Up (It seems, though, that the more of the ad hoc rules 
  we add, the further away from the data and models we move and 
  the closer we move to building models that ape analysts 
  expectations, no?).............................................   381

         Documents Related to Deteriorating Subprime Mortgages

Standard & Poor's Documents:

45. Standard & Poor's internal email, dated July 2005, re: 
  Washington Mutual (I have been a mortgage broker for the past 
  13 years and I have never seen such a lack of attention to loan 
  risk.).........................................................   383

46.a. Standard & Poor's internal email, dated September 2006, 
  re: Nightmare Mortgages (This is frightening. It wreaks of 
  greed, unregulated brokers, and ``not so prudent'' lenders.)...   384

  b. Standard & Poor's internal email, dated September 2006, re: 
  Nightmare Mortgages (. . . this is like another banking crisis 
  potentially looming!!).........................................   392

47. Standard & Poor's internal email, dated October 2006, 
  forwarding a October 19, 2006, The Wall Street Journal article, 
  More Home Loans Go Sour, and remarking about article, Pretty 
  grim news as we suspected - note also the ``mailing in the keys 
  and walking away'' epidemic has begun - I think things are 
  going to get mighty ugly next year!............................   393

48. Standard & Poor's internal email, dated October 2006, 
  forwarding a October 26, 2006, The Wall Street Journal article, 
  Home Prices Keep Sliding; Buyers Sit Tight, and remarking about 
  article, . . . just curious . . . are there ever any positive 
  repots on the housing market?..................................   396

49. Standard & Poor's internal email, dated February 2007, re: 
  Data sharing between surveillance and servicer evaluations 
  (Also remember, our data is the aggregrate [sic] and most of 
  the deals alledgely [sic] have better (cough, cough) subprime 
  loans.)........................................................   400

50. Standard & Poor's internal email, dated March 2007, re: 
  Subprime Vintage Comparison (After 12 months of seasoning, the 
  2006 vintage had approximately 13% in total delinquencies, . . 
  .).............................................................   404

51. Standard & Poor's internal email, dated March 2007, 
  forwarding a March 8, 2007 BusinessWeek Online article, The 
  Mortgage Mess Spreads; and remarking about article, This is 
  like watching a hurricane from FL moving up the coast slowly 
  towards us.....................................................   407

52.a. Standard & Poor/American Legal & Financial Network email, 
  dated March 2007, re: member firms reaction to troubled 
  servicers (To give you a confidential tidbit among friends the 
  subprime brou haha is reaching serious levels . . .)...........   410

   b. Standard & Poor's, Structured Finance Ratings - Overview 
  and Impact of the Residential Subprime Market, Monthly Review 
  Meeting, March 19, 2007........................................   412

   c. Standard & Poor's internal email, dated March 2007, re: 
  Pre-empting bad press on the subprime situation (In a meeting 
  with Kathleen Corbet today, she requested that we put together 
  a marketing campaign around the events in the subprime market, 
  the sooner the better.)........................................   439

53. Standard & Poor's internal email, dated April 2007, re: PWR 
  16 (. . . unbelievable . . . the bankers make shi**y loans with 
  such skinny margins tha [sic] they can't make any money and 
  expect us to eat it. . . . the opportunity cost of doing the 
  deal at that ridiculously low fee and risking eroding our 
  pricing structure going forward was deemed too high . . .).....   441

54.a. Standard & Poor's internal email, dated July 2007, re: 
  Tomorrow's FT Column - Saskia Sholtes (We did sound like the 
  Nixon White House. Instead of dismissing people like him or 
  assuming some dark motive on their part, we should ask 
  ourselves how we could have so mishandled the answer to such an 
  obvious question. I have thought for awhile now that if this 
  company suffers from an Arthur Andersen event, we will not be 
  brought down by a lack of ethics as I have never seen an 
  organisation [sic] more ethical, nor will it be by greed as 
  this plays so little role in our motivations; it will be 
  arrogance.)....................................................   442

   b. Standard & Poor's internal email, re: November 21, 2006 
  Q&A after Conference Call - How Bad is 2006 Subprime 
  Collateral? (Although the Rating Agencies have ``increased'' 
  their Loss Coverage %, David Liu thinks it will not compensate 
  ``enough'' for the poor performance of year 2006 Subprime 
  collateral. According to David, ``the Rating Agencies were 
  caught off guard, too!'')......................................   446

55. Standard & Poor's internal email, dated November 2007, re: 
  November presentation (Macroeconomic factors as well as the 
  combination of these higher risk characteristics coupled with 
  fraud seem to be the most likely reasons for the anomalous 
  behavior.).....................................................   449

56. Excerpt from The McGraw-Hill Companies, Inc. Minutes, 
  Regular Meeting of Board of Directors, December 5, 2007, (Mr. 
  Terry McGraw noted the 2005-06 vintage loans appear to be the 
  key problem areas in the recent subprime situation.)...........   453

Moody's Documents:

57. Moody's internal email, dated April 2007, re: near future 
  downgrades (Here is what I suggest. I will create a folder on 
  the p-drive: . . . which stores info on subprime RMBS which 
  were identified as potential ``near future downgrades''.)......   457

58. Moody's internal email, dated November 2007, re: Overnightor 
  NY - November 26th (You're right about CDOs as WMD--but it's 
  only CDOs backed by subprime that are WMD.)....................   460

                  Documents Related to Grandfathering

Standard & Poor's Documents:

59. Standard & Poor's internal email, dated June 2004, re: 
  LEVELS (What happens when we migrate to 6.0? Will they want 
  three versions in play, to facilitate pools structured across 
  different time frames?)........................................   463

60. Standard & Poor's internal email, dated June 2005, re: new 
  CDO criteria (The overarching issue at this point is what to do 
  with currently rated transactions if we do release a new 
  version of Evaluator.).........................................   466

61. Standard & Poor's internal email, dated July 2005, re: 
  Evaluator 3 (This has become such an intractable mess!!).......   468

62. Standard & Poor's internal email, dated October 2005, re: 
  Tomorrow's AM Agenda (How do we handle existing deals 
  especially if there are material changes that can cause 
  existing ratings to change?)...................................   471

63. Standard & Poor's internal email, dated October 2005, re: 
  CDO model (It raises several franchise level issues which could 
  be viewed as precedent setting from a policy perspective.).....   474

64. Standard & Poor's internal email, dated November 2005, re: 
  Disclaimer - Help (Lord help our f**king scam . . .)...........   476

65. Standard & Poor's internal email, dated November 2005, re: 
  E3 FAQ (We will also run all deals through both E3/Low and E3/
  High to determine if the result on E2.4.3 is within the 
  tolerance levels.).............................................   478

66. Standard & Poor's internal email, dated December 2005, re: 
  Transition and ongoing surveillance process for E2.4.2 versus 
  E3 (My view is that arrangers will be quite happy to hear that 
  their deal falls within our acceptable tolerance levels and 
  just get on with their trade.).................................   479

67. Standard & Poor's internal email, dated December 2005, re: 
  Call from Abby Moses, Derivatives Week re: status of CDO 
  Evaluator 3 (. . . it would be helpful to have a policy 
  framework communicated to the market on when S&P will apply new 
  criteria in model derived ratings to outstanding transactions 
  and when it won't. . . . we are not being as transparent as we 
  need to be.)...................................................   483

68. Standard & Poor's internal email, dated December 2005, re: 
  E3 docs (The important thing is to begin to ``craft'' the 
  ``politically correct'' external tolerance band message.)......   486

69. Standard & Poor's internal email, dated January 2006, re: 
  LNR ``Rabo Tango are withdrawing any interest from LNR because 
  they had a call with S&P who confirmed that this was being 
  rated off the old methodology.'')..............................   490

70. Standard & Poor's internal email, dated February 2006, re: 
  Fixed Income Activity Report (Though the tolerance bands have 
  provided some ``cushion'' as it pertains to mitigating a rating 
  action based solely on a model based change . . . they have 
  also created confusion given their lack of transparency.)......   492

71. Standard & Poor's internal email, dated March 2006, re: 
  Moody's (The official Moody's line is that there is no 
  ``grandfathering'' and that old transactions are reviewed using 
  the new criteria. However ``the truth is that we do not have 
  the resources to review thousands of transactions, so we focus 
  on those that we feel are more at risk.'').....................   493

72. Standard & Poor's internal email, dated June 2006, re: RMBS 
  LEVELS 5.7 and its Impact on Outstanding Deals (different from 
  cdo *** . . . although the RMBS Group does not ``grandfather'' 
  existing deals, there is not an absolute and direct link 
  between changes to our new ratings models and subsequent rating 
  actions taken by the RMBS Surveillance Group.).................   494

73. Standard & Poor's internal email, dated November 2006, re: 
  Hot Topics Polling Questions (Should S&P consider 
  ``grandfathering'' existing ratings when implementing criteria 
  changes?)......................................................   497

74. Standard & Poor's internal email, dated July 2007, re: 
  Special APB meeting (How do we handle the grandfathering issue 
  in the context of consistent application of criteria.).........   500

75. Standard & Poor's internal email, dated October 2007, re: 
  Here are thoughts around RMBS (Ratings no longer grandfather - 
  need batch processing for all deals rated within 12 months of 
  criteria or model changes)  ...................................   502

Moody's Documents:

76. Moody's internal email, dated May 2007, re: Upcoming CLOs/
  grandfathering list (We appreciate your willingness to 
  grandfather these transactions w/r/t Moody's old methodology.).   504

77. Moody's internal email, dated May 2007, re: Stratford CLO (. 
  . . they thought it would make sense to use the old 
  methodology, . . .)............................................   506
78. Moody's internal email, dated June 2007, re: PDR/LGD 
  methodology (It might be useful to know what our official 
  position is on this issue in case it arises again.)............   508

79. Moody's internal email, dated July 2007, re: Notching Status 
  (Shall we still provide rating for those bond we did not rate 
  then using the old methodology and the old loss coverage 
  number?).......................................................   510

80. Moody's Structured Finance Credit Committee, March 31, 2008, 
  Meeting Notes (Rating changes when methodologies change . . . 
  This decision to selectively review certain ratings is made due 
  to resource constraints.)......................................   512

            Documents Related to Chronic Resource Shortages

Standard & Poor's Documents:

81. Standard & Poor's, Framework For Analytics Policy Board 
  Review of Rating Surveillance Standards, January 27, 2006, (A 
  few areas (Asian Corporates, U.S. public power, student loans 
  and less active RMBS issuers in the U.S.) are substantially 
  below par.). (excerpt).........................................   514
82. Standard & Poor's internal email, dated April 2006, re: 
  Discussion with Lal (Each time I consider what my group is 
  faced with, I become more and more anxious.)...................   522

83. Standard & Poor's internal email, dated June 2006, re: Temp 
  (In addition to the project above that involved some 863 deals, 
  I have a back log of deals that are out of date with regard to 
  ratings.)......................................................   524

84. Standard & Poor's internal email, dated December 2006, re: 
  Please continue temps (Currently, there are nearly 1,000 deals 
  with data loads aged beyond one month.)........................   526

85. Standard & Poor's internal email, dated January 2007, re: 
  Data COE Resources Available for US ABS (. . . I want to take a 
  moment to reiterate my concerns regarding the significant 
  deficit in terms of the # of analysts currently assigned to 
  work on US ABS and RMBS data needs.)...........................   529

86. Standard & Poor's internal email, dated February 2007, re: 
  Headcount for RMBS Surveillance? (I talked to Tommy yesterday 
  and he thinks that the ratings are not going to hold through 
  2007. . . . We do not have the resources to support what we are 
  doing now.)....................................................   531

87. Standard & Poor's internal email, dated February 2007, re: 
  What's the problem now??? (We really need help. Sub prime is 
  going down hill. The 20% not covered in our system is also of 
  great concern.)................................................   535

88. Standard & Poor's internal email, dated April 2007, re: 
  Staffing for RMBS Surveillance (This model shows that the R-
  Surv staff is short by 7 FTE - about 3 Directors, 2 AD's, and 2 
  Associates.)...................................................   536

89. Standard & Poor's internal email, dated October 2007, re: 
  Alt. A Aged List (. . . we will take the appropriate rating 
  action on any of the deals that we reviewed that are on the 
  aged list.)....................................................   538

Moody's Documents:

90. Moody's internal email, dated January 2006, re: 2006 
  Priorities for M3 team (As a new product, good idea--but I 
  think we need full functionality w/M3 first, esp. if we're to 
  remain short-staffed for yet another year.)....................   539

91. Moody's internal email, dated May 2007, re: Paper on inter-
  CDO correlations - update from ABS Steering Committee 
  (Unfortunately, our analysts are owerwhelmed [sic] . . .)......   541

92.a. Moody's SFG 2002 Associate Survey, Highlights of Focus 
  Groups and Interviews, May 2, 2002.............................   543

   b. Moody's Investor Service, BES-2005, Presentation to 
  Derivatives Team, April 7, 2006................................   559

                   Documents Related to Failed Deals

93.a. Moody's internal email, dated December 2006, re: Subprime 
  performance (Holy cow - is this data correct? I just graphed it 
  and Freemont is such an outlier!!).............................   587

   b. Standard & Poor's internal email, dated January 2007, re: 
  Quick question: Fremont (No, we don't treat their collateral 
  any differently . . .).........................................   589

   c. Standard & Poor's internal email, dated January 2007, re: 
  Quick question: Fremont (Since Fremont collateral has been 
  performing not so good, is there anything special I should be 
  aware of?).....................................................   590

   d. Standard & Poor's internal email, dated February 2007, 
  forwarding a January 29, 2007 Reuters article, Defaults cause 
  Fremont to end ties to 8,000 brokers...........................   592

   e. Moody's downgrade of GSAMP Trust 2007 - FM2 containing 
  Fremont mortgages..............................................   594

   f. Standard & Poor's downgrade of GSAMP Trust 2007 - FM2 
  containing Fremont mortgages...................................   595

94.a. Standard & Poor's instant message, dated April 2007, (i 
  heard some fury . . . james yao at ubs)........................   598

   b. Standard & Poor's internal email, dated April 2007, re: 
  Vertical 2007-1/UBS/James Yao (Don't see why we have to 
  tolerate lack of cooperation. Deals likely not to perform.)....   599

   c. Standard & Poor's internal email, dated April 2007, re: 
  VERTICAL ABS CDO 2007-1, LTD.UBS (Sarah and I have been working 
  with James Yao from UBS but we have not been getting 
  cooperation from him.).........................................   600

   d. Moody's Pre-Closing Committee Memorandum, Closing: April 
  10, 2007, Deal: Vertical ABS CDO 2007-1, Ltd. (Vertical ABS CDO 
  2007-1, Ltd. is a mezzanine Hybrid ABS transaction that is 
  expected to be 95% synthetic (CDS assets) at closing.).........   601

   e. List of assets included in Vertical ABS CDO 2007-1, 
  prepared by Moody's............................................   614

   f. Moody's internal email, dated October 2007, re: Updated: 
  Rating Review Committee - Vertical ABS CDO 2007-1 EOD (Eric and 
  I spoke to UBS. They said that they still have not decided 
  whether to liquidate or keep the deal as is . . .).............   617

   g. Fitch internal email, dated October 2007, re: Vertical 
  Capital (. . . Vertical has over a dozen CDOs outstanding. Most 
  of the 2007 deals we are reviewing are rapidly encountering 
  serious difficulties . . .)....................................   618

   h. Standard & Poor's internal email, dated October 2007, re: 
  (BMP) Moody's Downgrades Vertical ABS CDO 2007-1 Notes; Further 
  (Oh, well. The cat is out of the bag.).........................   620

   i. Moody's internal email, dated October 2007, re: Debtwire: 
  (DW) ABS CDOs begin to liqudate; rating agency downgrades 
  ``detonating'' market, source says (. . . the picture is not 
  pretty.).......................................................   624

   j. Standard & Poor's internal email, dated October 2007, re: 
  Vertical CDO 2007-1 (. . . this is fairly urgent . . . We want 
  to review this transaction and see the results under the worst 
  possible outcome.).............................................   626

   k. Moody's downgrade of Vertical ABS CDO 2007-1, Ltd.........   629

   l. Excerpts from Connecticut Superior Court Memorandum Of 
  Decision on Plantiffs'' Application For A Prejudgment Remedy 
  (#124), Pursuit Partners, LLC et al v. UBS AG et al, September 
  8, 2009. (excerpts)............................................   630

  m. UBS internal email, dated August 2007, re: Mezz CDO 
  Offerings (Here is some new stuff we would offer the vertical . 
  . .)...........................................................   642

   n. UBS internal email, dated August 2007, (sold some more 
  crap to pursuit.)..............................................   644

   o. UBS internal email, dated July 2007, re: ABS Subprime & 
  Moody's downgrades (It sounds like Moodys is trying to figure 
  out when to start downgrading, and how much damage they're 
  going to cause--they're meeting with various investment banks.)   645

95.a. Moody's internal email, dated July 2007, re: Analyst for 
  Brighton (The reason is that Delphinus was a mezz deal with a 
  lot of cushion, so we did not really care that much.)..........   646

   b. Standard & Poor's internal email, dated August 2007, re: 
  Delphinus closing date vs effective date (Yes, the concern is 
  that the deal would've never passed (and actually would've been 
  worse) if they included the assets that they claimed they are 
  dummies.)......................................................   647

   c. Excerpt from Moody's Main Rating Change Report for 
  Delphinus CDO 2007-1, Ltd......................................   651

   d. Moody's downgrade of Delphinus CDO 2007-1, Ltd............   652

   e. Standard & Poor's downgrade of Delphinus CDO 2007-1 Ltd...   654

96.a. Standard & Poor's internal email, dated August 2007, re: 
  S&P CDO Monitor Kodiak CDO I: Urgent (Next thing I know, I'm 
  told that because it had gone effective already, it was 
  surveillance's responsibility, and I never heard about it 
  again.)........................................................   657

   b. Moody's downgrade of Kodiak CDO I, Ltd....................   662

   c. Standard & Poor's downgrade of Kodiak CDO I, Ltd..........   663

97.a. Moody's letters assigning rating to Long Beach RMBS, 
  January - December, 2006.......................................   665

   b. Washington Mutual, 2006 Transaction Statistics, re: Long 
  Beach RMBS transactions........................................   677

   c. Status of selected Long Beach RMBS transactions, as of 
  April 19, 2010.................................................   678

                            Other Documents

98. Moody's Investors Service: Managing Director's Town Hall 
  Meeting, September 10, 2007, (What happened in ``04 and ``05 
  with respect to subordinated traunches is that our competition, 
  Fitch and S&P, went nuts. Everything was investment grade. It 
  really didn't matter.).........................................   684

99. Excerpts from Standard & Poor's and Moody's Downgrades, July 
  10-12, 2007 and January 30, 2008...............................   765

100. Fitch Ratings, Structured Finance, The Impact of Poor 
  Underwriting Practices and Fraud in Subprime RMBS Performance, 
  November 28, 2007..............................................   776

101. Goldman Sachs internal email, dated November 2007, re: NYT 
  (Of course we didn't dodge the mortgage mess. We lost money, 
  then made more than we lost because of shorts.)................   787

102. Goldman Sachs internal email, dated October 2007, re: Early 
  post on P and L (Sounds like we will make some serious money 
  *** Yes we are well positioned)................................   788

103. Goldman Sachs internal email, dated May 2007, re: LBML 06A 
  (bad news . . . wipes out the m6s and makes a wipeout on the m5 
  imminent . . . costs us about 2.5mm . . . ood news . . . we 
  own 10mm protection on the m6 marked at $50 . . . we make $5mm)   790

104. Goldman Sachs internal email, dated July 2007, re: Private 
  & Confidential: FICC Financial Package 07/25/07 (Tells you what 
  might be happening to people who don't have the big short.)....   792

105. White Paper on Rating Agency Reform prepared by Arturo 
  Cifuentes and Jose Miguel Cruz, Department of Industrial 
  Engineering, University of Chile, Santiago, Chile, May 2010....   794

106. Responses to supplemental questions for the record 
  submitted to Raymond W. McDaniel, Jr., Chairman and Chief 
  Executive Officer, Moody's Corporation.........................   803

107. Responses to supplemental questions for the record 
  submitted to Yuri Yoshizawa, Group Managing Director, 
  Structured Finance, Moody's Investors Service..................   927

108. Responses to supplemental questions for the record 
  submitted to Peter D'Erchia, Current Managing Director, U.S. 
  Public Finance (Former Global Practice Leader, Surveillance), 
  Standard & Poor's..............................................   931

109. Richard Blumenthal, Attorney General, State of Connecticut, 
  prepared statement.............................................  1201



                         FRIDAY, APRIL 23, 2010

                                     U.S. Senate,  
              Permanent Subcommittee on Investigations,    
                    of the Committee on Homeland Security  
                                  and Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:36 a.m., in 
room SD-G50, Dirksen Senate Office Building, Hon. Carl Levin, 
Chairman of the Subcommittee, presiding.
    Present: Senators Levin and Kaufman.
    Staff Present: Elise J. Bean, Staff Director and Chief 
Counsel; Mary D. Robertson, Chief Clerk; David H. Katz, 
Counsel; Laura E. Stuber, Counsel; Adam Henderson, Professional 
Staff Member; Christopher Barkley, Staff Director to the 
Minority; and Anthony G. Cotto, Counsel to the Minority; Kevin 
Rosenbaum, Research Clerk; Robert Kaplan, Intern; Ryan McCord, 
Law Clerk; Ted Schroeder and Nhan Nguyen (Senator Kaufman).


    Senator Levin. Good morning, everybody. Today's hearing is 
the third in a series of Subcommittee hearings focusing on some 
of the causes and consequences of the 2008 financial crisis, a 
man-made economic assault on our country that is still 
foreclosing on homes, shuttering businesses, and driving 
unemployment. We saw the beginning of the assault in our first 
two hearings, which examined how U.S. financial institutions 
turned to high-risk lending strategies to earn quick profits, 
dumping hundreds of billions of dollars in toxic mortgages into 
the financial system, like polluters dumping poison upstream in 
a river. At the second hearing, we showed how regulators saw 
what was going on, understood the risk, but sat on their hands 
or fought each other rather than stand up to the banks which 
were profiting from the pollution.
    Those toxic mortgages were scooped up by Wall Street firms 
that bottled them in complex financial instruments and turned 
to the credit rating agencies to get a label declaring them to 
be safe, low-risk, investment-grade securities. Today, we are 
focusing on the role played by the credit rating agencies. Next 
week, we will look at the last stage of the economic assault, 
when Wall Street investment bankers magnified and spread the 
risk posed by toxic mortgages through the use of complex 
structured finance transactions.
    For a hundred years, Main Street investors trusted U.S. 
credit rating agencies to guide them toward safe investments. 
Even sophisticated investors, like pension funds, 
municipalities, insurance companies, and university endowments, 
have relied on credit ratings to protect them from Wall Street 
excesses and distinguish between safe and risky investments.
    But now that trust has been broken. We have used as case 
histories the two biggest credit rating agencies in the United 
States, Moody's and Standard & Poor's, and the ratings they 
gave to the key financial instruments that fueled the financial 
crisis--residential mortgage backed securities (RMBSs), and 
collateralized debt obligations (CDOs). The Subcommittee 
investigation found that those credit rating agencies allowed 
Wall Street to impact their analysis, their independence, and 
their reputation for reliability. And they did it for the 
    This chart, Exhibit 1g,\1\ shows that from 2002 to 2007, 
the three top credit rating agencies doubled their revenues, 
from less than $3 billion to over $6 billion per year. Most of 
this increase came from rating complex financial instruments. 
According to Standard & Poor's, between 2000 and 2006, 
investment banks underwrote nearly $2 trillion in mortgage-
backed securities, $435 billion or 36 percent of which were 
backed by subprime mortgages. All of those securities needed 
ratings. Moody's and S&P each rated about 10,000 RMBS 
securities over the course of 2006 and 2007. Credit rating 
executives got paid Wall Street-sized salaries.
    \1\ See Exhibit No. 1g, which appears in the Appendix on page 242.
    At the same time, the credit rating agencies were operating 
with an inherent conflict of interest, because the revenues 
they pocketed came from the companies whose securities they 
rated. It is like one of the parties in court paying the 
judge's salary or one of the teams in a competition paying the 
salary of the referee. The credit rating agencies assured 
Congress and the investing public that they could ``manage'' 
that conflict and that their ratings were independent and 
rigorous. But the documents tell a different story.
    First, some background. Credit ratings assess the 
creditworthiness of a particular financial instrument like a 
corporate bond, mortgage-backed security, or CDO. Essentially, 
they predict the likelihood that the debt will be repaid. We 
have all heard of AAA ratings, which are at the top of the 
credit rating scale and are supposed to designate the safest 
investments. The ratings below that, which range from AA down 
to C, designate investments at greater risk of default. 
Investments with AAA ratings have historically had an expected 
loss rate of less than 0.05 percent, while the expected loss 
rate for BBB investments is under 1 percent. That is why 
financial instruments with AAA through BBB ratings are 
generally called ``investment grade,'' while those with ratings 
of BBB or Baa3 or below are referred to as ``below investment 
grade'' or sometimes ``junk'' investments.
    A variety of U.S. laws and regulations rely on credit 
ratings to gauge risk. For example, the amount of risk-based 
capital that a bank must hold is determined in part by the 
credit ratings of its investments. Some investors, like pension 
funds, are barred from holding below-investment-grade assets. 
Because so many statutes and regulations reference ratings, 
issuers of securities and other financial instruments work hard 
to obtain favorable credit ratings to ensure more investors can 
buy their products.
    Over the last 10 years, Wall Street has engineered ever 
more complex financial instruments for sale to investors. 
Because these so-called structured finance products are so hard 
to understand, investors often place heavy reliance on credit 
ratings to determine whether they can or should buy them.
    Residential mortgage-backed securities (RMBSs), are one of 
the oldest types of structured finance. To create these 
securities, issuers bundle up large numbers of home mortgages 
into a pool, figure out the total revenue coming into the pool 
from all the mortgages, and then design a ``waterfall'' that 
assigns portions of the total incoming revenue to what are 
called ``tranches.'' Tranches are not collections of mortgages; 
they are simply recipients of income from the waterfall of 
mortgage payments coming into the pool.
    Each tranche is used to issue a mortgaged-backed security 
that receives a credit rating and is then sold to investors. 
The tranches that are first in line to receive revenues 
represent the safest investments in the pool and are designed 
to get AAA ratings. Tranches lower down the line get their 
revenues only after the more senior tranches are paid, and 
their securities get lower credit ratings.
    Wall Street did not stop there. They collected securities 
from RMBS transactions, put those into a pool, and 
resecuritized them into what are called collateralized debt 
obligations (CDOs). A CDO might contain, for example, BBB-rated 
securities from 100 different residential mortgage pools. CDOs 
often also contain other types of assets, such as corporate 
bonds or credit default swaps. Wall Street firms also created 
so-called synthetic CDOs which did not contain actual assets 
but simply referenced them. Like RMBS mortgage pools, CDOs were 
sliced and diced into tranches and the resulting tranches used 
to create securities. The securities were rated--some AAA--and 
then sold to investors.
    In exchange for large fees, Wall Street firms helped design 
the RMBS and CDO securities, worked with the credit rating 
agencies to obtain favorable ratings, and then sold the 
securities. Without credit ratings, Wall Street would have had 
a much harder time selling those products because each investor 
would have had to rely on themselves to figure them out. Credit 
ratings helped make the sales possible by labeling certain 
investments as safe, using their trademark AAA ratings.
    Wall Street firms also used financial engineering to 
combine AAA ratings--normally reserved for ultra-safe 
investments--with riskier securities, such as RMBS securities 
backed by high-risk mortgages. Because the underlying mortgages 
were high risk, those RMBS securities paid out a higher rate of 
return than safer loans. When those higher-paying securities 
also got AAA ratings, investors snapped them up.
    For a while, everyone made money: banks and mortgage 
brokers got rich selling high risk loans, Wall Street 
investment banks earned big fees creating and selling mortgage-
based securities, and investors profited from the higher 
    But those AAA ratings created a false sense of security. 
High-risk RMBS and CDOs turned out not to be safe investments. 
We heard in our first hearing how many of the high-risk 
mortgages backing those securities were riddled with poor-
quality loans, contained fraudulent borrower information, or 
depended upon borrowers being able to refinance their loans 
before higher loan payments kicked in. When housing prices 
stopped climbing and many borrowers could no longer refinance 
their loans, delinquency rates skyrocketed. RMBS and CDO 
securities rated as investment grade began incurring losses and 
were sharply downgraded.
    For example, take a CDO known as Vertical ABS CDO 2007-1. 
In early 2007, UBS, which is a major bank, asked Standard & 
Poor's and Moody's to rate this CDO. The UBS banker, however, 
failed to cooperate with the analysts. One S&P analyst wrote in 
an email to colleagues: ``Don't see why we have to tolerate 
lack of cooperation. Deals likely not to perform.'' That is 
Exhibit 94b.\1\
    \1\ See Exhibit No. 94b, which appears in the Appendix on page 599.
    Despite the analyst's judgment that the CDO was unlikely to 
perform, Standard & Poor's rated it anyway. So did Moody's. In 
April 2007, both agencies gave AAA ratings to the CDO's top 
four tranches. But just 6 months later, both agencies 
downgraded the CDO, which later collapsed. One of the 
purchasers, a hedge fund called Pursuit Partners, sued over the 
CDO's quick demise. Standard & Poor's and Moody's were dropped 
from the lawsuit since current law does not authorize private 
lawsuits against them even for reckless or unreasonable 
ratings, but the court ordered UBS to set aside $35 million for 
a possible award to the investor. The legal pleadings included 
internal emails at UBS referring to the supposedly investment-
grade Vertical securities as ``crap'' at the same time the bank 
was selling them.
    Take another example. In January 2007, S&P was asked to 
rate an RMBS being assembled by Goldman Sachs using subprime 
loans from Fremont Investment and Loan, a subprime lender known 
for loans with high rates of delinquency. On January 24, 2007, 
an analyst wrote seeking advice from two senior analysts: ``I 
have a Goldman deal with subprime Fremont collateral. Since 
Fremont collateral has been performing not so good, is there 
anything special I should be aware of?'' One of the analysts 
responded: ``No, we don't treat their collateral any 
differently.'' And the other analyst asked a question: ``Are 
the FICO scores current?'' Answer: ``Yup,'' came the reply. 
Then, ``You are good to go.''
    In other words, the analyst did not have to factor in any 
greater credit risk for an issuer known for poor-quality loans, 
even though 3 weeks earlier S&P analysts had circulated an 
article about how Fremont had severed ties with 8,000 brokers 
due to loans with some of the highest delinquency rates in the 
industry coming from those brokers. In the spring of 2007, 
Moody's and Standard & Poor's provided AAA ratings for five 
tranches of RMBS securities backed by Fremont mortgages. By 
October, both companies began downgrading the CDO. Today all 
five AAA tranches have been downgraded to junk status.
    Now, those are just two examples of securities given AAA 
ratings that turned out not to be worth the paper that they 
were written on. And there are many more.
    In fact, throughout 2006 and 2007, the toxic mortgages 
flooding the financial markets began going bad in record 
numbers. Delinquency rates skyrocketed. It became more and more 
apparent that the investment grade ratings given to subprime 
RMBS securities could not hold.
    Finally, in July 2007, within days of each other, Moody's 
and Standard & Poor's announced mass downgrades of hundreds of 
subprime mortgage-backed securities. The mass downgrades 
shocked financial markets, and the subprime secondary market 
dried up overnight. Banks, securities firms, pension funds, and 
others were left holding billions of dollars of suddenly 
unmarketable securities. The value of those securities began 
dropping like a stone, and the financial crisis was on.
    Two months later, in October, Moody's began downgrading 
over $10 billion of CDOs. On January 30, 2008, Standard & 
Poor's downgraded over 8,000 securities, including 6,300 RMBS 
and 1,900 CDO securities, an unprecedented onslaught of 
downgrades. The CDO market, like the RMBS market, evaporated. 
Financial firms around the world were suddenly stuck with even 
more unmarketable securities, and by September 2008, major 
global financial institutions like Lehman Brothers, AIG, 
Citibank, Goldman Sachs, and Morgan Stanley were either bailed 
out, bankrupt, or struggling.
    Looking back, if any single event can be identified as the 
immediate trigger of the 2008 financial crisis, my vote would 
be for the mass downgrades starting in July 2007, when the 
credit rating agencies realized that their AAA ratings would 
not hold, and finally stopped labeling toxic mortgages as safe 
investments. Those mass downgrades hit the markets like a 
hammer, making it clear the investment grade ratings had been a 
colossal mistake.
    This chart, Exhibit 1i,\1\ shows just how big a mistake it 
was. It shows that 91 percent of the AAA subprime RMBS 
securities issued in 2007 and 93 percent of those issued in 
2006 have since been downgraded to junk status. The numbers for 
Option ARM mortgages are even worse. Option ARMs, which we 
examined at our first hearing on Washington Mutual Bank, allow 
borrowers to pick from several types of payments each month, 
including a ``minimum payment'' that results in a growing, 
rather than declining, loan balance. The chart shows that 97 
percent of the Option ARM securities issued in 2006 and 2007 
are now in junk status.
    \1\ See Exhibit No. 1i, which appears in the Appendix on page 244.
    Had the credit rating agencies taken more care in handing 
out their initial ratings or had they issued downgrades in a 
more responsible manner, they could have reduced the impact of 
the toxic mortgages. But they did not, and there are a whole 
host of reasons why.
    First, let us talk about the credit rating models. Credit 
rating agencies use complex mathematical models to predict 
foreclosure rates for mortgages which, in turn, are critical to 
determine the ratings for mortgage-backed securities. The key 
problem was that the mortgage industry had changed drastically 
in the last 10 years. High-risk mortgages like subprime, 
interest-only, Option ARMs, and hybrids became widespread, 
displacing traditional, low-risk, 30-year fixed-rate mortgages. 
The credit rating agencies simply did not have data on how 
these higher-risk mortgages would perform over time. 
Traditional 30-year fixed-rate mortgages had default rates of 1 
to 2 percent; the higher-risk mortgages were expected to have 
higher default rates, but no one knew how high. With very 
little data, the credit rating agencies made assumptions in 
their models that turned out to be way wrong.
    Moody's and S&P knew their modeling assumptions were wrong 
and began revising their models. In the summer of 2005, S&P had 
revamped its CDO model, but put the model on hold for more than 
a year, as it struggled to rationalize why it would not use the 
new model to retest existing CDO securities. It is clear from 
over a year of internal emails that S&P delayed and delayed the 
decision, anticipating that the revised model would require 
existing CDO securities to be downgraded, disrupt the CDO 
market, and reduce public confidence in its CDO ratings. It 
would also have disrupted S&P profits from CDO ratings.
    In July 2006, S&P made a major change to its RMBS rating 
model, but decided not to retest existing RMBS securities. The 
revised RMBS model projected much higher default rates for 
high-risk mortgages and required greater protections against 
loss, including 40 percent more credit protection for BBB-
graded subprime securities. That meant a 40-percent larger 
cushion to protect against losses. Re-evaluating existing RMBS 
securities with the revised model would likely have led to 
downgrades, angry issuers, and even angrier investors, so S&P 
did not do it. Moody's did not either; after strengthening its 
RMBS model to issue new ratings, it chose not to apply it to 
existing securities. Recently, S&P has adopted a policy 
requiring retesting of rated securities within 1 year of a 
model change.
    A second reason the credit rating agencies did not blow the 
whistle sooner on poorly performing RMBS and CDO securities was 
competition. The drive for market share and the revenues from 
increased volumes of ratings created pressure on both agencies 
to provide favorable credit ratings to the investment bankers 
bringing in business.
    A 1995 article captures how the credit agencies used to 
operate. A journalist wrote: ``Ask a treasurer for his opinion 
of rating agencies, and he will probably rank them somewhere 
between a trip to the dentist and an IRS audit. You cannot 
control them, and you cannot escape them.'' Well, all that 
changed as the revenues from structured finance ratings came 
pouring in.
    Ratings and fees began to be played off against each other. 
For example, after a Moody's analyst emailed that he could not 
finalize a rating until the issue of fees was resolved, an 
investment banker from Merrill Lynch responded: ``We are okay 
with the revised fee schedule for this transaction. We are 
agreeing to this under the assumption that this will not be a 
precedent for any future deals and that you will work with us 
further on this transaction to try and get to some middle 
ground with respect to the ratings.''\1\ Now, Moody's assured 
the Merrill analyst that its deal analysis was independent from 
its fees. Nonetheless, that is what Merrill was asking for.
    \1\ See Exhibit No. 23, which appears in the Appendix on page 315.
    In another email, an S&P analyst commented: ``Version 6.0 
[of the ratings model] could've been released months ago and 
resources assigned elsewhere if we didn't have to massage the 
sub-prime and Alt-A numbers to preserve market share.''\1\ Some 
witnesses here today will describe how the environment changed 
from an academic culture focused on accurate ratings to one of 
intense pressure to get the deals done and preserve market 
    \1\ See Exhibit No. 5, which appears in the Appendix on page 258.
    The documents also show how the crushing volume of ratings 
undermined the ratings process. Despite record profits, both 
credit rating agencies were understaffed and overwhelmed with 
complex deals that investment bankers wanted to close within 
days. The documents show how investment bankers argued with the 
credit rating analysts, substituted worse assets at the last 
minute, and pressured analysts to waive their procedures and 
standards. We even saw instances of bankers pushing to remove 
analysts who were not playing ball. And at times, analysts who 
resisted banker demands or challenged ratings were restricted 
from rating deals.
    A focus on short-term profits also permeated the industry. 
One of the witnesses here today will describe how when he once 
questioned a banker about the terms of a deal, the banker 
replied, ``IBG-YBG.'' When asked what that meant, the banker 
explained, ``I'll be gone, you'll be gone.'' In other words, 
why give me a hard time when we are both making a lot of money 
and will be long gone before the house of cards comes crashing 
    In addition to inaccurate models and competitive pressures, 
the credit rating agencies failed to adjust their ratings to 
take into account credit risks from the fraud and lax 
underwriting standards that increasingly characterized the 
mortgages securitized and sold on Wall Street.
    In August 2006, an S&P employee wrote: ``[T]here has been 
rampant appraisal and underwriting fraud in the industry for 
quite some time as pressure has mounted to feed the origination 
machine.''\2\ In September 2006, another S&P employee wrote: 
``I think it is telling us that underwriting fraud, appraisal 
fraud, and the general appetite for new product among 
originators is resulting in loans being made that should not be 
made.''\3\ A colleague responded that the head of the S&P 
Surveillance Group ``told me that broken down to loan level 
what she is seeing in losses is as bad as high 40's--low 50 
percent. I would love to be able to publish a commentary with 
this data but maybe too much of a powder keg.'' Well, not 
taking into account mortgage fraud and lax underwriting 
standards did, indeed, turn into a powder keg, one that helped 
blow up the RMBS and CDO markets and triggered the 2008 
financial crisis.
    \2\ See Exhibit No. 14, which appears in the Appendix on page 293.
    \3\ See Exhibit No. 1d, which appears in the Appendix on page 236.
    In the fall of 2007, Moody's CEO Ray McDaniel called a town 
hall meeting to talk to his employees after the mass downgrades 
that shut down the subprime market. ``What happened in 2004 and 
2005,'' he said, ``is that our competition, Fitch & S&P, went 
nuts. Everything was investment grade. It really didn't 
matter[.] . . . No one cared because the machine just kept 
    \1\ See Exhibit No. 98, which appears in the Appendix on page 684.
    A Moody's managing director later responded our ``errors 
make us look either incompetent at credit analysis, or like we 
sold our soul to the devil for revenue, or a little bit of 
both.'' He said, ``I would like more candor from senior 
management about our errors and how we will address them in the 
    That is what we are calling for today as well: candor not 
only about what went wrong, but what can be done to prevent 
still another credit rating disaster in the future. The House 
and the Senate financial reform bills before Congress offer a 
number of measures to increase credit rating oversight. Both 
bills would, for example, eliminate the statutory prohibition 
on the SEC's evaluating rating models, though clearer language 
authorizing the SEC to set standards for credit rating models, 
methodologies, and criteria is, in my judgment, still needed. 
The bills would also beef up the SEC's enforcement authority 
toward credit rating agencies and subject the agencies to 
lawsuits by investors for reckless or unreasonable ratings. The 
bills should be further strengthened, in my judgment, by 
directing regulators to tackle the inherent conflicts of 
interest that arise when rating agencies are paid by the people 
that they rate. Our investigation provides strong support for 
better controls on credit rating agencies whose failures 
contributed to the economic damage still plaguing our country.
    One more matter. Yesterday, the Subcommittee was made aware 
of a longer version of an email that was included in the 
Exhibit Book as Exhibit 23. We were not aware of the longer 
version earlier when that book was put together, so we have 
added it to the book as Exhibit 23 Addendum. The emails show 
Merrill Lynch trying to make a direct link between the fees it 
paid and the ratings it would receive on a deal, but the longer 
email shows that Moody's told Merrill Lynch that its deal 
analysis was independent of any fee discussion. And that was 
surely a welcome response, but a very inappropriate request on 
the part of Merrill Lynch.
    My Ranking Member, Senator Coburn, had planned on being 
here today and had looked forward to it, but he was called away 
to matters in Oklahoma, so we will have to proceed without him. 
I do want to thank him and his staff again for their tremendous 
ongoing support of this investigation.
    I want to call on Senator Kaufman, who has also been a 
major supporter of what we are trying to do on this 
Subcommittee, and we are very grateful for his being on this 
Subcommittee and for that great participation. Senator Kaufman.
    Senator Kaufman. Thank you, Mr. Chairman, and thank you for 
holding this hearing, and I thank the witnesses.
    Since this meltdown occurred, as I travel around, after 
concern about jobs, the single most concern is about what 
happened on Wall Street and what are we going to do about it. 
And I got to tell you that the most scorn is on the rating 
agencies. That may not be deserved, but that is where it is, 
the idea that, as the Chairman said, you had this incredible 
growth in revenues at the same time they were rating thousands 
of residential mortgage-backed securities AAA that now turn out 
to be junk. AAA to junk is just a hard thing for people to deal 
with. How can you miss so badly?
    The problem we are dealing with today is what happened, but 
really more important is what are we going to do about it? I 
think both are important. AAA will never mean again what it 
used to mean. I do not care what we do here. I do not care what 
happens. AAA will not mean what it used to mean because people 
are just beginning to determine the incredible conflict of 
interest the Chairman pointed out, and also the way that rating 
agencies have protected and the way they view their job, when 
you hear them talk about the fact that they really have no 
responsibility to the average investor out there. That is not 
their customer. The customers are the people that just does not 
go with people. People do not understand that.
    The problem is, outside of the great people that inhabit 
the United States, that the two greatest things that make this 
country great are democracy and our capital markets. That is 
what makes us great. And the credibility of our capital markets 
is in tatters.
    Now, fortunately, in the rest of the world, they have 
capital markets where you even take a greater chance in many 
cases to get involved. But I do not think that is beginning to 
be the perception. And the idea that the average person cannot 
use rating agencies to determine the quality of the product 
means very simply people will stop using the product. Our 
markets will no longer be credible. They have lost a lot of 
credibility already.
    If we do not deal with this, this is not something we are 
just going on as business as usual. I spend a lot of time in 
New York. I spent a lot of time with people in New York. They 
think, oh, well, over that, now we are on to the next thing. It 
is not going to be that way. This is not going to go on 
forever. Our markets, if we lose our credibility, not only have 
the folks on Wall Street lost an incredible business, not only 
the rating agencies an incredible business, but the United 
States of America has lost one of the keys to its success. So 
what the Chairman is doing here with these hearings is 
incredibly important if we are going to maintain the 
credibility of our U.S. markets.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Kaufman.
    Now let me welcome our first panel of witnesses for this 
morning's hearing: Frank Raiter, Former Managing Director for 
Mortgage-Backed Securities at Standard & Poor's; Richard 
Michalek, Former Vice President and Senior Credit Officer for 
the Structured Derivative Products Group at Moody's; Eric 
Kolchinsky, a Former Team Managing Director of the Structured 
Derivative Products Group at Moody's Investors Service; and, 
finally, Dr. Arturo Cifuentes, a Former Moody's Senior Vice 
President and current Director of the Finance Center at the 
University of Chile in Santiago, Chile. We thank you for coming 
a great distance.
    Mr. Raiter, I understand that you are here under a 
subpoena, but I appreciate all of you being here, whether a 
subpoena was issued or not. We appreciate your being with us 
this morning. We look forward to your testimony.
    We have a rule on this Subcommittee that all witnesses who 
testify before the Subcommittee are required to be sworn, so at 
this time I would ask all of you to please stand and raise your 
right hand. Do you swear that the testimony you are about to 
give will be the truth, the whole truth, and nothing but the 
truth, so help you, God?
    Mr. Raiter. I do.
    Mr. Michalek. I do.
    Mr. Kolchinsky. I do.
    Mr. Cifuentes. I do.
    Senator Levin. We have a timing system here that does the 
following: About a minute before the red light comes on, you 
will see the light change from green to yellow, which will give 
you an opportunity to conclude your remarks. Your written 
testimony will be printed in the record in its entirety. We 
would ask that you attempt to limit your oral testimony to no 
more than 5 minutes.
    Mr. Raiter, I think we will have you go first.


    Mr. Raiter. Good morning, Senator Levin and Senator 
Kaufman. From 1995 until my retirement in 2005, I was the 
Managing Director and head of Residential Mortgage Ratings at 
Standard & Poor's. As such, I think I had an inside view of the 
role of rating agencies in the recent economic crisis.
    \1\ The prepared statement of Mr. Raiter appears in the Appendix on 
page 114.
    The failure of the major rating agencies--Fitch, Moody's 
and Standard & Poor's--to adequately assess the risks 
associated with new mortgage products introduced in the past 
decade is the result of several factors. The first was the lack 
of oversight of the rating agencies by the SEC and the various 
financial regulatory bodies that wrote regulations requiring 
ratings. The second was the impact these decisions had on 
management of the rating agencies. And the third factor was the 
disconnect between senior managers and the analytical managers 
responsible for assigning ratings. The final factor was the 
separation of the initial ratings process from the subsequent 
surveillance of performance of the rated bonds.
    The first factor, a lack of regulatory oversight, resulted 
from the failure of regulators to appreciate the unique 
position the rating agencies assumed in the financial markets. 
The rating agencies were granted their preferred status by the 
SEC. Other regulators followed suit and incorporated ratings 
into their investment and capital rules. There was no 
regulatory oversight nor were standards established to measure 
the performance or quality of ratings.
    The preferred position of the rating agencies led directly 
to the second factor. Management of the rating agencies came to 
believe that the increasing revenues and profits they were 
enjoying were the results of superior management skill and 
insight rather than the oligopoly granted them by the various 
regulators and the accommodative Federal Reserve interest 
rates. This success bred complacency and an aversion to change.
    This resistance to change was a primary cause of the 
failure of the ratings and the ultimate financial crisis. 
Analytical managers were driven by the desire to create and 
implement the best risk analytics and methodologies possible. 
Senior management, on the other hand, was focused on revenue, 
profit, and ultimately share price. Management wanted increased 
revenues and profit while analysts wanted more staff, data, and 
IT support which increased expenses and obviously reduced 
    In the Residential Mortgage Ratings Group, as in all the 
rating groups in structured finance, the analysts were 
responsible for both producing ratings and developing and 
maintaining ratings criteria. Balancing these two missions was 
a significant issue in the residential ratings group where 
revenues grew tenfold between 1995 and 2005, and rating volumes 
grew five- or six-fold without similar increases in staff. 
Rating production was achieved at the expense of maintaining 
criteria quality.
    Adequate staffing was not the only challenge faced in 
trying to maintain the quality of the rating process. The 
accuracy of the predictive models used to evaluate risk was 
also critical to the quality of the ratings. The version of 
LEVELS model developed in 1996 was based on a data set of 
approximately 250,000 loans. It was, I believe, the best model 
then used by a rating agency. As new models were programmed and 
tested, analysts continued to collect larger data sets for the 
next versions of the model. In late 2002 or early 2003, another 
version of the model was introduced based on approximately 
650,000 loans. At the same time, a data set of approximately 
2.8 million loans was collected for use in developing the next 
version of the model. By early 2004, preliminary analysis of 
this more inclusive data set and the resulting econometric 
equation was completed. That analysis suggested that the model 
in use was underestimating the risk of some Alt-A and subprime 
products. In spite of this research, the development of this 
model was postponed due to a lack of staff and IT resources. 
Adjustments to the model used in 2004, with the identified 
problems, were not made until March 2005. To my knowledge, this 
version of the model based on the 2.8 million loan data set was 
never implemented.
    The final condition contributing to the failure of the 
rating agencies was the separation of the initial ratings 
process from the subsequent surveillance of ratings 
performance. While the rating process utilized ever improving 
models, surveillance operated under their own criteria. At S&P, 
the manager of surveillance refused to use the ratings model in 
reviewing the performance of outstanding bonds. In fact, the 
resistance to ``re-rate'' bonds with each new model came from 
upper management. The concern was that ``re-rating'' 
outstanding deals with new information would significantly 
increase rating volatility and possibly result in lost revenue. 
By 2005, when adjustments were made to the model, it should 
have been intuitively obvious that some bonds rated in 2004 did 
not provide the necessary protection to support the assigned 
    In conclusion, it is my opinion that if S&P had vigorously 
pushed to implement the version of the model based on the 2.8 
million loan data set in late 2004 or early 2005, the economics 
of deals incorporating the lowest quality subprime and Alt-A 
loans would have disappeared. In addition, the riskiest 
transactions submitted for ratings in 2005, 2006, and 2007 
would likewise have been assigned much higher enhancement 
requirements which might have made it unprofitable for lenders 
to make additional loans. If the surveillance department had 
``re-rated'' existing deals each time ratings criteria were 
adjusted, transactions would have been put on Credit Watch or 
been downgraded in 2005 which would certainly have sent an 
early warning to investors and tempered their demand for 
similar bonds.
    This concludes my opening comments.
    Senator Levin. Thank you very much. Mr. Michalek.


    Mr. Michalek. Mr. Chairman and Senator Kaufman, my name is 
Richard Michalek. I am a former employee of Moody's Investors 
Service, a subsidiary of Moody's Corporation. I joined the 
Structured Derivative Products Group at Moody's in June 1999, 
and my position was eliminated in December 2007. At the end of 
my tenure at Moody's, I held the title of Vice President and 
Senior Credit Officer.
    \1\ The prepared statement of Mr. Michalek appears in the Appendix 
on page 119.
    My general responsibilities included performing legal 
analysis on the structure and documentation of complex 
structured finance transactions in order to assign a rating to 
that transaction and to assist in the development of, and 
refinement to, rating practices, policies, and methodologies 
used by the group. My regular responsibilities included 
participating in rating committees within the group, and on 
request for other groups at Moody's; consulting on legal 
matters for other groups in the New York, London, and Asian 
offices of Moody's when requested; and speaking at industry 
conferences on a wide variety of legal and structural issues. I 
prepared and published the group's quarterly and annual review 
and survey of activity. I assisted with the legal portion of 
semi-annual training sessions for new hires in the Structured 
Finance Department.
    During my last year at Moody's, my primary responsibilities 
were split between serving as the senior legal analyst on the 
team responsible for developing, refining, and implementing the 
methodology for assigning ratings to highly complex credit 
derivative product companies and being the project leader 
responsible for developing a methodology for rating collateral 
    Immediately prior to joining Moody's, I was a 
securitization consultant advising the New Zealand law firm of 
Chapman Tripp, and prior to that I was an associate lawyer in 
the New York office of the law firm Skadden Arps. I am admitted 
to practice law in New York State and was admitted to the bar 
as a solicitor in Wellington, New Zealand. I have a JD/MBA from 
Columbia University Law School and Columbia University Graduate 
School of Business.
    My testimony today is based on and primarily limited to my 
experience working in the Structured Derivative Products Group 
within Moody's Investors Service, and while I had the 
opportunity to interact with several other groups within 
Moody's, I do not profess any particular expertise or advanced 
knowledge of the methodologies or practices employed in those 
groups. My testimony today is also not being delivered with the 
intention to bring harm to any individual or to stand in 
judgment of individual behavior. On the contrary, as I hope my 
oral remarks and written statement will illustrate, I believe 
that any imperfections, flaws, and failures observed or 
identified in the credit rating process of structured 
derivative products are neither surprising nor unexpected in 
light of the framework of incentives presented to the competent 
and otherwise rational people comprising the credit rating 
    Credit rating agencies serve the important function of 
providing buyers and sellers of credit--that is, investors in 
and issuers of a promise to pay--an independent measure of the 
risk presented. In theory, these agents are independent, and 
because of repeat experience and a rationalization of costs, 
they should be able to provide this measure of risk at a lower 
cost than would otherwise be faced if the buyers or sellers 
produced the analysis themselves.
    My experience as an analyst, however, in the Derivatives 
Group and as a resource in the Derivatives Group for other 
groups in Moody's for legal issues provides what I hope would 
be a useful perspective with respect to a couple of questions 
the members might like to ask.
    I know one question that is being asked: Just how 
independent are these agencies, particularly within an ``issuer 
pays'' framework?
    Another question that is and should be asked is: What 
consequences do rating agencies suffer under the current or any 
proposed framework when these measures of risk either fail to 
perform as reasonably expected or which can be shown to have 
lacked a level of care commensurate with the risk of harm that 
may foreseeably befall the user who relies on such measures?
    As for that first question, in my view, the independence of 
the Derivatives Group changed dramatically during my tenure. 
The willingness to decline to rate or to just say no to 
proposed transactions steadily diminished over time. That 
unwillingness to say no grew in parallel with the company's 
share price and the proportion of total firm revenues 
represented by structured finance transactions. The apparent 
loss of bargaining power by the rating agencies in general and 
of the group in particular was coincident with the steady drive 
towards commoditization of the instruments we were rating.
    As our customers, principally the investment banks, 
produced more and more product for yield-hungry investors and 
as the quality distinction as between the different rating 
agencies lost some of its importance, the threat of losing 
business to a competitor rating agency, even if not realized, 
absolutely tilted the balance away from the independent arbiter 
of risk towards a captive facilitator of risk transfer.
    The second question--in essence, what price is paid or 
should be paid if a rating agency gets it wrong?--is in my view 
asking a handful of more fundamental questions. Who should bear 
the risk of getting it wrong, particularly when it is within 
reach to either not get it wrong or to choose not to rate? If 
we accept that the ratings are the rating agency products, 
should all the ratings issued by a rating agency be entitled 
equally to the same defenses for product liability? I am of the 
opinion that much more could have and should have been done to 
improve processes and procedures, but I am not so naive as to 
fail to appreciate that in the extremely competitive 
environment of hyper growth where the message from management 
was not, ``Just say no'' but, instead, ``Must say yes,'' any 
available resource had to be spent on remedial corrections. 
Installing improvements were left for the someday pile.
    I am in the camp that believes that, to some degree, 
ratings provide an important public good. I also believe that 
some ratings, in light of the public good they provide, deserve 
some measure of protection from liability and opportunistic 
claims of negligence. However, to the extent that agencies are 
to remain wholly private entities understandably concerned with 
market share and net profits, a distinction based on the extent 
of the public good provided might be made with respect to the 
products being rated. Where some question can reasonably be 
raised as to the extent of the public benefit from rating one 
or more of the highly complex or novel instruments, the 
liability for getting it wrong might be more fairly assigned to 
the private parties involved.
    I am confident that if questions of negligence were not 
easily dismissed by protestations of free speech opinion, at 
least for that subset of ratings on products where the benefit 
of the rating falls primarily to the private parties involved, 
the agencies would redirect some of their extraordinary profit 
margins into resources and research and would once again have 
an incentive to just say no.
    That concludes my oral remarks. Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Mr. Michalek. Mr. 


    Mr. Kolchinsky. Thank you very much. Good morning. I would 
like to thank Chairman Levin and the Subcommittee for holding 
this hearing on the role of the rating agencies in the 
financial crisis.
    \1\ The prepared statement of Mr. Kolchinsky appears in the 
Appendix on page 140.
    My name is Eric Kolchinsky, and during the majority of 
2007, I was the Managing Director in charge of the business 
line which rated subprime-backed CDOs at Moody's Investors 
Service. More recently, I was suspended by Moody's after 
warning the compliance group regarding what I believed to be a 
violation of securities laws within the rating agency.
    In my opinion, the cause of the financial crisis lies 
primarily with the misaligned incentives in the financial 
system. Individuals across the financial food chain, from the 
mortgage broker to the CDO banker, were compensated based on 
quantity rather than quality. The situation was no different at 
the rating agencies.
    It is my firm belief that the vast majority of the analysts 
at Moody's are honest individuals who try hard to do their 
jobs. However, the incentives in the market for rating agency 
services favored, and still favor, short-term profit over 
credit quality and quantity over quality.
    At Moody's, the source of this conflict was the quest for 
market share. Managers of rating groups were expected by their 
supervisors to build, or at least maintain, market share. It 
was an unspoken understanding that loss of market share would 
cause a manager to lose his or her job.
    Senior management would periodically distribute emails 
detailing their departments' market share. These emails were 
limited to managing directors only. Even if the market share 
dropped by a few percentage points, managers would be expected 
to justify ``missing'' the deals which were not rated. 
Colleagues have described enormous pressure when their market 
shares dipped.
    While, to my knowledge, senior management never explicitly 
forced the lowering of credit standards, it was one easy way 
for a managing director to regain market share. I do not 
believe that this was done in a deliberate manner. Instead, 
during the bubble years, it was quite easy to rationalize 
changes in methodology since the nominal performance of the 
collateral was often quite exceptional. Easier still was 
avoiding asking whether the collateral standards had declined 
or whether some of the parties had ulterior motives in closing 
the transaction.
    I began to receive these emails when I was promoted to 
managing director. They would list all the deals in the market 
for the relevant period and the amounts rated by Moody's, S&P, 
and Fitch.
    I believe that my 2007 dismissal from the rating agency was 
a consequence of placing credit quality above market share. I 
was a managing director in the derivatives group, which was 
responsible for rating CDOs. CDOs were an extremely lucrative 
area for Moody's: In the first two quarters of 2007, the group 
generated over $200 million of revenue. This amount accounted 
for approximately one-fifth of the total revenue of the entire 
rating agency.
    However, trouble for the securitization was already 
brewing. In early 2007, New Century, a major subprime lender, 
imploded. During the course of the year, the prices of 
synthetic subprime bonds precipitously declined. The end of 
this initial phase of the crisis was heralded by the fall of 
two Bear Stearns hedge funds which heavily invested in CDOs. 
The resulting price dislocation sent bankers hurrying to finish 
CDOs already in progress and to clean up their balance sheets.
    In September 2007, I was told that the ratings of the 2006 
vintage of subprime bonds were about to be downgraded severely. 
While the understaffed RMBS group needed time to determine the 
new ratings, I left the meeting with the knowledge that the 
then current ratings were wrong and no longer reflected the 
best opinion of the rating agency.
    This information was crucial for the few CDOs in my 
pipeline, which were being aggressively pushed by bankers. If 
the underlying ratings were wrong, the ratings on these CDOs 
would be wrong, also. I believed that to assign new ratings 
based on assumptions which I knew to be wrong would constitute 
securities fraud. I immediately notified my manager and 
proposed a solution to the problem.
    My manager declined to do anything about the potential 
fraud, so I raised the issue to a more senior manager. As a 
result of my intervention, a procedure for lowering subprime 
bond ratings going into CDOs was announced on September 21, 
2007. I believe this action saved Moody's from committing 
securities fraud.
    Just about a month later, in mid-October, another periodic 
market share email was sent to the managing directors in my 
group. Along with the email, our business manager noted that 
our market share dropped from 98 percent plus to 94 percent in 
the third quarter. My manager immediately replied to the email 
and demanded an accounting of the missing deals.
    This was the most disturbing email I had ever received in 
my professional career. A few days before, Moody's had 
downgraded over $33 billion in subprime bonds. At the time, 
this was the largest ever single downgrade at Moody's. As a 
direct result of the October 2007 additional downgrades, over 
$570 billion of ABS CDOs would be downgraded through the end of 
    Despite the massive manifest errors in the ratings assigned 
to structured finance securities and the market implosion we 
were witnessing, it appeared to me that my manager was more 
concerned about losing a few points of market share than about 
violating the law.
    In late October, less than a month after that email and 
less than 2 months after I intervened, my manager asked me to 
leave the group. I was given a smaller position with less 
responsibility and less pay in a different group.
    While Moody's has acknowledged that the rating situation in 
September 2007 constituted a ``problem,'' they failed to act to 
prevent a nearly identical situation in 2009 in connection with 
a transaction called Nine Grade Funding. Instead of following 
some common-sense steps to prevent a violation of the law, 
Moody's management chose to suspend me after I pointed out the 
    Recent rating activity indicates that market participants 
still prefer the most aggressive ratings. Rating firms which 
have taken conservative positions have seen their market shares 
tumble. We will no doubt see the results of this lesson when 
the regulatory spotlight is turned off. Credit standards will 
once again plunge as rating agencies race to build their market 
    The only way to prevent this from occurring is to recognize 
that the function which the rating agencies perform is a quasi-
regulatory one, much like accountants. A single set of public 
standards needs to be implemented, to be used for regulatory 
purposes only. This will allow rating agencies to compete for 
clients without being forced to lower credit standards.
    Thank you very much.
    Senator Levin. Thank you very much, Mr. Kolchinsky, for 
that testimony. Dr. Cifuentes.

                     CHILE, SANTIAGO, CHILE

    Mr. Cifuentes. Thank you, Mr. Chairman, thank you, Senator 
Kaufman, for the invitation to be here in this hearing.
    \1\ The prepared statement of Mr. Cifuentes with attachments 
appears in the Appendix on page 144.
    My name is Arturo Cifuentes, and I am a professor at the 
University of Chile. I recently moved back to Chile after 
living in the United States for 30 years. I spent probably the 
last 15 years working in finance.
    I worked at Moody's--I have to say that--from 1996 until 
the end of 1999 when ratings really mattered and AAA meant 
    This is the second time I am testifying before the Senate. 
I testified 2 years ago, and I made some observations regarding 
the problem at hand and some suggestions that I thought could 
be implemented, and I have articulated, I believe, in my 
testimony today all the relevant points that I wanted to make. 
So I am not going to read anything. I am just going to make 
three points which I believe are relevant in the context of 
what we are talking about here.
    The first observation that I would like to make is the 
following: Moody's and S&P are two different companies. They 
give ratings. A rating is basically nothing but an opinion 
about the credit risk of a security. Moody's gives ratings 
based on expected loss. S&P gives ratings based on probability 
of default. I do not want to go into the technical matters of 
what that means, but believe me, they are two different things. 
And they both profess to give ratings based on different 
benchmarks, different standards, different models, different 
approaches. They are two different companies in different 
buildings, different people.
    If you take a look, even a casual look, at the ratings 
given by Moody's and S&P, there is a high degree of agreement 
between the ratings given by these two companies, which makes 
you wonder whether the ratings are really independent. That is 
something probably I think that raises some issues and should 
be investigated in more detail. There are certain mathematical 
methods actually to do that in a careful fashion, but you 
become very suspicious if you see such a degree of agreement 
between AAAs given by the two rating agencies. Considering the 
approaches, they should be a little bit different, so you 
wonder are these two companies dancing independently or is this 
carefully calibrated footwork to make sure credit ratings are 
aligning with market share. That is something that I think is a 
little bit concerning.
    The other issue that I would like to address here today is 
something that is more just applicable to the subprime market. 
The rating agencies have said on many occasions that the 
ratings they gave to transactions involving subprime loans 
performed so badly because they rely on data provided by the 
bankers and the data was not good. So allegedly they were not 
at fault because they used information that they did not have 
the opportunity to verify and it turns out to be wrong.
    I do not believe that is a reasonable explanation. For one 
thing, that was not the case when I worked at Moody's. We 
always checked everything that the bankers told us. Whenever we 
are looking at the securitization for the first time, we look 
in a certain amount of detail to make sure the data presented 
to us actually was meaningful and accurate.
    If that were the case, it seems to me as a market 
participant that if the ratings were given on information that 
you did not verify, it seems to me that they should come up 
with a warning, something along the lines that, ``We are giving 
a rating based on information that we believe is true but we 
have not checked,'' or something like that. I think that would 
have been a reasonable thing to do.
    And, finally, the third point that I would like to make, 
because this is a very serious problem, is the situation where 
we are right now, what we really--Senator Kaufman was talking 
about democracy and capital markets. I believe the situation we 
have right now is really bad because what we have right now, it 
is really a marriage made in hell. You have a situation in 
which nobody believes in the ratings, and at the same time, the 
ratings are part of the regulatory framework. So nobody 
believes in these. Still, you have played by the rules.
    Now, I cannot tell you how critical that is because the 
situation right now is that the securitization market is 
paralyzed, the ABC commercial paper market is more or less 
paralyzed, or it is a shadow of what it used to be. It is about 
one-third of the size. And that has significant effects on the 
fixed-income market.
    There is a perception--and I am going to stop here--that 
this market is not regulated. Actually, I would say that this 
is probably the most regulated market in the world. It is just 
that it is regulated by the rating agencies, and it did not 
work out that well.
    So I think I am going to stop here, and then I am going to 
be happy to answer any questions that you might have. Thank you 
very much.
    Senator Levin. Thank you very much, Dr. Cifuentes.
    What we will do is have 20-minute rounds. We can have more 
than one round if we need them.
    If you all would take a look in the exhibit book at Exhibit 
94b,\1\ this is a CDO known as Vertical ABS CDO 2007-1. S&P 
analysts in 2007 complained about how the Vertical's issuer, 
UBS, was not cooperating with them, and the deal was unlikely 
to perform. In a 2007 email, the one that you are looking at 
there, Exhibit 94b, one analyst for S&P wrote, ``Vertical is 
politically closely tied to B of A--and is mostly a marketing 
shop--helping to take risk off books of BoA. Don't see why we 
have to tolerate lack of cooperation. Deals likely not to 
    \1\ See Exhibit No. 94b, which appears in the Appendix on page 599.
    Now, despite that judgment that the CDO was unlikely to 
perform, S&P rated it. Several months after that deal was 
rated, the loans began to show delinquencies, and a little 
later on, S&P and Moody's downgraded it. Those securities, by 
the way, are now below investment grade. They are in junk 
    One of the purchasers of the Vertical securities is a hedge 
fund called Pursuit Partners. They sued S&P, Moody's, and UBS 
over the quick demise of the security. As I mentioned before, 
S&P and Moody's annuities were dropped from the lawsuit because 
of the lack of the ability under our current law to sue the 
rating agencies. But the court ordered UBS to set aside some 
funds to pay a possible award to that investor.
    Now, the investor had also uncovered an internal email at 
UBS in which a banker wrote, ``Sold some more crap to 
Pursuit,'' referring to the Vertical securities which were then 
rated as investment grade. That is Exhibit 94n,\2\ by the way.
    \2\ See Exhibit No. 94n, which appears in the Appendix on page 644.
    So, first, Mr. Raiter, let me ask you: Is it common for an 
S&P analyst to rate a deal even though the analyst thought, as 
we looked at Exhibit 94b, that the deal was ``not likely to 
    Mr. Raiter. Senator, I have to say that I was not in CDOs 
and really do not know how they did things down there. On the 
residential side, at the time that I was involved, it was not 
unusual to turn down deals if we did not think they were going 
to perform or if they did not meet our criteria. But as I think 
as has been pointed out in your opening statements, things got 
dramatically more haywire after 2004 and 2005. But I honestly 
could not tell you what they did in CDOs.
    Senator Levin. All right. But where you worked, if 
something was expected not to perform, you would not be rating 
it, I assume, as being expected to perform?
    Mr. Raiter. No, sir, we would not. As I say, there were 
occasions where we had some real concerns about collateral, and 
we just would put such high levels on the transaction, it was 
not economic for them to do it and we would not rate it. In the 
late 1990s, Prudential Mortgage changed their waterfall 
structure, which did not meet our criteria, and for a number of 
years we would not rate any of their deals because they did not 
meet the standards that we had set.
    Senator Levin. OK. Now, Mr. Kolchinsky, you have had years 
of experience, I think, with CDOs. Should a CDO which is 
expected not to perform be given a AAA rating?
    Mr. Kolchinsky. Absolutely not. If the analyst was 
convinced that the deal would not perform, that deal should not 
be rated.
    Senator Levin. Take a look, if you would, Mr. Kolchinsky, 
at Exhibit 94e.\1\ Exhibit 94e shows that some of the assets 
that were included in the CDO had already been downgraded at 
the time that they were included. Do you see that downgrade?
    \1\ See Exhibit No. 94e, which appears in the Appendix on page 614.
    Mr. Kolchinsky. Yes, I do.
    Senator Levin. Both on pages 1 and 2. A lot more, actually, 
on page 2 than there was on page 1. But, anyway, there are a 
lot of those that had already been downgraded at the time they 
were included so they were not performing as expected.
    Now, if a downgraded asset is included in a CDO, is that 
something that an analyst would note?
    Mr. Kolchinsky. We had rules that if an asset was on watch, 
it would be taken down a few notches. Once an asset was 
downgraded, under these rules it would be used at that rating 
and no more or no less unless it was on watch.
    Senator Levin. And would that be a warning sign about the 
quality of the assets in the CDO?
    Mr. Kolchinsky. It would have been a qualitative warning. 
Quantitatively, I do not think that left an analyst, under the 
then prevailing rules, much room because at that point the RMBS 
Group has said this is our new view and this is our best view.
    Senator Levin. And should it affect the credit analysis?
    Mr. Kolchinsky. Oh, absolutely. With hindsight, I think 
this is something I tried to do later as we saw that once you 
take the path down to downgrade, that is not likely to stop. 
And so securities, we try to implement something where the 
securities that have been downgraded already but not currently 
on watch be stressed more severely.
    Senator Levin. It should affect the analysis, as you 
indicate, but it did not affect the analysis here. The S&P 
analyst there, Mr. Halprin, said in his email that Bank of 
America was using the CDO to take risk off its books. Now, 
Vertical is a company that was partly owned by Bank of America 
and was run by several former Bank of America employees. And if 
an analyst thinks that what is going on with a CDO is taking 
bad assets off a company's books, should that affect the rating 
    Mr. Kolchinsky. I think so.
    Senator Levin. Now let me ask all the panelists, how long 
is it expected that a AAA rating should hold?
    Mr. Raiter. It should hold for the life of the transaction 
and the life of the tranche, as you pointed out, Senator. The 
waterfall typically pays the higher-rated bonds off first, and 
as they pay down, then the bonds that are underneath it start 
receiving the flows. But it should last the life of the 
transaction, for mortgage-backed, 7 or 8 years.
    Senator Levin. Would you all agree with that?
    Mr. Kolchinsky. Yes.
    Mr. Michalek. I wouldn't.
    Senator Levin. So, in this case, these ratings were 
downgraded within a year and are now below investment grade. 
These are junk.
    Mr. Michalek. Senator, if I could respond.
    Senator Levin. Mr. Michalek, I am sorry. You did not agree.
    Mr. Michalek. No, I did not.
    I think that we are touching on something that you are 
likely to hear later in the day, that, in fact, the common 
perception of what a AAA rating is and means is not necessarily 
what the definition of a AAA rating is. This is something of a 
legal distinction, but at the same time, I think it is very 
important that this is not lost on the Subcommittee.
    In fact, there is published by Moody's the migration rates 
and history of the different ratings that are assigned, and 
those migration rates represent an average migration for a 
particular rating. But it is simply an average from a 
population of which there are tails at either end. Some AAAs 
never get downgraded, and there are others that are downgraded, 
unfortunately, quite quickly. And I do think that there is an 
expectation in the market and there is a proper expectation 
that AAAs are not going to be issued on Monday and on Friday 
downgraded to anything else.
    That debate as to whether or not there should be or is a 
necessary element of stability in the rating, at least at 
Moody's, was one that was ongoing.
    Senator Levin. OK, thank you. Let us take a look at another 
failed rating, this time involving mortgages issued by Fremont. 
Take a look at Exhibit 93b.\1\ In January 2007, S&P was asked 
to rate an RMBS with subprime loans issued by Fremont 
Investment, a subprime lender known for poor-quality loans. At 
that time an S&P ratings analyst sent an email to a supervisor 
saying the following: ``I have a Goldman deal with subprime 
Fremont collateral. Since Fremont collateral has been 
performing not so good, is there anything special I should be 
aware of?''
    \1\ See Exhibit No. 93b, which appears in the Appendix on page 589.
    Now, one of the supervisor's response was, ``No, we don't 
treat their collateral any differently.'' And the other one 
wrote back, in Exhibit 93c,\1\ that as long as we had current 
FICO scores for the borrowers, the analyst was ``good to go.''
    \1\ See Exhibit No. 93c, which appears in the Appendix on page 590.
    So we got S&P employees now that know there is a problem 
with Fremont loans, but treated those loans like any other.
    In Exhibit 93d,\2\ there is an email in which S&P analysts 
were circulating an article about--and this is January 29--how 
Fremont had stopped using 8,000 brokers because of loans with 
high delinquency--with some of the highest delinquency rates in 
the industry coming from those brokers.
    \2\ See Exhibit No. 93d, which appears in the Appendix on page 592.
    Now, in March, a couple months later, Fremont announced in 
an 8-K filing that the court of appeals had found sufficient 
evidence in a lawsuit filed by the California Insurance 
Commissioner that the company, among other things, was 
``marketing and extending adjustable-rate mortgage products to 
subprime borrowers in an unsafe and unsound manner that greatly 
increases the risk that borrowers will default on the loans or 
otherwise cause losses.'' And the suit then could proceed 
against the company. Just a few days later, Fremont entered 
into a publicly available cease-and-desist order with the FDIC 
regarding fraud and lax underwriting standards.
    Despite that information, Fremont RMBS securities were 
rated by both S&P and Moody's in late February and early March. 
Before the ratings were done, they knew of those facts which I 
just described. By the end of the year in 2007, both companies 
began substantially downgrading the Fremont RMBS securities.
    Does either S&P or Moody's take into account an issuer's 
reputation for issuing either good loans or bad loans and 
incorporate that into their credit analyst? Mr. Raiter.
    Mr. Raiter. The answer is yes, they do. At the time that 
this occurred, the policy had been in the past that when 
information was provided to the analytical staff by investors 
or other originators, they would look into the matter, and if, 
in fact, it was justified, it would have resulted in a visit to 
them and a review of their practices and procedures. It could 
ultimately have resulted in their deals being put on Credit 
Watch or, in fact, being held up for ratings until the 
information could be worked out.
    At this time, in fairness to what was going on, there were 
rumors rampant about the quality of appraisals and the quality 
of underwriting standards that could have been quite 
overwhelming for the staff to try and track them down. But it 
routinely would have been investigated----
    Senator Levin. Should have been.
    Mr. Raiter [continuing]. And factored in. It should have 
    Senator Levin. It should have been. So when the analyst 
said no special measures with Fremont, that was not what was 
supposed to happen.
    Mr. Raiter. It was the manager's responsibility to say this 
is a problem, we are going to get to the bottom of it, because 
the analysts took their marching orders from the managers that 
were in control of the criteria and the process.
    Senator Levin. So, again, when they said in that email no 
special measures, there should have been special measures 
    Mr. Raiter. There should have been, yes, sir.
    Senator Levin. Mr. Michalek.
    Mr. Michalek. I do not know if I feel competent to comment 
too much on how the RMBS team would have responded to those 
particular allegations. I know that with respect to collateral 
managers, and at the CDO level, if there was an issue that was 
raised regarding the reliability of the origination that the 
collateral manager was involved with, we might explore it and 
would definitely send a team to the collateral manager to do 
what we call an ops review to evaluate those procedures. The 
information that was obtained from those reviews would be used 
in our analysis in rating the transaction. But as to the 
underlying collateral, I am not competent to comment on.
    Senator Levin. OK. Mr. Kolchinsky, should there have been 
measures taken in those circumstances?
    Mr. Kolchinsky. I think so. As Mr. Michalek said, I am not 
competent on what occurred in the RMBS group, but had this 
information come on the CDO side, we certainly would have 
looked into it, or should have looked into it.
    I would also say I was not involved in 2007, as this 
information went through with the folks who rated subprime 
directly. But there was almost a feeling when dealing with them 
that there was a ``see no evil, hear no evil'' sort of 
attitude, and partly I think it is because people who had done 
these deals, rated these deals, did not want to believe what 
was going on, partly profit motivated, partly because they were 
part of this market, and it just should not be happening.
    Senator Levin. Part of that culture.
    Mr. Kolchinsky. Part of that culture. Closed eyes.
    Senator Levin. Dr. Cifuentes.
    Mr. Cifuentes. I can comment on what happened at the CDO 
group when I worked at Moody's. On many occasions, for example, 
we were presented with transactions that either did not make 
any sense or that had a particular peculiarity that made us 
nervous. The response was either no, you cannot do that, or the 
rating is going to be very low. It is not going to be a AAA; it 
is going to be way below. Or we took into consideration when 
analyzing the transaction or when modeling all the 
peculiarities that were applicable to that particular 
transaction. So that is the way it was done at the CDO group. I 
did not work mortgages, but----
    Senator Levin. When you were there, that is the way it was 
    Mr. Cifuentes. Yes. I remember many situations, as I said, 
in which we encountered a transaction, for example, that was 
done for the first time. We did not have enough data, for 
instance, so we had to make conservative estimates about 
certain things, and that is the way we did it.
    Senator Levin. And that is the way you believe it should 
have been done?
    Mr. Cifuentes. I believe so, because I can give you an 
example. For example, at Moody's I rated the first emerging 
market CDO that was done. That was in 1996, and we rated 
emerging market CDOs probably between 10 and 15 deals in that 
time frame. One of the problems with emerging markets was we 
did not have enough data. So the way we handled that--we were 
conscious of that--we made conservative assumptions regarding 
certain pieces of information that we did not have, and we did 
something--at the risk of sounding too technical, but I think 
you are talking about a trillion dollar problem, you better get 
the technical thing right. So we did something called stability 
analysis to see how the impact of uncertainty in the data would 
affect the ratings, and I have to say that all those emerging 
market deals did very well, actually.
    Senator Levin. Take a look at 93a.\1\ This says volumes 
about Fremont and what was known. This is a Moody's email, 
December 2006. They were talking about delinquency rates for 
issuers. If you look at page 2, ``Here is a chart of the top 10 
issuers'' that have high delinquency rates, and then on the 
bottom of the next email, it says, ``Holy cow - is this data 
correct? I just graphed it and Fremont is such an outlier!!'' 
In other words, they are one of the worst when it comes to 
delinquency rates. More evidence about Fremont, by the way, 
about as bad as it gets. They had those articles about the 
8,000 brokers and the other information that I mentioned.
    \1\ See Exhibit No. 93a, which appears in the Appendix on page 587.
    But just in terms of the deals, I wanted to talk about an 
email, Exhibit 95a.\2\ This was an email from July 2007, in 
which an investment banker described a deal called Delphinus. 
This was rated AAA by both S&P and Moody's. Exhibit 95a 
described Delphinus as having a lot of cushion, they needed a 
lot of cushion to protect against losses. Despite that cushion, 
by the way, Delphinus was downgraded 6 months after being 
rated. That may not be Monday to Friday, Mr. Michalek, but it 
is not the way it is supposed to be, right?
    \2\ See Exhibit No. 95a, which appears in the Appendix on page 646.
    Mr. Michalek. That is correct. It is not.
    Senator Levin. Now look at Exhibit 95b.\3\ This is an S&P 
email chain from August 2007. An S&P analyst wrote here 
regarding Delphinus, ``[I]t appears that the closing date 
portfolio they gave us for analysis and the effective date 
portfolio . . . were not the same. It appears the 25ish 
assets''--and we are looking at, again, Exhibit 95b--``that 
they included in our closing date portfolio that were dummies 
were replaced in less than 24 hours with assets that would have 
been notched and made the portfolio worse.''
    \3\ See Exhibit No. 95b, which appears in the Appendix on page 647.
    Now, if I read this right, the CDO had given S&P dummy 
assets that S&P used to come up with its rating, and then at 
the last minute replaced those dummies with new assets less 
than 24 hours before the closing, and the new assets, if I read 
this correctly, made the portfolio worse. And if that had been 
acted on, the rating would have been worse
    Mr. Raiter, is that a correct reading of that email, would 
you say, the way you read it, too?
    Mr. Raiter. These are relating to CDO analyses, and CDO, 
and it suggests that they pulled--they put dummy deals in the 
original run, and then they substituted them with loans or CDO 
credits that did not meet the standards that the original run 
was completing, or completed on or contemplated, and it looks 
like a bait and switch and that it did not meet the criteria. 
But I do not know who addressed it because if I follow the 
email stream, they were waiting for a manager to get back to 
    Senator Levin. Yes. I tell you, these emails are, I think, 
just devastating as to the kind of culture that was going on 
here. It is incredible that you could have this kind of dummy 
assets being put into a CDO, then substituted at the last 
minute with even poorer assets.
    Mr. Raiter. Well, I would like to point out, if I could, 
Senator, there were a lot of very good analysts that were 
writing these memos and asking for guidance, and the guidance 
was not forthcoming from the top.
    Senator Levin. I could not agree with you more. But that is 
the culture that existed here, and I am going to now turn this 
over to Senator Kaufman.
    Senator Kaufman. Thank you, Mr. Chairman.
    To follow up on that question, in your opening remarks, you 
attributed this to bad incentives, which clearly has gone on, 
the incentives were wrong, quality was gone, quantity, 
competition. Mr. Raiter, you mentioned the SEC oversight. How 
much of this was just outright fraud? I understand this about 
the business, and I am going to get into this a little bit. But 
it seems to me the things that were going on here, because of 
the incentives, because of the lack of oversight, people were 
actually doing stuff that they knew absolutely totally was 
wrong. Mr. Raiter.
    Mr. Raiter. Well, it is clear from a lot of these emails 
people were making very poor calls in terms of the analytics. 
But whether that is fraud or not, it was wrong, it did not look 
good. They certainly would not want it to have the headline 
risk in the Wall Street Journal. But there was no one over 
there watching over them to tell them this is not the right 
thing to do.
    Senator Kaufman. No. I understand that, and I am very 
sympathetic to that. And if you heard any of the speeches I 
have given on the floor, I pretty much beat up on the 
regulators for what they did not do. But I spent a lot of time 
in business. I worked for corporations. There were always 
incentives of some kind to make the quarterly earnings, push 
the stuff out the door, do the rest of it. But when you have 
the incredible amount of--the chart that he put up there on the 
number of RMBSs that were rated AAA and ended up turning to 
junk, many of them you were going after. And maybe ``fraud'' is 
too strong a word, but things that just are not common business 
practice no matter what the incentives are, no matter whether 
you are being regulated or not.
    Mr. Raiter. Well, they were not good business practices, 
and it is my opinion that there was a huge disconnect between 
management. Senior management thought that they were 
responsible for all these wonderful things and that the 
analysts were just the soldiers in the trenches doing what they 
were told.
    Senator Kaufman. You talked about a disconnect, and I want 
to get into it, between the people doing the rating and the 
surveillance. But talk a little bit about--I have been in 
organizations, not just government organizations, private--
where there is a disconnect, but a disconnect that this is a 
pretty incredible disconnect if you keep turning out products, 
and Mr. Michalek, I will get to the idea of what AAA really 
means or not. But you are turning out product because of the 
incentives, because of the regulators, because of the 
disconnect between management, all those things happen. But you 
are turning out product that is just really not good product, 
and how much of it is because of the emails, as Senator Levin 
said, where people just said, OK, and because of incentives, 
because of regulators, I am going to do something here and try 
to rearrange this thing.
    Mr. Raiter. Senator, if you have been in business, the 
choices that you face in a dilemma like this is you can quit.
    Senator Kaufman. Right.
    Mr. Raiter. If you have a family to support, that might be 
a little bit tenuous. And some of us chose to do just that. I 
retired because I got tired of the frustration. But a lot of 
the analysts that left tried to fight the good fight. Many of 
them have subsequently been laid off.
    Senator Kaufman. Right.
    Mr. Raiter. And when you bang your head against the 
management wall and ask for the money and give them 
presentations and show them the benefits of the higher-quality 
rating criteria and they come back and say, ``But revenues will 
go down,'' you are faced with just that choice. Either you 
continue to work there and fight, or you quit.
    Senator Kaufman. I am very sensitive to this, and I 
understand this. I have been there. But how much do you think 
the management really knew what was going on down in the 
trenches because of the pressures they were putting on the 
people down there in the trenches? Do you think they were 
oblivious to this, that they----
    Mr. Raiter. You have Kathleen Corbet, the former President, 
on the docket for the third panel.
    Senator Kaufman. Right.
    Mr. Raiter. She could possibly shed some light. Budgeting 
and the whole process of making requests and sending them up 
the line was a mystery. We never sat down and were explained 
why we did not get things, why they would not make the changes 
recommended. They just did not respond. They did not 
communicate down, from the top down.
    Senator Kaufman. Right. Mr. Michalek.
    Mr. Michalek. I can tell you at Moody's, while I was there, 
it was frequently the case that in a particularly sensitive 
issue, the information did travel upward. I was involved in one 
transaction where I was asked to consult with somebody in 
Public Finance. They had a ratings problem that was leading to 
litigation. And the general counsel for Moody's was at the 
table. We were on conference calls together. We were talking to 
the client. We were trying to resolve this.
    Brian Clarkson--at the time, I think he was president of 
Moody's Investors Service--was on the call, and this was for a 
relatively small matter. In terms of the total amount of 
issuance, it was probably a quarter of a billion dollars [$250 
million]. It was not as large as one of our CDOs.
    So from that alone, I would infer that the information 
regarding some of the much larger conflicts and potential 
problems was definitely reaching upwards.
    Senator Kaufman. Mr. Kolchinsky.
    Mr. Kolchinsky. Thank you. First, before I answer your 
question, I want to quickly come to the defense of the analyst 
mentioned in Exhibit 95a.\1\ In fact, that analyst that was 
mentioned was extremely bright and the reason that she was not 
wanted on that deal is because she asked a lot of very good 
questions. I wanted to come to her defense.
    \1\ See Exhibit No. 95a, which appears in the Appendix on page 657.
    Senator Kaufman. Sure. No problem.
    Mr. Kolchinsky. Second of all, I do not believe in the 
cause of the crisis there was a lot of instances of outright 
fraud, legal fraud. There may have been some on the front end 
with the mortgage brokers in filing applications that were 
clearly fraudulent. But the way the system worked, you had a 
chain--it was almost like a game of telephone where you pass 
some information down the line, and everybody changes it just a 
little bit--not enough to jump over the fraud, but because the 
length of the chain from the mortgage broker to the originator 
to the aggregator to the CDO, by the time everybody takes a 
little cut, changes it a little bit, by the time you got to the 
end of the line, the information or the product was garbage. So 
that is why you have not seen a lot of cases of outright fraud 
because everybody pushed the envelope, clearly pushed the 
envelope. But because of everybody pushing the envelope, the 
end product was garbage.
    Senator Kaufman. Yes, but, I can see that in 1 day, I can 
see it 2 days, I can see it 5 days, I can see it a month, I can 
see it 2 months, I can see it 3 months. I just find it--these 
are very smart people. I mean, when you look and see you are in 
the middle of a chain and you see what is happening, at some 
point you say, there is something really going on here. And 
maybe it is nonfeasance. It is not malfeasance. They are not 
doing it to be bad. They just do not go back and look to find 
out what they do not want to know, what actually happened.
    Mr. Kolchinsky. I think that is right. Yes, sir, I think if 
you were going to sort of talk about sins, it is sins of 
omission because of the market, because of the incentives. 
There was really no incentive to look, to look under the rocks. 
If the rocks kind of looked polished and nice, OK, we will pass 
it on.
    Senator Kaufman. This is the third hearing we have had, and 
this is kind of a common theme. No one knew what was happening. 
It just rings to me of other cases where no one knew what was 
happening. But people knew--these are not really dumb people. 
These are not people that just come in to work, sit in their 
cubicle, look at what they are doing, they are not reading the 
newspaper, they are not picking up the Wall Street Journal or 
Barron's and reading about what is going on with the housing 
market or mortgage-backed securities or any of this kind of 
stuff. They are just coming to work, doing their job, getting 
pushed, and have these incentives. As Mr. Raiter said, good 
people. And they are stuck. And I do not think it is the good 
people, frankly, in my experience, like the analyst you 
mentioned, that were the problem. I think this is a systemic 
problem here that was not--we talk about it in kind of surgical 
terms, like incentives and regulation and all that stuff, which 
are all absolutely totally on the mark. It was the incentives, 
and it was the regulatory environment, and it was a flawed 
business strategy, and it was competition, and it was quality 
over quantity.
    When you put all those things down, somebody in the middle 
of this thing would have to be totally, completely--they had to 
put together the big picture. Somebody had to say, look, we are 
putting incentives on here, we got this quantity problem, we 
got the competition problem, we are not having very much 
regulation and oversight. There is a potential here for 
something really bad to happen.
    Mr. Cifuentes.
    Mr. Cifuentes. I think you bring up a good point, Senator. 
In fact, you referred to your experience in the private sector. 
The thing to keep in mind here is that this is a very peculiar 
sector in the private market. I mean, to be perfectly blunt, if 
you are in the private business and you do a lot of things 
wrong, eventually you go out of business. I mean, that might be 
evident. Arthur Andersen does not exist anymore, for example.
    In the rating business, because of some really flawed 
regulatory framework, there is no penalty for giving bad 
ratings. In fact, we are having this conversation 2 years after 
my first--and the rating agencies, they keep issuing ratings 
and they keep collecting fees for that.
    So, in my opinion, one of the problems is the regulatory 
framework. Today the barriers to entry into the credit rating 
business are tremendous. There was a law that was passed by 
Congress, the Rating Agency Act. If you want to start a new 
rating agency, you have to show that you have been in operation 
for 3 years giving ratings and collecting fees. Now, who is 
going to pay you for a 3-year period to give ratings that do 
not have any validity?
    So, in my opinion, that is something that needs to be 
changed because one of the problems we have right now, there is 
no penalty for getting out ratings that are unreliable. I mean, 
basically the rating agencies were giving a free gift, and you 
cannot blame them for that. I mean, they are taking advantage 
of a very unique opportunity to bring money in.
    Senator Kaufman. Mr. Michalek, I think you have got at the 
other key point in this whole discussion, especially on the 
hearing today, and that is that you want to make sure that the 
Subcommittee understands what AAA really means.
    Mr. Michalek. Correct.
    Senator Kaufman. And I think there is such an incredible 
disparity between what everyone reads AAA to be and what AAA 
    Mr. Michalek. To the rating agencies, in the disclosure 
documents, I think there is a disparity--Senator Levin used the 
term ``safe,'' and I do not think that ``safe'' is correct, as 
a description--it is definitely the commonly understood 
adjective that you would use, but to be perfectly honest, I can 
think of an illustrating example--when this first debate first 
came up, there was a transaction that I was working on with an 
analyst that there was problematic--because of the particular 
assets that were in the pool--and they were not yet placed on 
negative Credit Watch, so quantitatively we could not take the 
haircut that we knew was going to be coming. And through some 
other measures, we were able to anticipate that there was going 
to be a likelihood that this would not hold its rating for a 
very long period of time.
    However, on the closing date, it did meet the published 
criteria. It did reach that particular quantitative number, and 
we could not say no--this was sort of at the beginning of the 
cultural change. We could not say it is a ``different'' AAA.
    Senator Kaufman. And, by the way, I am very sensitive to 
that. It is hard to give ratings to agencies. It is hard to 
figure out what is going to happen. And in cases like that, if 
what transpired after that had not happened, I would be sitting 
here as the most sympathetic man in the room to what you are 
    The question is at some point it went from that--which was 
a tough decision. And when you talk to the rating agencies or 
listen to what the rating agencies say, they still think it is 
like that. You just do not understand. We have these very 
difficult questions that we have to deal with. So AAA does not 
mean that it is going to be here forever, and AAA does not mean 
this and AAA does not mean that.
    Yes, AAA does not mean thousands of securities that are 
rated AAA that 2 years later are junk. So this is not a 
discussion--we are not having the first discussion, the 
discussion that I always learned about in business school, and 
also about what rating agencies are. I know what rating 
agencies are. And that is what they used to be. But when you 
are faced with a situation where because, again--because of not 
regulating the rating--so what is it that rating agencies are? 
AAA does not mean AAA. It does not mean AAA based on your very 
good definition of what it used to be. But AAA does not mean 
the same. So how do you deal with this, the fact that you had 
this systemic--is it fair to say a systemic problem?
    Mr. Michalek. I think so.
    Senator Kaufman. And how do you get at that so that 
specific problem--and we are going to have all kinds of new 
problems. We do it around here all the time. But how do you 
deal with that systemic problem?
    Mr. Michalek. In my opinion, I think that we would really 
have to begin with what we are disclosing. I personally believe 
that there are products that deserve a commonly understood 
rating, that the public can say this is safe, because the 
rating is saying that it is safe. And I think that for a large 
number of the highly complex structured products, it is a 
different ball game. And I think that to the extent that you 
are able to distinguish between those products that are clearly 
in the different ball game, then the caveat of buyer beware is 
more appropriately applied. But for that portion of the 
products that I think the enormous public good that comes from 
having an independent arbiter of risk apply a commonly 
understood and accepted measure of that risk, I think that is 
something that we should seek to preserve, and so that it would 
eliminate that bleed, if you will, from the extreme debate or 
debatable conversation that goes on with respect to the highly 
complex products, into what really should be beyond debate with 
respect to what is safe and what is definitely contributing to 
the public good.
    Senator Kaufman. And do you think you could do that? I 
mean, realizing that there would be some securities in the 
middle that would be--but having the idea that for what is 
commonly known as AAA corporate bonds you have one thing; for 
credit default swap you have something different.
    Mr. Michalek. I think that it would require an impetus from 
outside. Clearly, the rating agencies do not, as it has already 
been demonstrated, have an internal incentive given the way 
that they are structured to pursue market share and to pursue 
profits, to install that kind of change, at least not to be the 
first one to install that kind of change.
    I had the somewhat naive idea when I joined Moody's that 
there was a particular quality that Moody's was offering, and 
that was something that the company was going to seek to defend 
over time, and that effectively our brand meant something, and 
that I expected people to step in much earlier to say we are 
diluting our brand. And if we had this 96 or 98 percent market 
share, once our brand becomes absolutely equivalent to the 
other three, mathematically we are not going to stay there.
    Senator Kaufman. Mr. Michalek, you have just defined this 
whole thing. I mean, in my opinion, everybody just decided to 
go for the fastest possible money they could ever possibly make 
and not worry about the brand and not worry about anything. I 
think it goes to the whole thing where we--and we did not have 
this, as Mr. Raiter pointed out, and the big thing that was 
missing was the referees on the field. We just pulled the 
referees off the field not just in the rating agencies but with 
everybody else, and we said we do not need referees anymore. 
And I think just like in football, or here or anywhere else, 
just like why we need police on the beat, not because people 
are crooks, but because police should be on the beat because 
potentially they will become crooks if, in fact, the 
temptations are so great.
    Mr. Raiter, how do you think we deal with problems going 
down the road in terms of rating?
    Mr. Raiter. Well, I think you have to have some rules. 
Actually, you have to have some penalties for not doing the 
right thing, and there are none, and there are no measures of 
whether you are doing the right thing.
    Senator Kaufman. What would you define as not doing the 
right thing, for instance?
    Mr. Raiter. Well, I would say if you have developed a model 
in the house that shows that it is much better than anything 
you are running and it shows that you have been too optimistic 
with the ratings you have assigned, and you do not immediately 
start to use it and go back and re-rate the old deals so you 
can warn the investors that we have been wrong, then that is 
not doing the right thing. And I will point out from a cultural 
perspective, there were two mantras that we heard at Standard & 
Poor's all the time after I joined, and I am sure they went on 
before that. One was a AAA is a AAA is a AAA, and it did not 
matter if it was a corporate, a municipal, or the new 
structured products. And they used the transition studies to 
prove that by saying, look, here is the transition of a AAA 
corporate, what is the probability it might be downgraded? What 
is the probability it might go from AAA to default, as in Penn 
Central? There had never been a AAA mortgage-backed that had 
gone to default from AAA until this latest debacle. In the 
transition of AAA mortgage-backed's compared to AAA corporates, 
it was much better. All right? So AAAs were all the same.
    The other thing that was heard constantly--and it was in 
one of these emails--if we change, everybody will think that we 
have been wrong. And that just put a real anchor on any new 
ideas quickly going through the process because they were 
afraid somebody would suggest that they had not been right 
before and they would have liability or they would lose some 
market share. That was not doing the right thing, and they do 
not have a referee or anyone to tell them when they have 
crossed that line.
    Senator Kaufman. Well, the other thing is, look, 
everybody--there is not a single thing that has been raised 
here this morning in terms of what the behavior was. As an 
elected official, you hate to change your position on anything 
because it admits that you did something wrong. I mean, 
everybody does--these are all common things. I think the fact 
that there are no penalties is key, and I would like to get at 
least a little bit of questions in the second round about 
grandfathering, and exactly what you said, why there was not 
more grandfathering with all the witnesses.
    So with that, I yield to the Chairman.
    Senator Levin. There is always going to be a debate on how 
to cure a system, but we know there are a lot of things that 
should not have happened that did happen, and we are going to 
debate those cures as to what the remedies are legislatively in 
the week coming up.
    But I want to go back to some of the things that it is 
pretty obvious to me were wrong, wrong at the time, and as 
complex as some of the remedies are, some of these issues are 
not complex at all. Market share should not be driving ratings. 
Would you all agree with that?
    [Witnesses nodding affirmatively.]
    Senator Levin. Let us take a look at what drove the ratings 
here. Let us look at some more evidence. Exhibit 5, an email 
dated March 23, 2005, between S&P employees that I think you 
worked with, Mr. Raiter. Here is Exhibit 5.\1\
    \1\ See Exhibit No. 5, which appears in the Appendix on page 258.
    ``When we first reviewed 6.0 results `a year ago' we saw 
the sub-prime and Alt-A numbers going up and that was a major 
point of contention which led to all the model tweaking we've 
done since. Version 6.0 could've been released months ago and 
resources assigned elsewhere if we didn't have to massage the 
sub-prime and Alt-A numbers to preserve market share.''
    Should those numbers be massaged to preserve market share? 
Does anyone believe that? Mr. Raiter.
    Mr. Raiter. No, sir. They should not have been massaged. I 
think I stated earlier that as the models were developed by our 
consultant and they were tested in-house to verify that they 
were accurate and that their predictiveness was an improvement 
over the model that was currently running, the models were 
immediately put into force. We ran out of financing and funding 
in our budgets in 2003 to put this Version 6.0 model in place. 
But the preliminary analysis, as Dr. Frank Parisi suggested, 
was that we were not adequately rating the transactions. That 
model was delivered I believe in September 2006. They did an 
accuracy evaluation. It was determined to be accurate, better 
than what they were running, and the consultant was paid. But 
they also performed what was called an impact analysis on the 
ratings. We had never done that before, so I do not know where 
the order came to start doing impact analysis on the 
effectiveness new models had on market share. But it is 
apparent that is what happened.
    Senator Levin. And what was your reaction when you read 
that email?
    Mr. Raiter. I was pretty amazed. I mean, Frank Parisi was 
one of the Ph.D.s that worked on these models. He is very 
knowledgeable. He is one of the best analysts they have and 
very outspoken.
    Senator Levin. Were you bothered by it?
    Mr. Raiter. Certainly.
    Senator Levin. Mr. Michalek, should market share be 
preserved by massaging numbers?
    Mr. Michalek. No.
    Senator Levin. Is it troubling when you see that kind of an 
    Mr. Michalek. It is troubling in the sense that it is one 
more piece of evidence of what I was observing while I was at 
Moody's. One of the comments that might be somewhat 
illustrative of this is when I had some discussions with Brian 
Clarkson about the process, his perspective was, yes, we could 
effectively produce perfect ratings, but we would not be on the 
deals. And if we are not on the deals, then we are not able to 
add any value whatsoever. So in some sense, it is like, yes, we 
take a little bit of this poison, but we are going to save the 
patient because you have the opportunity to get in there and 
fight the good fight.
    Senator Levin. Right, and make profit.
    Mr. Michalek. He did not mention that.
    Senator Levin. He may not have mentioned it, but 
    Mr. Michalek. It was definitely a part of that. It was 
clearly--I mean, this was in the context of a discussion where 
my job was on the line, and it had already been said earlier in 
the conversation that if you are difficult in the transactions, 
there is no choice but to replace you.
    Senator Levin. That is pretty devastating, I tell you. Mr. 
Kolchinsky, what is your reaction to this kind of an email 
    Mr. Kolchinsky. It is very disturbing, and as the folks on 
this panel said, this is something we witnessed. Market share 
did drive the credit analysis, and I think that is why I was 
also let go from the rating agency.
    Senator Levin. Because you objected to it being the driver?
    Mr. Kolchinsky. I objected to it being the driver. I went 
ahead and tried to prevent us from what I believed was 
committing securities fraud.
    Senator Levin. Dr. Cifuentes, what is your reaction when 
you see an email like this?
    Mr. Cifuentes. Well, I do not think I have a lot of 
original thoughts to add after what my colleagues have said, 
but it is kind of obvious. It is really a little bit troubling.
    Senator Levin. Take a look, if you would, at Exhibit 
24a.\1\ Mr. Kolchinsky, by October 2007, Moody's had downgraded 
hundreds of RMBS securities, and was in the process of 
downgrading billions of dollars of CDOs. Yuri Yoshizawa wrote 
to you, ``Can you take a look at the deals that we didn't rate 
from the spreadsheet that Ivy sent out last night to double 
check the information and to let me know of any of the 
    \1\ See Exhibit No. 24a, which appears in the Appendix on page 318.
    And an earlier email in that chain says, ``Market share by 
deal count dropped to 94 percent. . . . It's lower than the 
98+% in prior quarters.''
    Is this something you got frequently, this kind of 
reference to market share, up, down, as being a driver?
    Mr. Kolchinsky. Yes, sir. These emails were sent out, the 
market share emails were sent out at least quarterly, but 
occasionally on a monthly basis. They were sent out to just the 
managing directors in a given group.
    Senator Levin. I will tell you something. For a firm that 
is supposed to have a reputation of high quality right in the 
middle of a financial crisis to be looking at the market share 
issue instead of whether their ratings are decent and whether 
or not what happened, how could our ratings have been so wrong, 
how do we improve it. What is on their mind: Market share, 
market share, market share.
    Mr. Kolchinsky and Mr. Michalek, let me ask, at Moody's did 
employees understand that the amount of market share that was 
maintained or increased by the RMBS and CDO groups influence 
the size of the employee year-end bonus?
    Mr. Kolchinsky. It was certainly the case in terms of the 
revenues impacted the stock, and most employees owned either a 
lot of options or restricted stock in the company, as well as 
the profitability of the group did influence the size of the 
bonus, yes.
    Mr. Michalek. It was even more pointed than that. I think 
that we underwent a revision in the compensation structure--I 
am not going to be able to remember exactly the date; I think 
it was in 2006--where a larger percentage of our compensation 
was going to be delivered in terms of deferred compensation. So 
it became more important to see that what we were looking at 
was whether or not we were reaching our revenue numbers on a 
quarterly and annual basis which would allow us to, ``maximize 
our--or max out our bonuses.''
    Senator Levin. And that meant that the ratings that you 
would give or not give to the banks could affect your bonuses?
    Mr. Michalek. Could affect your bonus. Clearly, if for any 
reason you were stopping a deal or delaying a deal or creating 
an issue with the relationship between the banker and Moody's, 
that was a problem.
    Senator Levin. And this is the fundamental conflict of 
interest that we need to do something about in the legislation. 
Would you agree, Mr. Kolchinsky?
    Mr. Kolchinsky. Yes, sir. that is correct.
    Senator Levin. Mr. Michalek, would you agree?
    Mr. Michalek. Absolutely.
    Senator Levin. Mr. Raiter, would you agree with that?
    Mr. Raiter. Yes, sir.
    Senator Levin. Dr. Cifuentes.
    Mr. Cifuentes. Yes, I do.
    Senator Levin. And it is legislation which is hopefully 
going to be allowed to be debated. We will find that out Monday 
night. But this is an issue which is not in the bill yet, and 
it has to be somehow or other put in that bill. There has got 
to be a way that the regulators are going to find to eliminate 
this conflict of interest. It is shocking that whether or not 
something is rated AAA or whatever--and that means something to 
people. I mean, it may mean too much to some people, by the 
way. It may mean more than technically it should mean. But it 
means a great deal, and legally means probably too much in 
terms of where some entities are allowed to invest or not 
invest. But that fact of life, it should not be dependent 
upon--the credit rating; it should not determine a bonus of 
somebody who is giving the rating. It is so clear, it is so 
obvious, there is such a fundamental conflict here to me. Your 
testimony is going to be very helpful to us in hopefully 
getting rid of that conflict and directing the regulators in 
whatever the new regulatory regime is to end that conflict of 
interest. It goes right to the heart of a rating, which is 
supposed to be an honest, objective, independent assessment of 
the likelihood of an investment paying off. And it is not 
performing that function when you have this kind of pressure on 
people to rate a certain way in terms of their own pay.
    Now, we had a situation, Mr. Raiter, I believe when you 
were head of RMBS, when you helped develop a model that was 
used to rate the RMBS securities. Then there was a period where 
S&P was doing very well in terms of revenue, and you asked 
senior management to buy mortgage data on the new types of 
mortgages so that you could improve that model. Is that 
    Mr. Raiter. Yes, sir.
    Senator Levin. And did you get the money?
    Mr. Raiter. No, sir, not while I was there.
    Senator Levin. OK. So this was supposed to keep models 
current and to do surveillance, so-called. Is that correct?
    Mr. Raiter. Well, predominantly to build models, but to be 
made available for surveillance at the loan level detail.
    Senator Levin. All right. Do you know why S&P did not spend 
the money on better analytics?
    Mr. Raiter. No, sir, I do not.
    Senator Levin. Now, there are also some things that should 
not happen regardless of the complexity of how you design a 
better system. There are some things, it seems to me, that are 
clearly wrong that happened and should not happen.
    In the subprime loan deals, a number of loans in which 
borrowers paid a low initial rate, sometimes interest-only 
payments, and then after a specified number of months or years, 
switched to a higher floating rate that was often linked to an 
index. Did you have any data at the time as to how those 
subprime loans would perform? Mr. Raiter, did you have data?
    Mr. Raiter. The model that is referenced in a number of 
these exhibits that we have looked at, the Version 6.0 was the 
first data set that we had that had a significant amount of 
information on those hybrid pay option type of loans. And it 
was the analysis of those loans that suggested that we were 
underenhancing or being overly optimistic and was the primary 
reason for trying to push that model into production as soon as 
possible in 2004 or at the most 2005.
    Senator Levin. Because you were trying to test as to 
whether or not that kind of a product would increase the risk 
of nonpayment. Is that correct?
    Mr. Raiter. Well, the products started to appear in 2003, 
but in very small numbers, and by 2004, when we built this 
database, we had more significant information on those types of 
products that indicated that what we thought--how we thought 
they were going to behave in the initial versions were--it was 
behaving worse than that, and we needed to get the new model in 
place because it had more data and gave us a better look at how 
these things might perform.
    Senator Levin. Was there a delay in putting that new model 
in place?
    Mr. Raiter. Well, we had some preliminary results in early 
2004. I left in April 2005, and I believe the model was 
delivered in September 2006. And I do not know if it was ever 
    Senator Levin. All right. Now, some of the subprime loans 
also used stated income loans in which the lender just accepted 
a borrower's oral presentation of his income and did not verify 
it. In your judgments, would that make loans riskier to have 
unverified income in these loan applications?
    Mr. Raiter. Yes, sir, they were considered riskier.
    Senator Levin. All right. Would you all agree with that, it 
would be riskier if there was no verification of income?
    Mr. Michalek. Absolutely.
    Senator Levin. OK. Mr. Kolchinsky.
    Mr. Kolchinsky. Yes.
    Senator Levin. Would you agree with that, Dr. Cifuentes?
    Mr. Cifuentes. Yes. Actually, the real point is what you do 
about that. I mean, if you know it is riskier, you take 
precautions and you do your analysis with much more 
conservative assumptions. That is really to me the bottom line.
    Senator Levin. All right. Mr. Raiter, going back to you 
again, you had insufficient data to predict how a new loan 
would perform. Was there something assigned called a magic 
    Mr. Raiter. When we could not get the data in order to do a 
full analysis on a major revision to the model, they would come 
up with a multiplier that could be applied to the model results 
that were being run, which were inadequate in order to beef 
that number up. And it was always intended that those magic 
numbers would be replaced with full-blown analytics when the 
data came in. And it is my understanding that there were some 
magic numbers installed in early 2005, when they made 
adjustments to the existing model, and if they were massaging 
information on the 6.0 model when it came out, it would 
typically be in the form of these multipliers that they would 
    Senator Levin. Was there a fee charged for surveillance?
    Mr. Raiter. Yes, sir. Surveillance was a profit center.
    Senator Levin. And there was a fee, perhaps a large amount, 
that was supposed to last for the life of the security. Is that 
correct? Were surveillance fees smaller than the initial rating 
    Mr. Raiter. Yes, very much smaller.
    Senator Levin. But they were supposed to pay for ongoing 
ratings and re-ratings, were they not?
    Mr. Raiter. Right, the ongoing review of the rating.
    Senator Levin. Let me ask you, Mr. Cifuentes, perhaps. If a 
ratings model changes its assumptions or criteria, for 
instance, if it becomes materially more conservative, how 
important is it that the credit rating agency use the new 
assumptions or criteria to re-test or re-evaluate securities 
that are under surveillance?
    Mr. Cifuentes. Well, it is very important for two reasons: 
Because if you do not do that, you are basically creating two 
classes of securities, a low class and an upper class, and that 
creates a discrepancy in the market. At the same time, you are 
not being fair because you are giving an inflated rating then 
to a security or you are not communicating to the market that 
the ratings given before were of a different class. So I think 
the right thing to do is to analyze or actually re-analyze all 
the transactions with the new parameters.
    There is no revenue involved in that, as you probably 
    Senator Levin. Mr. Raiter, were there discussions within 
S&P about using rating models to conduct surveillance?
    Mr. Raiter. Yes there were.
    Senator Levin. And were those discussions heated at times? 
Were there disagreements over that?
    Mr. Raiter. Yes, there were disagreements. Yes, sir.
    Senator Levin. What was the argument about?
    Mr. Raiter. Well, there was a certain number of analysts on 
our side that thought that it would make a lot of sense to 
protect the investors, go back and look at exactly how these 
deals were performing with new criteria and with the marks that 
were available in the model to mark the properties when the 
prices went down or up. And there was the other side of the 
argument that it would increase ratings volatility which might 
make us look bad in the eyes of the investor and could cost us 
market share.
    Senator Levin. So the market share was a factor there as 
well as to whether or not you would use the new available 
information to re-rate the existing securities?
    Mr. Raiter. Yes, sir.
    Senator Levin. Mr. Michalek, was there a restricted list 
for rating analysts at Moody's who were prohibited from working 
with certain banks?
    Mr. Michalek. I do not know if there was such a list.
    Senator Levin. Were you on a restricted list where you 
could not work for Goldman or Credit Suisse?
    Mr. Michalek. There were quite a number of banks that had 
previously requested that I not be assigned to their 
    Senator Levin. And they were complaining about you?
    Mr. Michalek. There was a variety of complaints, that I 
would be either too aggressive, too abrasive, or that I was 
asking for things that were not being asked for by other 
analysts in the transactions.
    Senator Levin. Was that in your mind because at least in 
some of the cases you were asking too many questions which 
would negatively affect the rating?
    Mr. Michalek. Absolutely. It was a case that I attempted to 
provide the same analysis to every transaction that came into 
my view, and, unfortunately, we were not facing the same set of 
bankers on the other side of the phone.
    Senator Levin. Let me just ask a couple questions quickly 
about synthetic CDOs. There was a huge increase in those. I 
think everyone knows the numbers or at least knows of the large 
numbers that were being rated. Did those synthetics cause any 
problems for credit rating agencies? Mr. Kolchinsky.
    Mr. Kolchinsky. Yes, sir. The synthetics, the key element 
of synthetics is their complexity as well as their flexibility.
    Senator Levin. And were they being used to short the market 
a lot?
    Mr. Kolchinsky. From news reports I understand yes.
    Senator Levin. And if they were being used to short the 
market, would that be saying something about the quality of the 
reference to the assets? Logically, would it be saying 
something about the assets being referenced?
    Mr. Kolchinsky. I think if you hear all the stories of 
folks shorting not just a few securities but in size and 
massively, I think they obviously had a view that these 
securities were not that good and the whole market was going to 
    Senator Levin. And is it correct that you supervised the 
staff at Moody's that rated the transaction known as Abacus?
    Mr. Kolchinsky. That is correct. That was under my business 
line. I think you are referring to the ABACUS AC1.
    Senator Levin. That is correct.
    Mr. Kolchinsky. In the 2007-AC1. That was under me. I 
staffed the transaction. I was not involved in it day to day.
    Senator Levin. Were you aware that the bank that presented 
the deal to Moody's was Goldman Sachs?
    Mr. Kolchinsky. I was.
    Senator Levin. And have you seen reports that the Paulson 
firm shorted the ABACUS transaction using Goldman Sachs as its 
    Mr. Kolchinsky. I have seen the recent reports on the SEC 
    Senator Levin. And have you also seen reports that Paulson 
played a role in selecting referenced assets for the ABACUS CDO 
that he expected to perform poorly?
    Mr. Kolchinsky. I have seen those.
    Senator Levin. And were you or your staff aware at the time 
that Moody's was working on the ABACUS rating that Paulson was 
shorting the assets in ABACUS and playing a role in selecting 
referenced assets expected to perform poorly?
    Mr. Kolchinsky. I did not know, and I suspect, I am fairly 
sure, that my staff did not know either.
    Senator Levin. And are these facts that you or your staff 
would have wanted to know before rating ABACUS?
    Mr. Kolchinsky. From my personal perspective, it is 
something that I would have wanted to know, because it is more 
of a qualitative not a quantitative assessment if someone who 
intends the deal to blow up is picking the portfolio. But, yes, 
that is something that I would have personally wanted to know. 
It changes the incentives in the structure.
    Senator Levin. Are people usually putting deals together 
that want the deal to succeed? Isn't that the usual assumption?
    Mr. Kolchinsky. That is the basic assumption, yes.
    Senator Levin. And if the person wanting the deal to blow 
up is picking the assets, that would run counter to what the 
usual assumption is?
    Mr. Kolchinsky. It just changes the whole dynamic of the 
structure where the person who is putting it together, choosing 
it, wants it to blow up.
    Senator Levin. Well, I could not agree with you more. 
Senator Kaufman.
    Senator Kaufman. Thank you. I would just like to touch on a 
few things here. Grandfathering. What are the factors in 
deciding whether you grandfather or not, Mr. Raiter?
    Mr. Raiter. Can you define the term ``grandfather''?
    Senator Kaufman. In other words, finding out--going back 
and you look at securities, things you have already rated, and 
deciding whether you are going to apply a grandfather to that.
    Mr. Raiter. Well, you do not grandfather them. They do get 
surveilled. There are just different levels of criteria that 
you can apply in taking a look at how a deal is performing. One 
way is to look at the pool level and decide that we are just 
going to track the delinquencies, the foreclosures, and the 
losses. Another way is to use the loan level on the 
transaction. If you can get updated loan level files, then you 
can basically re-rate the transaction based on today's 
economics, today's house prices, and changes in the credit 
quality of the borrowers and get a better look at how it would 
perform today if you were going through the process.
    Those two different ways to surveil can produce 
dramatically different results.
    Senator Kaufman. Mr. Michalek, after you changed the model 
that you were using, you decided whether to go back and use the 
new model to older loans, is that correct?
    Mr. Michalek. Again, I think this is outside of my 
    Senator Kaufman. OK. Mr. Kolchinsky.
    Mr. Kolchinsky. In the CDO world, a lot of times deals that 
were out there and closed ended up being grandfathered. For 
some practical purposes, some of the models that the deals 
used, for example, a diversity score model or a CDO model which 
were provided by Moody's were almost baked into the deal. And 
as a result, when that model changed--and that model had 
actually a positive effect in terms of for the deal's 
compliance--a positive meaning that there is a direct line that 
you have to comply with this test. There was no way for us to 
say now you have to stop using that old model, use the new 
model. We could have applied the new model on the portfolio. We 
had the portfolio. But that step was not taken. Usually we let 
deals who used old models continue using those models.
    Senator Kaufman. Mr. Cifuentes.
    Mr. Cifuentes. I left Moody's in 1999.
    Senator Kaufman. OK.
    Mr. Cifuentes. But we did not really have that issue. At 
that time the market was really very small compared to what it 
is today.
    Senator Kaufman. Mr. Raiter, did you have an indication 
that stated income loans were being used in any of the 
instruments that you were dealing with?
    Mr. Raiter. Yes. stated income loans were there. They were 
known as ``liar loans,'' ``NINAs.'' When they started using the 
stated income loan concept in the late 1990s, it was applied to 
the highest credit borrowers--doctors, lawyers, self-employed 
people. As they started developing in the subprime arena, 
again, you started out with the top of the subprime market with 
the initial loans that were coming into the bonds.
    By 2004 and 2005, with the new hybrids and the stated 
numbers, you were stepping down to much lower FICO scores, much 
lower credit quality of the borrower, and there was evidence 
starting to bubble up that brokers were impacting the way 
stated income was put on the various applications, that there 
were questions about appraisals, whether they were accurate or 
    So when they first started out with the no-income, low-doc 
kind of loans, we did have modeled in the ratings process 
higher credit enhancements for those loans, and as we tried to 
collect data on the new products that were developing and how 
they performed or were expected to perform, we were factoring 
that into the models. And, again, I hate to beat a dead horse, 
but we had a 2.8 million loan set that was used to build the 
Version 6.0 of the model, and at that time it had the most 
information we had collected on the hybrid loans. And the next 
data set that we were trying to collect had almost 10 million 
loans in it, and it was even more powerful.
    Senator Kaufman. Right.
    Mr. Raiter. So we were always looking forward to getting 
that additional information to make a better judgment as to how 
things were performing without waiting for those portfolios to 
start going bad.
    Senator Kaufman. Do you think the decision not to move with 
the more advanced models was a financial decision, or do you 
think it was a decision made with the fact that it was going to 
make things more difficult to give higher ratings and, 
therefore, be not as competitive?
    Mr. Raiter. I think the initial decisions not to fund it 
were because of resource constraints and the desire to maintain 
higher profits. I think the decisions that were made when it 
was finally developed and available for implementation would 
indicate whether they were starting to take a more serious look 
at what the impact on market and profitability was than just 
the analytics. I was gone by then.
    Senator Kaufman. Mr. Michalek.
    Mr. Michalek. Senator, I wanted to just bring to the 
attention of the Subcommittee that what you are in part drawing 
out is an extreme reliance on modeling and on the quantitative 
analysis that was going on. To the extent that you had a stated 
income loan or a NINJA loan, effectively it was simply another 
data input for which you could make some assumptions.
    So there was necessarily a stepping back on some level, in 
my mind, of the qualitative analysis of what was going on down 
below, and instead you were saying, ``Can we model it? Yes. Do 
we need to adjust our assumptions? Perhaps.'' And the debate 
would then be around: Is this the correct adjustment to the 
    Senator Kaufman. Right. But at some point, if, as Mr. 
Raiter said, it starts out being a very small problem at the 
very top for people with high income and now it is getting 
wider and wider and wider use, because I can understand, 
modeling works great because those stated income loans, from 
everything I gather, when they first started, high income, they 
had very few defaults. But it was clear to everyone that early 
on, Mr. Raiter, when you were still there, stated income loans 
were becoming a larger and larger part of the portfolio.
    Mr. Raiter. Well, they were growing, but in 2004 and early 
2005, they had not reached the numbers that were on your slide. 
And, again, we had a data set that told us that we needed to 
increase the numbers in our model, and the fact that it did not 
get implemented in a timely manner, those increases were just 
    Senator Kaufman. Right.
    Mr. Raiter. But the other side of it is, in all candor--and 
I do not want to get into an analytical debate. But when you 
have pools coming in with 1,000 to 10,000 loans, each one with 
about 85 to 100 data points, it is difficult to have an 
individual sit there and look at a printout and come up with 
some qualitative decision on what is a five-basis-points 
difference in enhancement at the AAA. You cannot do these 
products without models. And if there is an area that you might 
address, the Fair Credit Reporting Act prevents the rating 
agencies from getting the kind of in-depth information on 
borrowers that would help them gauge the credit performance 
    Senator Kaufman. Right.
    Mr. Raiter. It is post the loan being made, so it is not 
going to be a disparate impact on----
    Senator Kaufman. Good point.
    Mr. Raiter [continuing]. People trying to get a loan, but 
it gives the credit rating agencies that additional amount of 
information to help them track and determine how they will 
behave. We did not get the income. We had to back into the 
income numbers with the ratios they gave us for the mortgage in 
the front and back end, because we were not allowed to collect 
    So there were some issues there with just the information 
being made available that would take us out of the box.
    Senator Kaufman. Mr. Kolchinsky----
    Mr. Cifuentes. If I could add something----
    Senator Kaufman. Yes.
    Mr. Cifuentes. For example, in that situation, clearly you 
receive 10,000 loans, there is no way you can examine each one 
of those, and I would not expect a rating agency or anybody to 
do that. However, having said that, if a banker comes to you 
and he tells you, look, I have 10,000 loans, these are the 
characteristics of the loans, one reasonable thing you can do 
is you take a random sample, see if what you find agrees with 
what the banker tells you, and that gives you an idea. We did 
that many times when I was there at the CDO Group, not in the 
context of mortgages but in the context of different things. So 
that would be a way to handle the situation.
    Senator Kaufman. Mr. Kolchinsky.
    Mr. Kolchinsky. On this issue, I am actually more in Mr. 
Michalek's camp because I believe models are important and you 
cannot do these without models. But models are--you need a 
human being to have a quality judgment of what the results are 
and what the input is into a model.
    A financial model is like a weapon. You really have to--it 
could be useful if you are holding it, not so useful if it is 
being pointed at you. And my experience has been once the model 
is out there, once it has been published, bankers, originators 
understand how to game that model.
    Senator Kaufman. Exactly.
    Mr. Kolchinsky. And they will--anecdotally, I understand 
there is some good data on some of these no-income loans 
because most of the early borrowers, the loan officer knew the 
borrower, was driving around--was the plumber who worked off 
the books, had that information. But to extend that information 
to the whole universe of borrowers is maybe statistically 
workable, but does not make sense. And that is where you need a 
sort of qualitative judgment--I know why this was happening, 
but the model does not make sense to me anymore.
    Senator Kaufman. And I think one of the classic examples--
anybody who has read Michael Lewis' ``The Big Short''--was 
barbelling. Are you familiar with barbelling?
    Mr. Kolchinsky. Yes. It is layering of poor assets with 
good assets in the same portfolio.
    Senator Kaufman. And isn't it almost a perfect example of 
what you were just saying, where people now begin to game the 
model? They are not trying to figure out what the best product 
is. They are trying to put together a product that meets with 
the model.
    Mr. Kolchinsky. One of the lessons learned for me 
personally is that averages lie. So if you have a model rolling 
by an average, it is not telling you all the information.
    Senator Kaufman. Mr. Michalek, do you have any comments on 
    Mr. Michalek. It was an early example of how we had to 
respond in what became an aggressively or an increasingly 
aggressive game of cat and mouse, that effectively once we had 
published some criteria and this was the established 
requirement, we would quickly see that here was a set of 
reactions--here was a portfolio that presented some compliant 
averages, as Eric was referring to. And so then there was our 
response to that, in which case that generated yet another 
response to that. And so it goes.
    Senator Kaufman. Mr. Raiter, was barbelling a problem when 
you were still----
    Mr. Raiter. I think it may have been raising its head, but 
you can fight the concept of barbelling only by maintaining the 
models as accurately and based on the most amount of data you 
can get. And that just requires that--frankly, as the market 
exploded and the new products arrived, we really should have 
been looking at coming out with new models every 6 months, a 
year at the worst. Anybody is going to try and game it, and the 
only way you can avoid gaming is to keep improving it and 
changing it so you capture the nuances that allowed the gaming.
    Senator Kaufman. Did you have any indication management was 
concerned about this? This has come up as another one of the 
problems, just this massive flood of new business. I mean, 
business just exploded based on the chart we saw earlier, and 
it is a little like having a restaurant and tripling the number 
of people eating there without keeping the same kitchen. Did 
you see any indication by management they were concerned about 
the fact that we were not doing these new models, we were 
getting a massive influx of new business, this could be a real 
    Mr. Raiter. No, we did not get any indication that it 
really bothered them because they were turning us down for 
staff, they were turning us down for the resources we needed. 
And what they were looking at was you must not have been 
working very hard because your volume has doubled and nobody is 
quitting, so I guess you had slack down there.
    Senator Kaufman. Right.
    Mr. Raiter. And they were just enjoying the revenue, and by 
2005, when I left, we were getting calls from corporate 
monthly: How much money are you going to make this month? 
Structured was driving the whole ratings business, and RMBS was 
the fastest-growing unit.
    Senator Kaufman. Mr. Michalek, it was 2005 when Mr. Raiter 
left. I think by 2007, 2008, people must have been getting--
there must have been some understanding by the management that 
this was not all going well.
    Mr. Michalek. Absolutely. There had to be.
    Senator Kaufman. Did you ever see any indication of that?
    Mr. Michalek. Certainly one good example would be in the 
effort to try to catch up, it was clear that from 2004 on, we 
were playing a game of catch-up in terms of staffing, in terms 
of systems. We were trying to transfer a lot of the input for 
our monitoring process to sources offshore to try to speed up 
the quantity that was being driven through. We were working on 
developing a model for doing the monitoring. But effectively 
all of the resources were being directed backward trying to fix 
what was acknowledged to be broken as opposed to trying to get 
ahead of what was coming. All the energy that was directed 
forward effectively was how do we survive this onslaught of 
    Senator Kaufman. Did you ever philosophize about what they 
were thinking in management? Clearly, the brand was not doing 
well. You could see an erosion of the quality.
    Mr. Michalek. Sure. I think that it was common to 
commiserate, particularly amongst the rear guard, those that 
had been there longer, and the culture changed the most 
dramatically, that the place is not what it once was, I do not 
know what they are thinking. Personally I was anticipating a 
steady erosion until there was just a pure equivocation between 
the rating agencies. So it was a matter of just throwing a 
three-sided dice and you would pick that rating agency, it did 
not matter anymore.
    It was disappointing, but for those that did want to try to 
continue to pursue the good fight, if you will, I think we did 
our best under the circumstances.
    Senator Kaufman. Mr. Kolchinsky.
    Mr. Kolchinsky. I think the drive for market share was 
front and center, and any other resources did not really matter 
as much, and the focus was how much revenue we made.
    Senator Kaufman. I got that. Did you have any indication 
that management was aware of the fact that the incentives--all 
the things we talked about, the lack of regulation, the 
incentives, market share, profit, that they realized that there 
was an erosion of the product and that this was not a good 
long-term strategy?
    Mr. Kolchinsky. I do not know. They must have understood 
that this is not something that could continue, but I am not 
sure if they did or not.
    Senator Kaufman. All right. Mr. Cifuentes, from your 
vantage point far away from this, how did it look to you?
    Mr. Cifuentes. Well, my view here is a little bit from an 
outsider because, as I said, I left in 1999.
    Senator Kaufman. Right.
    Mr. Cifuentes. But being in the market until recently--to 
some extent I am still in the market--I know this--and I could 
not claim that I was the only person who did--a few funny 
things going on regarding the rating assumptions and the models 
at both Moody's and S&P.
    For example, I remember I gave a talk at the CDO conference 
at the end of 2006, and I made the point that there were many 
changes to many things--default probabilities, correlations, 
things that might sound too technical here. But the speed of 
the change was a little bit suspicious. There were some changes 
at that time to something called correlation, which would 
probably do not have the time to discuss what it means here, 
but basically it amounted to a relaxation of the standards.
    So anyone looking at the rules of the game from the outside 
would have noticed that certain assumptions that were being 
made in the past, now they were a little bit relaxed, and 
certain transactions that were receiving AAA ratings probably, 
with just a quick back-of-the-envelope calculation, you could 
come to the conclusion that they were probably not.
    Senator Kaufman. I am just going to end my questions now. 
Just anybody--we have been here for a while talking about this. 
Is there anything you can say to kind of sum up what you think 
went on during this period?
    Mr. Cifuentes. Thank you, Senator. I would like to add a 
brief point here, if I may, because I think it is relevant. It 
might sound like a too academic or subtle point, but I think it 
is very profound, because the problem that we have here, I 
believe, is a little bit more serious than what we think it is.
    We have been talking here about AAA, BBB, and the rating 
agencies clearly were given the right to determine whether 
something is AAA or BBB or whatever. Fine. But there is another 
level of complexity here. Congress has given the rating 
agencies also the right to define what AAA means, or BBB for 
that matter. So, in effect, Congress has given the rating 
agencies the right to legislate, and this is a little bit crazy 
because let me give you an example, and I think I am going to 
finish my statement here. But I think sometimes an example is a 
little bit more clear than a lengthy explanation.
    Suppose you pass a law stating that, say, in Washington, 
DC, you cannot build a tall building, but you forget to define 
what ``tall'' means. And now there is a private company that 
will decide what ``tall building'' means. So that company might 
decide that it is a five-story building. Next year they might 
change, and it is a ten-story building. So that remains 
    So that is the situation we have right now. Nobody knows 
what BBB means. The only thing that is known is that, for 
example, if you are a particular company, you cannot buy 
anything with a rating below BBB. If you are a pension fund and 
you buy a BBB asset and it is downgraded, you might be forced 
to sell. But who knew what BBB means? Well, it does not really 
matter because the rating agencies not only determine whether 
something is BBB, but they can change the definition of what 
BBB means. And I think that is a very extraordinary state of 
affairs. I mean, it is really--it is very screwed up at a very 
fundamental level.
    Senator Kaufman. Because essentially the ratings are used 
by the regulatory agencies to make decisions and, therefore, 
you are right, I mean, I never thought of it that way, but 
essentially the rating agencies are determining on their own--
    Mr. Cifuentes. Exactly.
    Senator Kaufman [continuing]. What these ratings actually 
are, and then the ratings are used----
    Mr. Cifuentes. Legislating all the time.
    Senator Kaufman. Right. Thank you very much, Mr. Chairman.
    Senator Levin. I just have a couple more questions for this 
panel. Did investment bankers apply pressure in connection with 
rating analysts during the rating process? We have already seen 
some evidence of pressure, but in terms of, for instance, 
getting deals done quickly, increasing size of the tranches to 
make additional money, were those kind of pressures put on the 
analysts during the rating process? Mr. Kolchinsky.
    Mr. Kolchinsky. Yes, all the time.
    Senator Levin. Mr. Michalek.
    Mr. Michalek. It was part of the daily workload.
    Senator Levin. Mr. Raiter.
    Mr. Raiter. Well, it was not particularly prominent in 
residential because our model was distributed. Everybody got 
the same answer. We could not have Bear Stearns run a deal and 
bring it in and get a structure and have Goldman bring the deal 
in and get something else. People would say, ``Well, how did 
they get a different transaction?'' So we were somewhat 
    Senator Levin. In your particular area.
    Mr. Raiter. In this particular area, yes, sir.
    Senator Levin. And in terms of that kind of pressure that 
you felt, let me ask you, Mr. Kolchinsky. Did you ever hear the 
phrase IBG-YBG?
    Mr. Kolchinsky. Not until today, sir.
    Senator Levin. Mr. Michalek, did you ever hear of that?
    Mr. Michalek. That was quoted to me.
    Senator Levin. When you worked there?
    Mr. Michalek. I was working on a transaction, and I think 
it was--well, the name of the bank is not relevant. It was a 
large bulge bracket bank.
    Senator Levin. It was a large?
    Mr. Michalek. Bulge bracket bank.
    Senator Levin. What does that mean?
    Mr. Michalek. A bulge bracket bank is describing one of the 
largest banks that has a large balance sheet.
    Senator Levin. All right. What bank is that?
    Mr. Michalek. I think it was Deutsche Bank.
    Senator Levin. OK. And then, what does it mean?
    Mr. Michalek. IBG-YBG was explained to me to mean, ``I'll 
be gone, you'll be gone. So why are you making life difficult 
right now over this particular comment?'' Effectively--I mean, 
he said it laughingly as if you are losing perspective here.
    Senator Levin. Did it mean to you that basically you ought 
to think short term because everybody would be gone before the 
chickens came home to roost?
    Mr. Michalek. When it was originally told to me, I did not 
realize how that thinking really was driving much of what was 
going on, actually.
    Senator Levin. Short-term thinking.
    Mr. Michalek. Short term, get this deal done, get this 
quarter closed, get this bonus booked, because I do not know 
whether or not my group is going to be here at the end of next 
quarter, so I have to think of this next bonus.
    Senator Levin. Who basically did your agency think was the 
client? Was it the investment banker or was it the investor? 
Mr. Kolchinsky.
    Mr. Kolchinsky. It was the banker. The bankers were 
typically referred to as clients. If an investor called, they 
would be clients, but they never did. It was just simply the 
bankers, and they were the clients.
    Senator Levin. Do you have any more?
    Senator Kaufman. No.
    Senator Levin. Thank you. You have been very helpful, all 
of you. Some of you have come a long distance. We greatly 
appreciate it.
    Mr. Kolchinsky. Thank you.
    Mr. Cifuentes. Thank you.
    Senator Levin. We will now move to our second panel of 
witnesses: Susan Barnes, currently Managing Director for 
Mortgage-Backed Securities and former North American Practice 
Leader of Residential Mortgage-Backed Securities at Standard & 
Poor's; Yuri Yoshizawa, Group Managing Director for Structured 
Finance at Moody's Investors Service; and, finally, Peter 
D'Erchia, currently a Managing Director of U.S. Public Finance 
and former Global Practice Leader of Surveillance at Standard & 
Poor's. We thank you for being with us today.
    We have a rule here, which I think you are familiar with, 
Rule VI. I believe you were here when I said that it requires 
us to ask all of our witnesses to please stand and be sworn in. 
Raise your right hand, if you would. Do you swear that the 
testimony you are about to give will be the truth, the whole 
truth, and nothing but the truth, so help you, God?
    Ms. Barnes. I do.
    Ms. Yoshizawa. I do.
    Mr. D'Erchia. Yes.
    Senator Levin. Was that a yes?
    Mr. D'Erchia. Yes.
    Senator Levin. The timing system we will be using today, 
again, you may have heard it, but there will be a red light 
that will come on about 5 minutes from after you begin. A 
minute before that light comes on, it will be changing from 
green to yellow, which will give you a chance to conclude your 
remarks. We will print your entire testimony in the record, of 
course. We would ask you to try to limit your oral testimony to 
no more than 5 minutes.
    Ms. Barnes, we will have you go first, and then follow that 
testimony by Ms. Yoshizawa and then Mr. D'Erchia. So, Ms. 
Barnes, please proceed.


    Ms. Barnes. Thank you. Mr. Chairman, Members of the 
Subcommittee, good morning. I am Susan Barnes, a Managing 
Director of Standard & Poor's Rating Services. From 2005 to 
2008, I was the North American Practice Leader for Residential 
Mortgage-Backed Securities (RMBS). I have been asked to appear 
today to discuss S&P's ratings for RMBS products.
    \1\ The prepared statement of Ms. Barnes appears in the Appendix on 
page 155.
    I want to begin by saying that at S&P we have learned hard 
lessons from the difficulties in the subprime residential 
mortgage area. Although the subprime mortgage market improved 
access to credit and homeownership for millions of Americans, 
apparent abuses in that market have had a reverberating impact 
on the economy.
    S&P began downgrading some of its ratings in this area in 
2006 and had warned of deterioration in the subprime sector 
long before that. We were watching this market. But at the end 
of the day, the assumptions and criteria underlying our ratings 
simply did not anticipate the extent of the collapse of the 
housing market, which has been more severe and more precipitous 
than we, along with so many others, had anticipated.
    Although my focus today is on S&P's process for rating RMBS 
securities, it is helpful at the outset to discuss the nature 
of our credit ratings. At their core, S&P's credit ratings 
represent our opinion of the likelihood that a particular 
obligor or financial obligation will timely repay owed 
principal and interest. Ratings do not speak to whether an 
investor should buy, sell, or hold rated securities or whether 
the price of the security is commensurate with its credit risk.
    While evaluating the credit characteristics of the 
underlying mortgage pool is part of our RMBS ratings process, 
S&P does not rate the underlying mortgage loans made to 
borrowers or evaluate or regulate whether making those loans 
was a good idea in the first place.
    Originators make loans and are responsible for verifying 
information provided by borrowers. They also make underwriting 
decisions. In turn, issuers and arrangers of mortgage-backed 
securities bundle those loans, perform due diligence on those 
loans, structure transactions, identify potential buyers, and 
underwrite the securities.
    Our role in the process is to reach an opinion as to the 
ability of the underlying loans to generate sufficient proceeds 
to pay the purchasers of securities issued under stress 
scenarios that correspond to our rating levels. In doing so, we 
rely on the data coming from issuers, arrangers, and servicers 
that other market participants also rely on. For the system to 
function properly, the market must be able to rely on these 
participants to fulfill their roles and obligations, to verify 
and validate information before they pass it on to others, 
including S&P.
    S&P's analysis of an RMBS transaction evaluates the overall 
creditworthiness and expected cash flow of a pool of mortgage 
loans by, among other things, using models that embody and 
reflect our analytic assumptions and criteria. The models apply 
those criteria to particular loan pools using up to 70 
different data points regarding each loan provided by the 
arranger of the securitization. The assumptions and analysis 
embodied in our models are under regular review and are updated 
as appropriate.
    After reviewing the relevant information, the lead analyst 
then presents the transaction to a rating committee. The 
qualitative judgments of the committee members are an integral 
part of the rating process as they provide for consideration of 
asset- and transaction-specific factors, taking into account 
the judgment and experience of the committee members.
    A key component of our analysis is assessing the amount of 
credit enhancement available to support a particular rating--in 
other words, how much cushion there is in a transaction to 
account for potential losses. For example, subprime loans are 
expected to perform worse than prime loans, so a transaction 
backed by subprime loans would have significantly more credit 
enhancement than a similarly rated transaction backed by prime 
loans. Thus, it is not the case that through securitization 
poor credit assets magically become solid investments. Rather, 
the question is what amount of AAA-rated securities can a 
particular pool of collateral support.
    Once a rating is determined by the rating committee, S&P 
notifies the issuers and disseminates the rating to the public. 
Along with the rating, we frequently publish a short narrative 
for information to the public.
    The Subcommittee has asked me to speak to S&P's awareness 
of deteriorating conditions and reports of fraud in the 
subprime mortgage market. S&P was aware of these reports, and 
from 2005 to 2007 S&P consistently informed the market of its 
concerns about the deteriorating credit quality of the RMBS 
transactions as set forth in more detail in my written 
testimony. We also revised our models and took action when we 
believed action was appropriate.
    I thank you for the opportunity to participate in the 
hearing today, and I would be happy to answer any questions you 
    Senator Levin. Thank you very much, Ms. Barnes. Ms. 


    Ms. Yoshizawa. Good afternoon, Mr. Chairman and Senator 
Kaufman. I am Yuri Yoshizawa, Senior Managing Director of the 
Derivatives Group at Moody's Investors Service. My group rates 
various types of derivative securities, including 
collateralized debt obligations, better known as CDOs. I would 
like to thank you for the opportunity to provide our views 
    \1\ The joint prepared statement of Ms. Yoshizawa and Mr. McDaniel 
appears in the Appendix on page 186.
    Moody's plays an important but narrow role in the 
investment information industry. We offer reasoned, 
independent, forward-looking opinions about credit risk. We 
publish credit rating opinions and credit research about 
entities, including corporations and governments active in the 
debt capital markets globally. Our credit ratings are opinions 
about the future likelihood of full and timely repayment of 
debt obligations, such as notes, bonds, and commercial paper.
    In rating debt securities, regardless of whether the debt 
is issued by a CDO or by a corporation, Moody's analysts follow 
established analytical methodologies and adhere to established 
procedures. I will discuss these as they pertain to CDOs, but 
first I would like to give a brief overview of what CDOs are.
    CDOs have been around since the early 1990s. CDOs cover a 
wide range of instruments and can have in their collateral 
pools various types of assets, including securities issued by 
financial institutions, corporations, and other structured 
finance securities. Additionally, CDOs may either be static or 
managed transactions. In static transactions, the collateral 
pool typically is not subject to change. In managed CDOs, the 
collateral manager can buy and sell assets based on a set of 
covenants spelled out in the CDO's governing documents.
    As with all securities that Moody's rates, our methodology 
for rating CDOs incorporates qualitative and quantitative 
factors. The quantitative factors include the credit risk 
associated with the collateral backing the CDO and its 
structure. Some of the qualitative factors that we also 
typically evaluate include the governing documents of the CDO, 
the collateral manager, and the trustee. The relevance of these 
and other factors will vary depending on the specifics of 
individual transactions.
    Moody's runs its rating process through a committee system; 
that is to say, rating committees decide the ratings rather 
than any one individual. After the analyst obtains relevant 
information from the issuer through meetings and other 
communications, he or she incorporates information from public 
sources as well as Moody's own macroeconomic and sector-
specific perspective.
    The analyst then formulates a view and presents it to a 
rating committee. Rating committee members are selected based 
on relevant expertise and diversity of opinion. Each member is 
encouraged to express dissenting or controversial views and 
discuss differences in an open and frank manner. Once a full 
discussion takes place, the members then vote, with the most 
senior members voting last so as not to influence the votes of 
the junior members. Each committee member's vote carries equal 
weight, and the majority vote decides the outcome.
    Once a credit rating is published, we monitor the rating on 
an ongoing basis, and we will modify it as appropriate to 
respond to changes in our view of the relative creditworthiness 
of the issuer or obligation.
    One common misperception is that our credit ratings are 
derived solely from the application of a mathematical process 
or model. This is not the case. Models are tools sometimes used 
in the process of assigning ratings, but the credit rating 
process always involves much more--most importantly, the 
exercise of independent judgment by the members of a rating 
    Our committee system is at the core of everything we do at 
Moody's and is designed to protect the quality, integrity, and 
independence of our ratings. Having said that, we recognize 
that we must continue re-evaluating all of our methodologies 
and processes to determine how they might be enhanced further 
in order to respond to the evolving market.
    Let me make clear we at Moody's are not satisfied with the 
performance of our ratings in RMBS and structured finance CDOs 
over the past several years. In light of the recent crisis, we 
have made a number of enhancements, some of which have been 
highlighted in Moody's written testimony.
    Thank you, and I would be happy to take your questions.
    Senator Levin. Thank you very much, Ms. Yoshizawa. Mr. 

                       STANDARD & POOR'S

    Mr. D'Erchia. Mr. Chairman and Senator Kaufman, good 
afternoon. I am Peter D'Erchia, a Managing Director of Standard 
& Poor's Ratings Services. During 1997 through 2008, I was the 
Global Practice Leader for Structured Finance Surveillance at 
Standard & Poor's.
    \1\ The prepared statement of Mr. D'Erchia appears in the Appendix 
on page 173.
    As the head of that group, I supervised surveillance for 
five rating and ranking categories: residential mortgage-backed 
securities, RMBS; commercial mortgage-backed securities, CMBS; 
collateralized debt obligations, CDOs; asset-backed securities, 
ABS; and servicer evaluations.
    Each of those groups was headed by a separate manager who 
reported to me as a member of my management team. S&P's 
structured finance surveillance portfolio grew substantially 
during my time as the group's head. Our resources expanded to 
meet this increasing workload, and our growth with respect to 
RMBS in particular outpaced the increase in Standard & Poor's 
monitored transactions. Standard & Poor's RMBS surveillance 
team increased in size by 75 percent from the beginning of 2003 
through 2006. In 2007, responding to the unprecedented 
deterioration in RMBS deal performance, the group's head count 
increased an additional 57 percent.
    In order to understand the context for Standard & Poor's 
surveillance work in 2006 and 2007, it is important to consider 
the basic process behind Standard & Poor's surveillance review. 
After a rating is assigned on an RMBS transaction, a new 
transaction, it is transferred to the Surveillance Group for 
monitoring. Standard & Poor's surveillance analysis takes 
information related to the actual performance of the rated pool 
over time, and it uses that performance data to assess whether 
Standard & Poor's rating remains appropriate in light of our 
evolving view of the deal's current credit support.
    Standard & Poor's surveillance process differs somewhat 
from a new rating review. This difference reflects the 
practical reality of different pre- and post-rating deal 
metrics, but it also serves an important function in providing 
a form of analytical check and balance. Therefore, each deal 
rated by Standard & Poor's is subjected to two analytical 
processes, providing for a more robust analysis than a simple 
reapplication of the same initial method over time.
    As I noted, the volume of RMBS rated transactions under 
surveillance at Standard & Poor's increased throughout the 
years 2003 to 2007. In the past, Standard & Poor's looked for 
at least 12 months of performance data, or seasoning, in this 
analysis and used a variety of internal monitoring tools to 
identify and track individual deals for closer review. In late 
2006, as the performance of recent vintage U.S. RMBS 
transactions experienced broad deterioration out of line with 
our expectations, Standard & Poor's Surveillance Group began a 
process of vintage reviews to prioritize the review of 2005 and 
2006 RMBS transactions and to monitor those entire annual 
vintages on a monthly basis as each month's actual data came 
    Starting in late 2006 and through the first half of 2007, 
delinquency data coming in each month did not resemble anything 
seen before. At that point, however, no significant realized 
losses had been reported for the deals under review. Moreover, 
historically delinquencies did not always lead to losses. 
Accordingly, there was a lot of analyses and debate at Standard 
& Poor's to determine what that data meant.
    As we received more data throughout early 2007, Standard & 
Poor's new issue, surveillance, and criteria personnel all 
worked together to understand what was happening and how to 
respond. During our ongoing analyses in early 2007, Standard & 
Poor's took numerous significant steps to react to the 
deteriorating RMBS performance and to inform the market of our 
analyses. Standard & Poor's recognized the unprecedented nature 
of the early delinquencies occurring in the 2006 vintage, and 
it fundamentally changed its practice in February 2007 to place 
issues on Credit Watch without waiting for losses to develop.
    Standard & Poor's continued to downgrade ratings as 
appropriate on an ongoing basis. By July 2007, Standard & 
Poor's had adapted its methodology sufficiently to issue a 
substantial number of further downgrades. That evolution 
continued after July 2007, resulting in further downgrades as 
the subsequent performance data and criteria warranted.
    Finally, I would like to thank the Members and the staff of 
this Subcommittee for giving me the opportunity to participate 
in this hearing. In my experience at Standard & Poor's, we have 
always been committed to doing the best we can to develop and 
maintain appropriate ratings, and I am proud of the hard work 
that our team put in trying to understand and respond to 
historic market disruption to the best of our abilities. I have 
set forth additional information about my own work and Standard 
& Poor's public discussion of the RMBS market in my written 
statement, and I am happy to answer any questions you may have.
    Senator Levin. Thank you very much, Mr. D'Erchia.
    Let me start with some of the failed deals that we went 
into with the first panel. First, the Vertical deal, if you 
will look at Exhibit 94b.\1\ This is a CDO known as Vertical 
ABS. An S&P analyst in 2007 complained about how Vertical's 
issuer, UBS, was not cooperating with them and how the deal was 
unlikely to perform. And this is what one S&P analyst wrote in 
that 2007 email at the top: ``Vertical is politically closely 
tied to [Bank of America]--and is mostly a marketing shop--
helping to take risk off books of [Bank of America]. Don't see 
why we have to tolerate lack of cooperation. Deals likely not 
to perform.''
    \1\ See Exhibit No. 94b, which appears in the Appendix on page 599.
    Despite that judgment that it was unlikely to perform, S&P 
rated it--so did Moody's, by the way. Both rated the top three 
tranches as AAA. It defaulted within a few months thereafter.
    Ms. Barnes, S&P's own analysts were uncomfortable with 
rating the deal, yet it was rated. Should it have been rated? 
Should that have been taken into consideration that there was 
no cooperation there?
    Ms. Barnes. Well, I can't speak to this specific example, 
    Senator Levin. But you can speak to the question of whether 
or not if there is a lack of cooperation and a deal is not 
likely to perform, should it be rated?
    Ms. Barnes. Well, I would say the analyst would take that 
into account, and it would be part of their presentation and 
discussion in the rating committee for all of the members to 
    Senator Levin. But if an analyst concludes, the analyst on 
the deal, that a deal is not likely to perform, should you be 
giving AAA tranches to that deal?
    Ms. Barnes. Right. I guess, Mr. Chairman, what I am trying 
to emphasize is the committee process at Standard & Poor's.
    Senator Levin. I understand.
    Ms. Barnes. No one person determines a rating, so they can 
have an opinion, and you have differing opinions that will come 
to committee.
    Senator Levin. How about if the committee decides the deal 
is not likely to perform?
    Ms. Barnes. If the committee decided that, then it would 
either take action or change the ratings that it would assign 
at that time.
    Senator Levin. All right. And if an analyst says that the 
Bank of America is using the CDO to take the risk off its 
books, should that be a factor? In other words, if the analyst 
thinks that what is going on with the CDO is taking bad assets 
off the company's books, does that affect the rating process? 
Should it affect the rating process?
    Ms. Barnes. Right. I mean, I cannot speak to the aspects of 
a transaction that the CDO criteria considers, but whatever the 
committee thinks is appropriate, and if they think it was 
material from a credit perspective and it could impact the 
performance of the transaction, then I would expect that they 
would consider it, yes.
    Senator Levin. So that it should affect it?
    Ms. Barnes. If they believe that it would affect it, then 
it should be an aspect that they should consider, yes, Mr. 
    Senator Levin. Well, I am asking you not if they think 
something, then something should happen. I am asking you for 
your opinion.
    Ms. Barnes. I would think--yes, I would agree that it would 
be an aspect from a credit perspective.
    Senator Levin. Let me ask you, Ms. Yoshizawa. This is 
Exhibit 94e.\1\ In this 2007 CDO, securities were included that 
had previously been downgraded the year before, so they had not 
been performing as expected. Is that common for a CDO to 
include downgraded assets?
    \1\ See Exhibit No. 94e, which appears in the Appendix on page 614.
    Ms. Yoshizawa. A CDO can include assets that have been 
downgraded in the past, yes.
    Senator Levin. That is common?
    Ms. Yoshizawa. It could be common, yes.
    Senator Levin. Could be common. All right. Take a look, if 
you would, at 93b.\2\ In January 2007, S&P was asked to rate a 
RMBS with subprime loans issued by Fremont. Now, Fremont was a 
subprime lender that was known for poor-quality loans. At that 
time an S&P rating analyst sent an email to his supervisor 
saying, ``I have a Goldman deal with subprime Fremont 
collateral. Since Fremont collateral has been performing not so 
good, is there anything special I should be aware of?'' One 
supervisor said, ``No, we don't treat their collateral any 
differently.'' So that is Exhibit 93b.
    \2\ See Exhibit No. 93b, which appears in the Appendix on page 589.
    The other one wrote in Exhibit 93c \3\ that as long as he 
had current FICO scores for the borrowers, the analyst was 
``good to go.''
    \3\ See Exhibit No. 93c, which appears in the Appendix on page 590.
    Two days later, an article was circulated within S&P noting 
that Fremont was not now using 8,000 brokers, because their 
loans had some of the highest delinquency rates in the 
industry. That is Exhibit 93d.\4\
    \4\ See Exhibit No. 93d, which appears in the Appendix on page 592.
    And, by the way, Fremont had also announced in an 8-K 
filing that the California Court of Appeals found that 
marketing and extending adjustable-rate mortgage products to 
subprime borrowers in an unsafe and unsound manner greatly 
increased the risk that borrowers will default on the loans or 
otherwise cause losses. The suit against Fremont was allowed to 
continue. Then there was a cease-and-desist order that Fremont 
entered into with the FDIC regarding fraud and lax underwriting 
    Now, despite all this information, we have Fremont RMBS 
securities rated by both S&P and Moody's in the spring of 2007. 
Should they have taken those factors into account? Ms. Barnes.
    Ms. Barnes. Well, I would take from this email, Mr. 
Chairman, that they are considering it and discussing it, and 
the analyst is bringing up the points, as we would expect and 
encourage them to do. And the manager is discussing and sharing 
their views that they believe--I guess the criteria at the time 
was appropriate and it should not be modified.
    Senator Levin. Well, that may be what they believed, but I 
am asking you what should be the case. Fremont's collateral has 
been performing ``not so good.'' That does not make any 
    Ms. Barnes. Right.
    Senator Levin. According to this email, it does not make 
any difference. Should it make a difference?
    Ms. Barnes. Well, Mr. Chairman, I guess when we look at the 
models, as we were discussing on the prior panel, the data that 
is used in those models is used from an array of originators 
and performance and used to establish the expected performance.
    Senator Levin. I am just asking a simple, straightforward 
question. You have an analyst who is saying their collateral 
has been performing not so good. The supervisor says that does 
not make any difference. Should it make a difference?
    Ms. Barnes. Well, I would say it----
    Senator Levin. Do you folks care whether the collateral 
makes a difference?
    Ms. Barnes. Yes, Mr. Chairman, the collateral should make a 
    Senator Levin. So why does he get an answer back from his 
supervisor saying it does not make a difference?
    Ms. Barnes. Well, again, because it goes in the context of 
what the criteria is including. If you are looking at the 
overall performance of the industry and how far is it 
deviating, what they are reporting back to this analyst is that 
they do not think an outside adjustment or change to the 
assumptions is appropriate at that time.
    Senator Levin. It is not assumptions. It is having to do 
with a deal. I have a Goldman deal with subprime Fremont 
collateral. Fremont is not performing well. There are all kinds 
of problems with Fremont.
    If Fremont does not get a higher credit risk, I am trying 
to figure out who does. I do not understand how you can just 
simply say it does not make any difference. You folks are 
supposed to be assessing credit risks here. Does it not make 
any difference that their collateral is not performing? That is 
what the email says. We do not treat their collateral any 
differently. Shouldn't their collateral be treated differently 
if it is not performing? That is a simple question.
    Ms. Barnes. Well, Mr. Chairman, I guess you mean different 
than the industry standard. If it is performing differently 
than what our models projected for that type of loans, then, 
yes, they should----
    Senator Levin. Is the fact it is not performing well 
    Ms. Barnes. It would be relevant to the analysis, but if 
    Senator Levin. It was not relevant to that supervisor.
    Ms. Barnes. I guess you have to look at it, Mr. Chairman, 
in the context of how the assumptions are built, and the 
assumptions are built on an array of data. So it would depend 
how far off and where that performance is expected to perform. 
And just because the performance is poor, it does not mean that 
a deal was underenhanced. We can have poor-quality loans put 
into transactions that have an array of credit enhancement that 
could reflect that poor credit quality. So just because 
delinquencies necessarily are high at that time for that 
particular vintage.
    Senator Levin. It is irrelevant?
    Ms. Barnes. I would not say it was irrelevant. What I would 
say that it was ignored.
    Senator Levin. He was told to ignore it. Ms. Barnes, take a 
look at 93a.\1\ I mean, this is the thing which, it seems to 
me, is going to shake up folks that are listening to this 
testimony as to how much these credit ratings can be relied on. 
Here you have a chart. This is at the top of page 2, 93a. Now, 
this is a Moody's deal, so I am going to ask Moody's as well. 
``Here is the chart of the top ten issuers'' of high 
delinquencies. It comes back: ``Holy cow--is this data correct? 
I just graphed it and Fremont is such an outlier!!'' In other 
words, they are terrible. Is that relevant?
    \1\ See Exhibit No. 93a, which appears in the Appendix on page 587.
    Ms. Barnes. It is definitely relevant.
    Senator Levin. So why doesn't the supervisor say, ``You are 
damn right it is relevant''?
    Ms. Barnes. Well, I guess I am trying to make a 
differentiating point----
    Senator Levin. You are trying not to answer the question. 
Should the supervisor have said, ``Yes, it is relevant. You 
better dig into this''?
    Ms. Barnes. It should be relevant in looking at the 
collateral characteristics and estimating the performance, yes.
    Senator Levin. Thank you.
    Ms. Yoshizawa, this is Moody's. Should that have been 
relevant? Is that a factor that there are big delinquency folks 
that Fremont is such an outlier, they are one of the worst when 
it comes to delinquency? Is that relevant to your credit rating 
or should it be relevant to your credit rating?
    Ms. Yoshizawa. Well, I am not part of the RMBS group.
    Senator Levin. You are not what?
    Ms. Yoshizawa. I am not responsible for the RMBS area. I 
have not worked in that area. However, my understanding is that 
the originator and servicer and their collateral quality is a 
factor in the analysis, yes.
    Senator Levin. And should be?
    Ms. Yoshizawa. Yes, it should be.
    Senator Levin. I am glad to hear that.
    We took an in-depth look in the early hearings into home 
loans being issued by Washington Mutual, and they were riddled 
with lax lending standards, fraud, borrowers whose income had 
not been verified, appraisal problems, loan errors. They had 
among the worst delinquency rates in the country right there 
along with Fremont.
    It seems to me it is obvious that you ought to distinguish 
between lenders when you do these kind of analyses, and I am 
glad that Moody's does. I do not know if you were at the time. 
But it seems to me that it is so obvious that you should that I 
am just kind of stunned at the reluctance of S&P to just say 
obviously they ought to be a factor. But I think at the end of 
the eighth time I asked the question, I think we got the answer 
that it ought to be a factor.
    Let us take a look at, if you would, Exhibit 95. This is 
Delphinus. I am not sure what the pronunciation is of this. 
Exhibit 95 is a Moody's deal, so I will address this to you, 
Ms. Yoshizawa. This also was rated, then downgraded within 6 
months by both Moody's and S&P. First, in July 2007 it was 
rated, then in January 2008, both of you downgraded it, and it 
became junk status.
    In Exhibit 95a,\1\ an investment banker wrote to a Moody's 
analyst that ``Delphinus was a mezzanine deal with a lot of 
cushion, so we did not really care that much.'' That is July 
2007. Well, that cushion obviously was not big enough.
    \1\ See Exhibit No. 95a, which appears in the Appendix on page 646.
    And then you look at Exhibit 95b,\2\ which is an email in 
August 2007. This is an S&P analyst. He is writing the 
following--or she is writing the following: ``Regarding 
Delphinus, it appears that the closing date portfolio they gave 
us for analysis and the effective date portfolio . . . were not 
the same. It appears that the 25ish assets that they included 
in our closing date portfolio that were dummies were replaced 
in less than 24 hours with assets that would have been notched 
and made the portfolio worse.''
    \2\ See Exhibit No. 95b, which appears in the Appendix on page 647.
    Why are dummies being used in this way? I think this is 
Exhibit 95b, since this is a Standard & Poor's document, I will 
ask you again, Ms. Barnes. The dummies----
    Ms. Barnes. I am sorry. I cannot speak to the CDO practice. 
I am not in that area.
    Senator Levin. OK. Mr. D'Erchia, do you have an idea about 
the CDO practice?
    Mr. D'Erchia. No. This would be discussing the individuals 
on the new transactions side, and it would----
    Senator Levin. Well, do you know anything about the use of 
these dummies generally? Have you head about that practice, 
substituting assets shortly before the rating comes out? Have 
you heard about that at all? You are not familiar?
    Mr. D'Erchia. I am not familiar with that.
    Senator Levin. Are you familiar with the practice, Ms. 
    Ms. Barnes. Not with respect to CDOs.
    Senator Levin. Do you use dummies in RMBSs?
    Ms. Barnes. Not in this manner, but at times, banks--I do 
recall, Mr. Chairman, where people could submit statistical 
pools that they think would be representative of the collateral 
that they would submit finally for rating. But it would not be 
a substitution, so to speak. It would be once the collateral 
was originated from a timing perspective.
    Senator Levin. All right. It would not be a substitution of 
one asset for another.
    Ms. Barnes. No.
    Senator Levin. OK. Do you know anything about the use of 
dummies, Ms. Yoshizawa?
    Ms. Yoshizawa. I do not. As I mentioned in my opening 
testimony, CDOs can either be static or managed transactions. I 
do not know about this transaction, but to the extent that it 
was a static transaction, then we would expect that the 
portfolio that was provided to us at closing would be the same 
portfolio as of the effective date.
    Senator Levin. Take a look at Exhibit 1i.\1\ This is what 
happened to the AAAs. We ask all of you to take a look at this. 
BlackRock Solutions made an assessment in February of this 
year, and they looked at the entire universe of AAA ratings 
that have been given to RMBS securities from 2004 to 2007.
    \1\ See Exhibit No. 1i, which appears in the Appendix on page 244.
    First, subprime RMBS securities--91 percent of the AAA 
ratings handed out in 2007 are now junk. Ninety-three percent 
of the AAA ratings in 2006 are now junk. Option ARM securities, 
these are securities that they looked at--we looked at these, 
actually, in our first hearing, full of negatively amortizing 
loans that are issued to borrowers with initial low interest 
rates but with a much higher loan payment that kicks in later. 
These are high-risk loans because nobody knew how many of the 
borrowers would default if they couldn't refinance and had to 
pay the higher loan payments. We examined at that hearing email 
traffic showing that Washington Mutual wanted to sell its 
Option ARM loans starting in early 2007, because it had already 
decided that they were likely to fail, so they had better get 
rid of them, get them off their inventory, securitize them, and 
get them out there, put them in the stream of commerce.
    And then later, in 2007, they securitized billions of 
dollars of its Option ARM loans in several mortgage pools that 
resulted in dozens of securities. These pools won AAA ratings 
for their senior tranches, and this chart shows that 97 percent 
of the AAA ratings given to Option ARM securities in 2007 and 
2006 have now been downgraded to junk status.
    The numbers for other high-risk loans on the chart are 
equally shocking. Alt-A, fixed, and variable loans, and these 
are the loans with little or no documentation, their AAA 
ratings have fallen to junk status 96 to 98 percent of the 
time. Prime fixed and variable loans are not included in the 
    So, does that chart shock you, to look what happened to all 
the AAA loans? Mr. D'Erchia.
    Mr. D'Erchia. Yes, Mr. Chairman, it does shock--it is 
shocking, 98 percent, but my group would have been responsible 
for lowering these ratings, and in doing so, it is a tremendous 
amount of work, so----
    Senator Levin. We will get to that. It took you quite a bit 
of time to downgrade the ratings, but we will get to that 
    Does this shock you, Ms. Yoshizawa?
    Ms. Yoshizawa. Yes. It is certainly not what we would have 
expected, how our ratings would perform.
    Senator Levin. Now, Ms. Yoshizawa, the first panel of 
witnesses raised a lot of concerns about Moody's handling of 
the CDOs, and here are some of the things that they said. 
Pressure by the investment bankers on your analysts. Pressure 
applied by managers at Moody's to maintain market share. Over 
and over and over again, that is what we heard. Pressure to 
maintain market share in RMBs and CDOs.
    Next, managers felt like they would lose their job if they 
lost market share. Next, drive for market share led to 
deterioration of credit standards applied by Moody's. Next, 
emphasis on keeping the investment banker customer happy, 
keeping them appeased. Next, lack of adequate resources to rate 
deals effectively or to re-rate them effectively. Change in 
culture. Great importance placed on meeting the investment 
bankers' demands. Next, the quality of assets assumed by 
Moody's model was not the same as the collateral provided by 
the investment bankers. Next, bankers were aggressively pushing 
the CDO to get done in the summer. Well, we didn't get into 
that one, so I won't ask you that.
    But is all that you heard, does that trouble you?
    Ms. Yoshizawa. Yes, all those statements are troubling.
    Senator Levin. And were you surprised to hear them, or have 
you heard them before?
    Ms. Yoshizawa. I have heard statements such as those 
before, yes.
    Senator Levin. Senator Kaufman.
    Senator Kaufman. Thank you, Mr. Chairman. To continue the 
testimony, I would like to, just for the record, kind of go 
through--thousands of RMBSes rated AAA in 2006 and 2007 are 
rated now as junk. Ms. Barnes, can you just give me what you 
think are the one, two, or three reasons why that happened?
    Ms. Barnes. Well, Senator, the assumptions that we use in 
our criteria have obviously not panned out the way we had 
expected and the market deteriorated more precipitously and 
dramatically than we had expected.
    Senator Kaufman. The assumptions didn't work out and the 
overall market went down?
    Ms. Barnes. Yes.
    Senator Kaufman. That is why an organization like yours, 
with a long and honorable tradition of rating AAA, all of a 
sudden had a massive failure--I think that is fair to say--and 
your assumptions were wrong and it was just a market thing 
because the housing market just went bad. Nobody could ever 
foresee that was going to happen, clearly. If you look at the 
housing market, it would seem that it was going into areas that 
it had never gone in before. I mean, there was no discussion at 
S&P about the fact that there was--I will just show this chart 
\1\--you had a chart like this to describe the housing prices, 
that might be a factor?
    \1\ See Exhibit No. 1j, which appears in the Appendix on page 245.
    Ms. Barnes. Well, Senator, there are many assumptions that 
we use in the rating process, market value decline being one of 
them, ultimate default rates, things that impact the defaults 
and the severity. So in looking at how market appreciation 
impacts people's equity positions and defaults, those would be 
things that we did consider, yes.
    Senator Kaufman. OK. Ms. Yoshizawa, why do you think that 
there was this thousands of RMBSes that were graded AAA that 
are now--in 2006 and 2007--rated as junk?
    Ms. Yoshizawa. Once again, I am not in the RMBS area.
    Senator Kaufman. Well, I just used that as an example--I 
think you have the flavor----
    Ms. Yoshizawa. We strive for and we believe we have 
achieved historically a long history of accurate and reliable 
ratings. And even outside of those structured transactions and 
others that have been affected by the housing crisis and the 
knock-on effects, we have ratings that have performed in 
structured as well as other parts of Moody's. I think that we 
certainly did not predict when we were rating these instruments 
and we were looking at the long-term credit expectations on 
these instruments, we did not predict the magnitude of the 
housing crisis. We did not predict the velocity and we did not 
even predict the length of time over which this crisis would 
extend. I think that is the main reason.
    Senator Kaufman. Mr. D'Erchia, do you have any opinions of 
why it happened?
    Mr. D'Erchia. Again, well, from a surveillance perspective, 
we had the value of seeing the actual delinquencies and we had 
never seen that precipitous a rise----
    Senator Kaufman. Sure.
    Mr. D'Erchia [continuing]. On a comparative basis with the 
previous vintages in that period of time.
    Senator Kaufman. Yes. So this is 2006, 2007. You are doing 
surveillance, though. You are not really rating. You are not 
anywhere involved in the actual rating of these being AAA. You 
are just looking back and trying to see whether they should be 
re-rated or changed, right?
    Mr. D'Erchia. Yes--well, Senator, we are trying--one 
singular goal is to make sure that rating is appropriate, yes.
    Senator Kaufman. But in 2005, S&P was already talking about 
the deteriorating market. In your testimony on page six, you 
talk about an article entitled, ``Subprime Lenders Basking in 
the Glow of a Still Benign Economy With Clouds Forming on the 
Horizon.'' Following the internal housing market simulation 
conducted in 2005, S&P had published a study concerning the 
potential impact of a housing downturn on RMBSes using the 
following assumptions: A January 19, 2006 article entitled, 
``U.S. RMBS Markets Still Robust But Risk Increases and Growth 
Drivers are Softening.''
    So it wasn't like a shock. In 2005, you were already 
discussing the fact that this is a real problem. But then in 
2006--and I guess maybe you are the wrong person--I guess I 
should be talking to you, Ms. Barnes, in terms of you are just 
doing surveillance. You are not actually doing the ratings.
    So I guess I will switch over to you, Ms. Barnes, and also 
just add to this, in your testimony, on page 11, you recount 
the same thing. So in 2005, now, you knew that there was a 
serious problem in the housing market. Take a look at that. 
There is the chart I was holding up there, which shows the fact 
that by 2006, we were now operating--June 2006, the housing 
bubble was twice the--anyway, it is just going through the 
roof.\1\ So you knew in 2005 that this is a really big problem, 
yet through 2006 and 2007, you were still giving AAA ratings to 
a whole series of RMBSes which then ended up being junk.
    \1\ See Exhibit No. 1j, which appears in the Appendix on page 245.
    Ms. Barnes. Yes, Senator. Through that time period, we were 
looking at the market and trying to understand the developments 
and what was happening, so the study in 2005 that you are 
discussing about the housing bubble, people were discussing 
that in the marketplace, so we were informing our opinions and 
then did an analysis to see what impact that would have on the 
ratings should that scenario occur.
    So from 2005 on, we were looking at the different 
developments, the different types of collateral we were 
    Senator Kaufman. No, I got all that, but during that 
period, the main thing that I am interested in about these 
instruments is you didn't give them a lower rating. They still 
got the solid gold rating, which I understand, and I think it 
doesn't mean what everybody thinks it means, which is another 
problem which we can talk about today. So you are not 
indicating any kind of--I am really concerned about this 
subprime market and maybe I ought to take a look and not give 
every single one of these things, or the vast majority--not 
every single one--so many AAA which then turn out being junk.
    Ms. Barnes. Well, Senator, through that time period, we did 
release and update our criteria--in many cases, which you would 
see that did increase our credit enhancements. So we did expect 
defaults and losses to occur through those periods and did 
increase our credit enhancement, which we believed at that time 
would be reflective of the ultimate exposure and default 
experience of those deals.
    Senator Kaufman. Ms. Yoshizawa, I know in your testimony, 
page 18, by you and Mr. McDaniel, you go back to 2003. We 
identified and began commenting about the loosening of 
underwriting standards starting in 2003. And that was 4 years 
before 2007, if my math is right. So there had to be some 
knowledge in the management of Moody's that there is trouble 
here, and it didn't all of a sudden happen then in 2007, there 
is a housing problem here of massive proportions and we are 
still rating everybody AAA--not everybody, excuse me. We are 
still putting out a good portion of AAA bonds, which in 
retrospect was just----
    Ms. Yoshizawa. Our RMBS group from 2003 on, as we mentioned 
in the testimony----
    Senator Kaufman. Sure.
    Ms. Yoshizawa [continuing]. Wrote about various concerns 
that they had in the market. At the same time, my understanding 
is that they were increasing enhancement levels required to get 
certain ratings. So there were changes being made to the 
methodology as well as requirements for reaching certain 
ratings. I don't know about the specific practices in terms of 
when they took certain actions or how much enhancement they 
changed, for example. It was not my area. However, I am aware 
that they had been continually identifying and adjusting their 
    Senator Kaufman. Did all three of you hear the previous 
    Ms. Yoshizawa. Yes.
    Senator Kaufman. Were you here for the previous panel?
    Ms. Barnes. Yes, Senator.
    Mr. D'Erchia. Yes, Senator.
    Senator Kaufman. OK. Ms. Barnes, the previous panel said 
that is not it at all. The previous panel said it was lack of 
regulation. They said that there were the incentives given to 
folks within the organization. They said it was a search for 
profit. They said it was market share. Can you comment on any--
I mean, did you have any firsthand experience of any of those 
things having an impact on what happened? Or it just didn't 
happen to folks you knew?
    Ms. Barnes. Are you directing it----
    Senator Kaufman. Yes.
    Ms. Barnes. Well, Senator, I have no personal knowledge of 
people's incentives being directly tied to the number of deals 
they rate or rated. But overall financial performance of the 
organization did impact people's----
    Senator Kaufman. But you don't think anybody in your 
organization you knew felt that the incentives distorted what 
decisions they were making?
    Ms. Barnes. Not on the deal level, no.
    Senator Kaufman. OK. Ms. Yoshizawa.
    Ms. Yoshizawa. Well, first, from the personal incentives, 
the analysts were not compensated based upon the performance of 
an individual group or----
    Senator Kaufman. No, I am not talking about the analysts. I 
am talking about everybody up the chain. You just went through 
the whole thing that the analysts--when Chairman Levin 
mentioned analysts, you said, wait a minute. There is a whole 
process here that we go through.
    Ms. Yoshizawa. Right.
    Senator Kaufman. Management is involved with that, is it 
fair to say, Mr. Chairman? So we are not talking about the 
analysts now, just the analysts. We are talking about the whole 
chain that you had, that both of you went into great detail to 
explain how this works. Do you think folks in that chain felt 
like there were incredible incentives for them to get as many 
deals out the door as they possibly could and with the highest 
possible rating?
    Ms. Yoshizawa. I personally did not feel any undue pressure 
for market share.
    Senator Kaufman. All right.
    Ms. Yoshizawa. I had for a very long time been responsible 
for the synthetic CDO area. We had very low market share in the 
20 and 30 percent range. It was an area that I was expected to 
explain why our market share may have been lower in terms of 
our methodologies----
    Senator Kaufman. Right.
    Ms. Yoshizawa [continuing]. In terms of could it be fees, 
but I was expected to know why that was the case. At no time 
was I told that my mandate was to increase that market share--
    Senator Kaufman. Sure.
    Ms. Yoshizawa [continuing]. Or to even maintain the market 
    Senator Kaufman. So you didn't feel any pressure to 
increase business at all. So what the other panel was talking 
about was something that happened with them but didn't happen 
with you? Everybody in the organization, that we want to be a, 
yes, we can organization, we want to expect as many deals as we 
can, the more deals the better, that happened to the folks that 
were on the first panel, but you didn't feel--and people around 
you, when you went out to lunch, people didn't talk about this, 
this pressure on us to do more business, to make deals work, to 
do whatever it took to make the deals work, to increase market 
share? You didn't feel any of that?
    Ms. Yoshizawa. I did not feel the pressure to do deals at 
the cost of credit, not at the cost of everything else.
    Senator Kaufman. How about pressure just to do deals?
    Ms. Yoshizawa. We were expected to be able to rate the 
deals that we could rate----
    Senator Kaufman. Right.
    Ms. Yoshizawa [continuing]. Those that we could understand 
or those that we could come up with methodologies for.
    Senator Kaufman. Right.
    Ms. Yoshizawa. We were expected to rate them at the levels 
that we thought that they should be rated.
    Senator Kaufman. Right.
    Ms. Yoshizawa. So it is not a black or white as to whether 
you can or cannot rate something. Sometimes it is. Sometimes 
you don't have enough information.
    Senator Kaufman. Sure.
    Ms. Yoshizawa. Sometimes you think that the transaction 
complexity may not allow you to come up with an analysis for it 
a couple times----
    Senator Kaufman. You were in a different environment than 
the first panel, clearly, right?
    Ms. Yoshizawa. I was in the same----
    Senator Kaufman. No, I mean, the environment they talked 
about was something that didn't impact on you. Didn't they--I 
mean, you were here when they said that there were incentives--
    Ms. Yoshizawa. I did hear that. I never felt that my job--
    Senator Kaufman. But you never felt--I am just trying to--
basically, they were working in the same company, but they were 
just seeing things differently from what you did, which is 
perfectly--Mr. D'Erchia, what do you think?
    Mr. D'Erchia. My plate was full. I had 100 percent market 
    Senator Kaufman. Right.
    Mr. D'Erchia. My workload came from the new deal side, so 
that was a factor. I would be in a different place.
    Senator Kaufman. Yes. I can perceive that.
    I think, Mr. Chairman, I am going to turn it back to you.
    Senator Levin. Ms. Yoshizawa, take a look, if you would, at 
Exhibit 24a.\1\ It is an internal Moody's email chain from 
early October 2007. The second email is from Sunil Surana to 
you. Who is Sunil Surana, if I am pronouncing her name 
    \1\ See Exhibit No. 24a, which appears in the Appendix on page 318.
    Ms. Yoshizawa. Sunil was a business analyst reporting to my 
boss at that time.
    Senator Levin. Reporting to your boss?
    Ms. Yoshizawa. Yes.
    Senator Levin. And here is what she wrote in Exhibit 24a. 
``Market share,'' and she is writing to you, ``Market share by 
deal count dropped to 94%, though by volume it's 97%. It's 
lower than the 98+% in prior quarters. Any reason for concern, 
are issuers being more selective to control costs (is Fitch 
cheaper?) or is it an aberration.'' What was your answer to 
    Ms. Yoshizawa. We were expected to know why we were not on 
deals that we were not on. There were multiple reasons for 
that. It could be because of price. It could be because of 
credit enhancement. It could be because of other relationship 
issues, and we were----
    Senator Levin. So market share mattered? Isn't that what 
that email says?
    Ms. Yoshizawa. Market share mattered in that we were 
expected to know what the story was----
    Senator Levin. Yes.
    Ms. Yoshizawa [continuing]. And so I passed that on to my 
managing directors to find out. I am assuming there was a list 
of transactions and I was asking them to let me know what the 
story was for the transactions.
    Senator Levin. So market share----
    Ms. Yoshizawa. There was no mandate to rate those 
transactions. There was no punishment for not being on those 
transactions. But we were expected to know why we were not on 
those transactions.
    Senator Levin. And so market share mattered, in a nutshell.
    Ms. Yoshizawa. For various reasons.
    Senator Levin. And to various people, higher up?
    Ms. Yoshizawa. Yes. They wanted to know why we were not on 
certain transactions.
    Senator Levin. And then if you will look at the email, Mr. 
D'Erchia and Ms. Barnes, look at Exhibit 5 talking about market 
share.\1\ There is an S&P email chain, March 2005, and this is 
an email from Frank Parisi to you, Ms. Barnes. Who is Mr. 
    \1\ See Exhibit No. 5, which appears in the Appendix on page 258.
    Ms. Barnes. Oh, Frank Parisi at that time--I am trying to 
look at the time frame, because he performed different roles.
    Senator Levin. Oh, I see. OK. March 2005.
    Ms. Barnes. I believe he was part of our research group at 
that time----
    Senator Levin. OK. Here is what he had to say. He said, 
``When we reviewed the 6.0 results a year ago, we saw the sub-
prime and the Alt-A numbers going up and that was a major point 
of contention which led to all the model tweaking we've done 
since. Version 6.0 could've been released months ago and 
resources assigned elsewhere if ''--and listen to this--``we 
didn't have to massage the sub-prime and Alt-A numbers to 
preserve market share.'' Market share mattered to him, wouldn't 
you agree, Ms. Barnes?
    Ms. Barnes. Mr. Chairman, I would say yes. He was saying 
that was a point he believed was being considered for the 
implementation of the model at that time.
    Senator Levin. Yes. It mattered. Preserving market share 
mattered, isn't that what he is saying, point blank?
    Ms. Barnes. He is saying that was his interpretation, yes, 
Mr. Chairman. Could I clarify for----
    Senator Levin. Well, you can try to clarify. I am just 
reading the words. It says here something could have been 
released months ago, which should have been released months 
ago, and resources assigned elsewhere if that had happened, 
``if we didn't have to massage the subprime and Alt-A numbers 
to preserve market share.'' Isn't that pretty clear?
    Ms. Barnes. Right. Well, I guess there are two points I 
would make related to this. I mean, one, there are people with 
a client focus on the email and market share would have an 
impact in relation to them. But also, from a----
    Senator Levin. It mattered to them.
    Ms. Barnes. Yes.
    Senator Levin. And that was transmitted, was it not, to the 
    Ms. Barnes. This email is to the analytic managers of the 
mortgage group.
    Senator Levin. Yes, to the analysts. It was transmitted to 
the analysts that market share was important.
    Ms. Barnes. It was a factor at that time for people to 
consider, yes, Mr. Chairman.
    Senator Levin. OK. How about you, Mr. D'Erchia. Pretty 
    Mr. D'Erchia. Well, I am reading the words and I can't 
pretend to know what Frank is thinking when he is saying this.
    Senator Levin. Well, just about what he is saying. Forget 
what he is thinking.
    Mr. D'Erchia. Well, the words itself, I mean----
    Senator Levin. Pretty clear, aren't they?
    Mr. D'Erchia. You just repeated them----
    Senator Levin. Would you say they are pretty clear?
    Mr. D'Erchia. With the caveat that I don't know what he is 
thinking when he says it. But just the words themselves, yes, 
they are clear.
    Senator Levin. We heard from Mr. Michalek this morning, Ms. 
Yoshizawa, that there was a dramatic change in culture at 
Moody's led by Brian Clarkson, and that Moody's moved away from 
a more analytical, academic environment to an environment which 
is aimed more at satisfying the investment bankers who are 
paying Moody's for the ratings. Did you hear that testimony?
    Ms. Yoshizawa. I did.
    Senator Levin. Did that trouble you?
    Ms. Yoshizawa. It troubled me that was his view, yes.
    Senator Levin. And he testified that some of the bankers 
had complained to Brian Clarkson that Mr. Michalek was asking 
too many questions, he was doing too thorough of a review. They 
wanted him removed from their deal reviews, and they got their 
wish. Did you hear that?
    Ms. Yoshizawa. I don't think I heard him say that they got 
their wish.
    Senator Levin. Well, he said that he was not with two 
banks. He was taken off the case, right?
    Ms. Yoshizawa. I don't know of a case where he was, no.
    Senator Levin. You didn't hear him say that he was no 
longer allowed to work with a couple banks?
    Ms. Yoshizawa. No. In fact, to my knowledge, he worked with 
at least one of those banks that I know of----
    Senator Levin. But did you hear him say that he was taken 
off the case with those two banks, taken off the client list 
with those two banks?
    Ms. Yoshizawa. I did listen to his testimony. I don't 
    Senator Levin. No, I am saying, did you hear him testify--
    Ms. Yoshizawa. I did hear him testify----
    Senator Levin. And was it true that he was, in fact, told 
not to work with one or more banks?
    Ms. Yoshizawa. I am not aware of that.
    Senator Levin. Were you there at the time?
    Ms. Yoshizawa. I was there at the time.
    Senator Levin. OK. So you were not aware that he was 
restricted in any way from working on CDO deals with certain 
banks? You were not aware of that?
    Ms. Yoshizawa. I was not aware of that, no. We had a quite 
contentious relationship with most of the investment banks that 
were out there, and there were many times that we would be 
requested either to remove an analyst from a transaction or 
that they not be put on the next transaction because it was 
that contentious relationship. That happened quite commonly. We 
did not make it a practice to remove people from transactions.
    Senator Levin. Did you ever do that? Did you ever remove a 
person from transactions with particular banks because of 
complaints from that bank?
    Ms. Yoshizawa. Not because of the complaints, because of 
timing, because of----
    Senator Levin. Following conversations with banks--where 
they asked for the removal of somebody from the relationship, 
did you ever accommodate that?
    Ms. Yoshizawa. There would be cases where they would ask, 
because the timing that the analyst told them that they needed 
in order to be able to work on a transaction, because their 
plate was full or because they had other things on their 
transaction, that at that time that I would say that I would 
see if I could get somebody else on the transaction.
    Senator Levin. It was only a complaint that the analyst was 
not moving quickly enough?
    Ms. Yoshizawa. No, it would be because they were not able 
to start or work on the transaction, so----
    Senator Levin. And that complaint came from the banks?
    Ms. Yoshizawa. It could come from--it usually would come 
from the banks. However, it could also come from the analyst 
who comes back and says, I have a vacation or I have a conflict 
in terms of my time and so I would not be able to work on this 
    Senator Levin. But you never heard from a bank that they 
really would prefer you to remove somebody, it is just not 
working out well with that person? It always related just to 
the person not having enough time?
    Ms. Yoshizawa. No, we did get complaints from banks that 
they wanted people removed because they were unhappy with the--
    Senator Levin. But you never accommodated that?
    Ms. Yoshizawa. No, we did not. We may add other people to 
the transaction. However, we would emphasize that the decisions 
were made on a committee basis, and so we would keep that 
analyst on. I may go to the analyst to find out what the issues 
were. However, I do not remember an instance where I took 
somebody off because the bank complained about their 
performance or because they were upset about some of the things 
that they may have said.
    Senator Levin. And you are telling us under oath that you 
never removed somebody because of a conflict between that 
person and the bank?
    Ms. Yoshizawa. I cannot remember an instance where I did.
    Senator Levin. You don't remember? So you are not denying 
that happened, is that correct?
    Ms. Yoshizawa. I cannot remember an instance where I did 
    Senator Levin. How about personality conflict?
    Ms. Yoshizawa. There were cases where transactions would 
occur--as I mentioned, a lot of transactions could be very 
contentious. We typically had a couple of analysts who would 
work on transactions with us or arrangers so that they 
understood the transactions. But sometimes those relationships 
could get very contentious and very abusive and so sometimes 
for the next transaction, I would not put them on it, both from 
the perspective of protecting the analyst, because sometimes, 
as I said, the relationships could get very contentious and 
very abusive and----
    Senator Levin. So it wasn't just a matter of there wasn't 
adequate time. Now you are protecting the analyst from abuse, 
is that it?
    Ms. Yoshizawa. To the extent that we thought that the 
discussions could get very--if somebody was being yelled at or 
if we thought that the discussions were getting very 
aggressive, it was a very difficult situation, and so we did 
not necessarily want to put them on the next transaction or----
    Senator Levin. Or if the bank got mad enough at an analyst 
and it was contentious enough, then you might tell the analyst, 
we are removing you for your own sake.
    Ms. Yoshizawa. Not during a transaction. It would be for 
the next transaction----
    Senator Levin. Yes, for the next transaction with that 
bank. We are removing you for your own sake.
    Ms. Yoshizawa. We could do that. In other cases, I have 
brought in more senior people into the transaction.
    Senator Levin. Yes, but you could removed analysts. You 
might have remove analysts for that reason.
    Ms. Yoshizawa. Not removing them from the transaction----
    Senator Levin. No, from the next transaction with that 
    Ms. Yoshizawa. We may assign it to another person.
    Senator Levin. Yes.
    Ms. Yoshizawa. We didn't necessarily have the same analysts 
working on every transaction----
    Senator Levin. Right, but you may have decided not to put 
that analyst with a particular bank because there was that kind 
of a personality conflict.
    Ms. Yoshizawa. That could be the case, yes.
    Senator Levin. That, you do remember?
    Ms. Yoshizawa. Yes.
    Senator Levin. Why would you not just tell the banker, 
knock it off?
    Ms. Yoshizawa. We did.
    Senator Levin. So you stopped your relationship with 
    Ms. Yoshizawa. We would----
    Senator Levin [continuing]. Based on their abuse?
    Ms. Yoshizawa. We would ask them to knock off the----
    Senator Levin. Did you ever tell them, we are not going to 
do any more credit rating for you with this kind of abuse of 
our analysts?
    Ms. Yoshizawa. I do not remember whether we did. I don't 
think we did.
    Senator Levin. Would you consider that pressure from banks?
    Ms. Yoshizawa. There was always pressure from the banks.
    Senator Levin. That type of pressure, to remove analysts?
    Ms. Yoshizawa. There was always pressure from banks, 
    Senator Levin. Including that?
    Ms. Yoshizawa. Including that type of pressure, yes. It was 
our job as managing directors to push back against that.
    Senator Levin. I want to let you know, in your testimony 
you are shifting around here a little bit. I want to let you 
know that. First, you were saying you only would do it because 
of time, that you only would not have somebody assigned to a 
particular bank. Then you are saying, well, you didn't 
remember. Now you are saying that, yes, you might have not 
assigned a particular analyst to a particular bank in the next 
transaction because of that kind of heated conflict between the 
two. So I just want to let you know the way your testimony 
comes across. It is very unsatisfactory and----
    Ms. Yoshizawa. If I can clarify, there----
    Senator Levin. Sure.
    Ms. Yoshizawa. To me, when you say ``remove,'' I think of 
    Senator Levin. That you did not assign somebody to that 
bank for the next transaction because of that conflict.
    Who are you talking to here?
    Ms. Yoshizawa. I am sorry. It is our legal----
    Mr. Ross. I am her counsel and I am handing her a note, 
just like your counsel handed you a note.
    Senator Levin. I just want to know who.
    Mr. Ross. I am Stephen Ross from Akin Gump.
    Senator Levin. Thank you.
    Mr. Ross. Thank you.
    Ms. Yoshizawa. I am sorry. I just wanted to clarify the 
difference between removing someone in the middle of a 
    Senator Levin. I understand.
    Ms. Yoshizawa [continuing]. Because we were being--versus 
assigning somebody to the next transaction----
    Senator Levin. OK. You did not assign that person to a 
particular bank for the next transaction because of that 
    Ms. Yoshizawa. Because there could be--because of the 
conflict or what happened during that in terms of the 
    Senator Levin. All right.
    Ms. Yoshizawa. However, I wanted to make clear----
    Senator Levin. The bank got their way. Don't assign that 
person to me from now on. The bank got their way for the next 
    Ms. Yoshizawa. I think that was something that was asked of 
us quite often----
    Senator Levin. And you sometimes did it.
    Ms. Yoshizawa [continuing]. It would depend on how we felt 
about how that analyst----
    Senator Levin. Right.
    Ms. Yoshizawa [continuing]. Felt about that--the pressure 
and the relationship.
    Senator Levin. And you sometimes then did what the bank 
asked you to do, which is not to assign that person for the 
next transaction.
    Ms. Yoshizawa. Not for the benefit of the bank, no. It was 
for the benefit of--because we felt that our analysts were 
being abused and we did not want that to happen. We want to 
have--we may have assigned a more senior person that we felt 
could push back better.
    Senator Levin. And the bank got their way, though. That 
person would not have been assigned to the next transaction. So 
they succeeded.
    Ms. Yoshizawa. They may have succeeded in that instance, 
but it was not a practice and it was not for their benefit.
    Senator Levin. There was at Moody's, I believe--a man named 
Andy Kimball, is that correct?
    Ms. Yoshizawa. Yes.
    Senator Levin. Does that strike a bell? If you would take a 
look at Exhibit 24b,\1\ this is attached to the cover sheet 
from Mr. McDaniel to himself for his file. This is a long memo 
about credit policy issues at Moody's. It looks like it came at 
about October 2007, Exhibit 24b. We understand this is a memo 
that Mr. Kimball wrote. Are you familiar with this?
    \1\ See Exhibit No. 24b, which appears in the Appendix on page 319.
    Ms. Yoshizawa. I am not.
    Senator Levin. You are not? OK.
    Ms. Yoshizawa, we were advised by Moody's Chief Credit 
Officer that it was common knowledge that ratings shopping 
occurred in structured finance. In other words, investment 
bankers sought ratings from credit rating agencies who would 
give them their highest ratings. Would you agree with that?
    Ms. Yoshizawa. I agree that credit shopping does exist, 
    Senator Levin. Ms. Barnes, would you agree that the same 
thing existed in your area?
    Ms. Barnes. Yes, Mr. Chairman.
    Senator Levin. And Mr. D'Erchia?
    Mr. D'Erchia. No. There would be no reason to shop----
    Senator Levin. OK. So because you were doing surveillance, 
right, it would not be applicable.
    Mr. D'Erchia. That is correct.
    Senator Levin. OK. Mr. D'Erchia, whenever S&P made a 
criteria change to its RMBS model and that change was more 
conservative than the previous model, did S&P retest the old 
deals to see if their structure still passed for rating 
    Mr. D'Erchia. Traditionally, no.
    Senator Levin. And if you would take a look at that exhibit 
we talked about before, Exhibit 5,\1\ this is a March 2005 
memo. I don't think I asked you about this memo. I think I 
talked to Ms. Barnes about it. Are you familiar with this 
    \1\ See Exhibit No. 5, which appears in the Appendix on page 258.
    Mr. D'Erchia. Well, not really, Senator. I am just reading 
it now with you.
    Senator Levin. OK. Well, let me read it. ``When we first 
reviewed 6.0 results a year ago, we saw the sub-prime and Alt-A 
numbers going up and that was a major point of contention which 
led to all the model tweaking we've done since. Version 6.0 
could've been released months ago and resources assigned 
elsewhere if we didn't have to massage the sub-prime and Alt-A 
numbers to preserve market share.'' Are you familiar with 
Version 6.0?
    Mr. D'Erchia. Not really, Mr. Chairman.
    Senator Levin. OK. That was not something that you had any 
dealings with?
    Mr. D'Erchia. The situation is different on the new deal 
side. They are rating a transaction by looking at certain 
information and making projections and assumptions. I had the 
luxury of getting monthly runs and seeing what the actual 
delinquencies were----
    Senator Levin. All right.
    Mr. D'Erchia [continuing]. And so I could measure against 
the actual information.
    Senator Levin. So this was not relevant to your work doing 
the surveillance?
    Mr. D'Erchia. I wouldn't say that. There is certain 
information you can get when you are doing new transactions 
that you just don't have once the transaction has been issued. 
A FICO score, you would get from the banker, I would assume, on 
the deal side, which I couldn't get current consistently. It 
was a difficult thing to get on a regular basis. If the home 
was sold and refinanced, it was very difficult to get current 
loan-to-value information, and the like.
    Senator Levin. OK. Ms. Barnes, if you would take a look at 
Exhibit 45,\2\ please. This was an email sent to you in June 
2005. This is a mortgage broker who was writing you saying, ``I 
saw you today on CNBC and the reason for my email is that I am 
extremely afraid of the seeds of destruction the financial 
markets have planted.'' This is now June 2005. ``I have been a 
mortgage broker for the past 13 years and I have never seen 
such a lack of attention to loan risk. I am confident our 
present housing bubble is not from supply and demand of 
housing, but from money supply.''
    \2\ See Exhibit No. 45, which appears in the Appendix on page 383.
    ``In my professional opinion the biggest perpetrator is 
Washington Mutual.'' And then listing what Washington Mutual 
was all about--``no income documentation loans;'' ``Option 
ARMs, negative amortization on over-leveraged collateral;'' 
``Interest income on negative amortization is not taxed,'' 
going down to 2C, or 3, ``Option ARMs make up 90% of Bay Area 
loans in California.'' ``4, ``WaMu's recent bid for Providian 
is the purchase of another highly leveraged/securitized bank.'' 
5, ``100% financing loans. I have seen instances where WaMu 
approved buyers for purchase loans; where the fully indexed 
interest only payments represented . . .''--these are interest 
only payments--``100% of the borrower's gross monthly income. 
We need to put a stop to this madness!!!''
    Did you know the person who wrote about that madness, 
Michael Blomquist? Did you know that person?
    Ms. Barnes. No, not that I recall.
    Senator Levin. This was just an email that you got from 
    Ms. Barnes. I believe so. Yes, sir.
    Senator Levin. All right. He sure put his finger on WaMu.
    So S&P, you raised credit protection for investment grade 
RMBS securities because of issues that were raised like this, 
however, is that correct? Did you not----
    Ms. Barnes. Yes, we did, sir----
    Senator Levin. You did?
    Ms. Barnes. In the middle of 2005, what precipitated my 
appearance on CNBC was that we increased our credit enhancement 
requirements for the Option ARM loans.
    Senator Levin. All right. And so you also had data showing 
that the subprime was not performing in the first part of 2006, 
as well, is that correct?
    Ms. Barnes. It started to perform a little differently, but 
from a delinquency perspective.
    Senator Levin. That meaning worse?
    Ms. Barnes. Worse, yes, sir.
    Senator Levin. Now, these were some of the factors that led 
to a major model change to levels in July 2006. According to 
the testimony, I believe, that you gave to the Senate Banking 
Committee in April 2007, this model change resulted in more 
protection against loss, so-called credit enhancements. ``They 
were increased by 50 percent in the average subprime ratings as 
compared to deals rated in the first half of 2006 and during 
2005.'' Is that correct?
    Ms. Barnes. Yes, it is, Mr. Chairman.
    Senator Levin. And, Ms. Yoshizawa, Moody's also increased 
its credit enhancement for its model by 30 percent during that 
time frame, is that correct?
    Ms. Yoshizawa. I don't know about the RMBS model, sir.
    Senator Levin. OK. But your model that you were using, was 
that increased by 30 percent?
    Ms. Yoshizawa. I am not aware of how the RMBS model was 
    Senator Levin. OK. Let me go back, then, to you, Ms. 
Barnes. The model changes to Levels was finalized in July 2006. 
You had better data. You had improved assumptions about how 
subprime would behave in the future and that would allow you to 
better predict how deals would behave. It was a better model 
than the previous model. If you had used the new model to 
reevaluate existing RMBS securities, it would have resulted in 
downgrades for many of those securities, is that correct? If 
you had used that model?
    Ms. Barnes. If we had used that model at that time?
    Senator Levin. Yes. It would have resulted in downgrades 
for many of the RMBS securities.
    Ms. Barnes. Well, if we had rated them at the point of 
issuance, it would have ended up with different ratings being 
issued at that time, yes.
    Senator Levin. OK.
    Ms. Barnes. Possibly.
    Senator Levin. Mr. Barnes, your company did not use that 
revised model to reevaluate the existing RMBS securities, is 
that correct?
    Ms. Barnes. I am sorry. I didn't understand your question.
    Senator Levin. You did not use this revised model to 
reevaluate existing RMBS securities, is that correct?
    Ms. Barnes. We did not, Mr. Chairman.
    Senator Levin. Even though those were all under 
surveillance, is that correct?
    Ms. Barnes. That is correct.
    Senator Levin. OK. And were you familiar with that 
decision, Mr. D'Erchia?
    Mr. D'Erchia. Yes. As I said, Mr. Chairman, we had the 
luxury, if you will, of receiving the current information on a 
monthly basis.
    Senator Levin. Right. And you did not have resources, as 
well, is that correct, to apply those revised models to 
reevaluate all the existing RMBS securities? It was also a 
resource issue, is that correct?
    Mr. D'Erchia. No, Mr. Chairman.
    Senator Levin. That is not correct? It was not a resource 
    Mr. D'Erchia. No. Having the ability to look at the actual 
delinquencies and monitor them to see what percentage, if any, 
turn into losses was something that I didn't have to be 
predictive. I can see what was happening.
    Senator Levin. OK. Now, take a look at Exhibit 62.\1\ At 
the top of page two, this is a Standard and Poor's memo from 
Roy Chun, is that correct?
    \1\ See Exhibit No. 62, which appears in the Appendix on page 471.
    Mr. D'Erchia. Yes.
    Senator Levin. Did you ever see this memo before, or this 
email before? Disseminated to surveillance----
    Mr. D'Erchia. I haven't seen it since 2005.
    Senator Levin. OK. ``How do we handle existing deals 
especially if there are material changes that can cause 
existing ratings to change?'' Who is Mr. Chun again?
    Mr. D'Erchia. Mr. Chun worked in the surveillance group and 
reported to me.
    Senator Levin. All right. ``How do we change existing deals 
. . . if there are material changes that can cause existing 
ratings to change? I think the history has been to only re-
review a deal under new assumptions . . . when the deal is 
flagged for some performance reason.'' And then he said, ``I do 
not know of a situation where there were wholesale changes to 
existing ratings when the primary group changed assumptions or 
even instituted new criteria. The two major reasons why we have 
taken the approach is, (i), lack of sufficient personnel 
resources.'' That wasn't the reason? What he said was the 
reason, one of two, is not the reason, lack of personnel 
    Mr. D'Erchia. Mr. Chairman, I can't speak to the 
    Senator Levin. No, but you disagree with that, is that 
correct? That was not a reason why that new model was not 
applied to the existing deal.
    Mr. D'Erchia. In 2005, I did not know that resources was--
    Senator Levin. Did you ever have a problem in existing 
resources when it came to your job of surveillance? Did you 
ever raise the issue?
    Mr. D'Erchia. Oh, yes----
    Senator Levin. You needed more resources?
    Mr. D'Erchia. Yes, I did.
    Senator Levin. OK. Tell us about that.
    Mr. D'Erchia. Well, when we started to see the increased 
delinquencies, we switched to doing vintage reviews on the 2006 
and 2007 transactions. We worked in conjunction with a number 
of people throughout the organization, criteria, data, 
management, the new deal side, and also in New York. I had the 
luxury, if you will, again, it was moving targets with 
attrition and new hires and terminations, etc., anywhere from 
100 to 125 people reporting to me in New York. So when I would 
have a particular area that needed additional resources, I 
would shift people around to cover that. At the same time, I 
would make requests for additional resources for the future so 
that I could adequately cover all of our workload.
    Senator Levin. Right. And you didn't get those resources, 
did you?
    Mr. D'Erchia. I got resources.
    Senator Levin. Were they adequate to do your job?
    Mr. D'Erchia. I would say they were adequate to do the job 
at the time it needed to be done.
    Senator Levin. Take a look at Exhibit 86,\1\ if you would. 
Who was Ernestine Warner?
    \1\ See Exhibit No. 86, which appears in the Appendix on page 531.
    Mr. D'Erchia. Ernestine Warner was the head of the RMBS 
surveillance area.
    Senator Levin. And she was asking for help?
    Mr. D'Erchia. She is asking for resources.
    Senator Levin. Yes. And you told her, I believe, is it not 
true, that they would be coming later on?
    Mr. D'Erchia. Well, I was identifying a potential avenue 
where we can get additional resources.
    Senator Levin. She was asking for additional resources, was 
she not?
    Mr. D'Erchia. Yes.
    Senator Levin. To do the surveillance job, and right in the 
middle of that Exhibit 86, you write, ``[Y]ou should be getting 
4 or 5 new Associates from the 2007 Associate class for 12 and 
continuing to get them going forward. That might help.'' Her 
response, I believe, was at the top----
    Mr. D'Erchia. That is right.
    Senator Levin. ``They will be a great help but they . . 
.''--and this is February 2007, this is a critical time--``They 
will be a great help but they will not start until August, 
right?'' So she needs help now, she is telling you, and now 
being February, and you are telling her she will get a few in 
August. And then she says, ``Let's talk about anything we might 
be able to do in the interim. I talked to Tommy yesterday and 
he thinks that the ratings are not going to hold through 
2007.'' Your ratings, your surveillance, you are supposed to 
make sure those ratings stay.
    Mr. D'Erchia. Yes, sir.
    Senator Levin. And she has talked to Tommy--I am not sure 
who that is--but he thinks the ratings are not going to hold 
through 2007. ``He asked me to begin discussing taking rating 
actions earlier on the poor performing deals. I have been 
thinking about this for much of the night. We do not have the 
resources to support what we are doing now.''
    You kept saying to my questions, you thought the resources 
were adequate now. But she is telling you, we do not have 
resources to support what we are doing now. A new process 
without the right support would be overwhelming. What was your 
    Mr. D'Erchia. Oh, my response was to request resources, but 
here is----
    Senator Levin. Did you get them?
    Mr. D'Erchia. I got some, as I said----
    Senator Levin. Did you get what you needed?
    Mr. D'Erchia. Well, it depends on the job. On this 
particular job, I feel we were adequately covered and I think 
that was----
    Senator Levin. Were there some jobs you weren't adequately 
covered? In your judgment then?
    Mr. D'Erchia. I would triage according to volatility.
    Senator Levin. Triage? That means something was being 
shorted. That is the meaning of triage. If you have two sick 
patients, you are going to deal with the one that can live. I 
mean, come on. Triage means you were not providing adequate 
resources where they were needed.
    Mr. D'Erchia. Well, if I could, Mr. Chairman----
    Senator Levin. Sure. Go ahead.
    Mr. D'Erchia. Ernestine Warner is in charge of the 
Residential Mortgage Group. Her job is to inform me when she 
needs resources and what those resources are. This email is her 
doing her job.
    Senator Levin. Right.
    Mr. D'Erchia. What I am doing is trying to address that 
request. I am looking to move the entire associate class over. 
I understand we are talking February to August, and she is 
asking about the interim. The ``Tommy'' she is referring to is 
the head of the Criteria Group. In the interim, I am looking 
for help. I am also shifting people over from other areas where 
they can help support me. This is in addition to and including 
the data area and the deal side if there was the luxury of 
people available, because to go out and hire, you are looking 
at at least a 6-month learning curve but she needs the help 
now. And so I had to address this situation at that time by 
shifting people over and making sure that we can help now.
    Senator Levin. Did she get the resources that she needed 
when she needed them?
    Mr. D'Erchia. I think, sadly enough, your chart shows that 
with the amount of downgrades that we had to do to make that 
rating, to make the ratings be appropriate--and at that 
particular time, I would say I was never satisfied with 
anything, and that typically was the budget process, is where I 
would go and I would request and document the need for those 
requests and then we would get them. But at this particular 
time, and knowing what I did in shifting over personnel, this 
particular issue, yes, this was resolved.
    Senator Levin. It was resolved. Were the resources 
adequate? She was warning you, the storm is coming. The ratings 
aren't going to hold. You are going to need to start 
downgrading. We need people. We need resources now. And you are 
telling me she got the resources that she needed? That is what 
your testimony is, under oath?
    Mr. D'Erchia. Yes. We increased our staff--as I said, I had 
about 100--over 115 people to 125 people at any given time.
    Senator Levin. All right. Now take a look at Exhibit 84,\1\ 
if you would, the third page. This is Ernestine Warner again 
writing. ``In light of the current state of residential 
mortgage performance, especially sub-prime, I think it would be 
very beneficial for the RMBS surveillance team to have the work 
being done by the temps to continue. It is still very important 
that performance data is loaded on a timely basis as this has 
an impact on our exception reports. Currently, there are nearly 
1,000 deals with data loads aged beyond one month.'' Was that 
satisfactory, to have that kind of a backlog?
    \1\ See Exhibit No. 84, which appears in the Appendix on page 526.
    Mr. D'Erchia. No, and that is what we did. Also, we used--
for data loading and data collection, I would in addition use 
our affiliate company--CRISIL--and have them do a lot of the 
data loading and data collection. The people she is talking to 
are people in the data group, and she is seeking additional 
help in loading data.
    Senator Levin. And, Ms. Barnes, you had to borrow staff for 
new ratings, I understand, from surveillance, is that correct?
    Ms. Barnes. Yes, Mr. Chairman. At different times, we 
shifted resources between the two.
    Senator Levin. How about at that time, at that time that we 
are talking about?
    Ms. Barnes. In December 2006?
    Senator Levin. Yes.
    Ms. Barnes. I don't think so in December 2006, but in 
February, we were working jointly.
    Senator Levin. Jointly, but you were short of staff at the 
same time they were short of staff, is that correct? You were 
both short of staff?
    Ms. Barnes. Yes, Mr. Chairman. Everyone was working very 
hard and----
    Senator Levin. I know everyone was working hard. Were you 
both short of staff?
    Ms. Barnes. Right. As a manager, you are always asking for 
more resources to do more things----
    Senator Levin. This is just a routine time, right?
    Ms. Barnes. Right.
    Senator Levin. This was all routine.
    Ms. Barnes. No, not at all.
    Senator Levin. There wasn't a collapse, or a calamity that 
was about to hit us. It was just ordinary, bureaucratic, 
everyone can always use more staff. Everybody is working pretty 
hard. You needed more staff. You saw something coming, didn't 
    Mr. D'Erchia. Yes.
    Senator Levin. And didn't you also need more staff, and 
didn't you make requests for more staff? Didn't you have to 
pull staff from other parts of the operation?
    Ms. Barnes. Yes, we did, Mr. Chairman.
    Senator Levin. February 2007, we need to talk about getting 
more resources in general. I see evidence that I really need to 
add staff to keep up what is going on with subprime and 
mortgage performance in general. And the company was doing 
well, wasn't it, pretty well profit-wise at this time, S&P at 
that time?
    Ms. Barnes. I can't speak to the financial performance.
    Senator Levin. Can you speak to that?
    Mr. D'Erchia. No. We, as I said, had our hands full with 
monitoring delinquencies to see if they would lead to realized 
    Senator Levin. And in 2006, delinquency rates for loans 
supporting subprime securities were hitting record levels, is 
that true, Mr. D'Erchia?
    Mr. D'Erchia. In 2006, yes.
    Senator Levin. And they outpaced any previous year for 
subprime RMBSes, is that correct?
    Mr. D'Erchia. To my knowledge, yes, Mr. Chairman.
    Senator Levin. And by the end of 2006, delinquencies in the 
high-risk subprime securities, RMBS securities, were 
approaching 10 percent and the vintage was not even a year old, 
is that correct?
    Mr. D'Erchia. The specific numbers sound correct.
    Senator Levin. There were a lot of reasons for the 2006 
loans that were going bad so quickly. Fraud in mortgage 
applications was up substantially. Low and no doc loans were 
prevalent. stated income loans, in which a bank doesn't verify 
the borrower's income, were everywhere. Combined loan-to-value 
was pushing 90 percent for subprime. Housing prices had peaked 
and were beginning to fall, making refinancing difficult. Is it 
correct that by late 2006, that you were of the opinion that 
subprime was rapidly deteriorating? Is that correct, Ms. 
    Ms. Barnes. I am sorry, which month?
    Senator Levin. What time?
    Ms. Barnes. I am sorry, I didn't catch the last part of 
    Senator Levin. Is it correct that by late 2006, you were of 
the opinion that subprime was rapidly deteriorating?
    Ms. Barnes. I would say it was deteriorating at a pace that 
was higher than the previous vintages, yes.
    Mr. D'Erchia. Yes, I agree.
    Senator Levin. How about you, Ms. Yoshizawa?
    Ms. Yoshizawa. I think our RMBS group was publishing that 
it was higher than previous vintages, but it was still tracking 
with some of the previous downturn years.
    Senator Levin. OK. In late 2006, I believe that Standard 
and Poor's advised the head of structured finance was a person 
named Joanne Rose?
    Ms. Barnes. Yes, it was, sir.
    Senator Levin. That subprime was rapidly deteriorating and 
that you felt that Standard and Poor's should start downgrading 
subprime, is that correct?
    Mr. D'Erchia. We were downgrading subprime.
    Senator Levin. So that you felt Standard and Poor's should 
downgrade subprime, significantly.
    Mr. D'Erchia. At this time period.
    Senator Levin. Yes.
    Mr. D'Erchia. Yes.
    Senator Levin. And you continued to bring that up in 2007, 
is that correct?
    Mr. D'Erchia. Your charts show----
    Senator Levin. And was she resistant at all?
    Mr. D'Erchia. I wouldn't say resisted. She would want us to 
work more in conjunction with the deal side and others, 
including Frank and our research and our criteria groups, in 
order to ascertain whether or not we are seeing an anomaly 
where the delinquencies are front-end loaded, and the reality 
over the life of the transaction, if that became true, then we 
wouldn't be seeing such large losses and downgrades. When it 
became apparent that those losses were being realized, yes, we 
made those ratings appropriate.
    Senator Levin. Yes. But you had kind of a bone of 
contention, was there not, between you and Joanne Rose? Isn't 
that a fair statement? There was a disagreement between you and 
Joanne Rose on this issue, was there not? I mean, people have 
disagreements. Was there a disagreement about this issue?
    Mr. D'Erchia. About this issue?
    Senator Levin. Yes.
    Mr. D'Erchia. Yes.
    Senator Levin. OK. And as a matter of fact, it became such 
a bone of contention that she gave you a bad performance 
evaluation, didn't she? You had strong convictions on this 
subject, about the rapid deterioration of subprime mortgages 
and the need to downgrade, is that not true?
    Mr. D'Erchia. Yes, but it wasn't clear to me that the 
evaluation was personal issues or related to this issue.
    Senator Levin. But it may have been related to this issue, 
is that what you are saying? It wasn't clear to you----
    Mr. D'Erchia. It wasn't clear to me why she wrote that.
    Senator Levin. All right. It followed, however, some 
continued disagreements about the issue of the rapid 
deterioration of the subprime mortgages and the need to 
downgrade. Is that fair, that bad performance evaluation came 
at that time?
    Mr. D'Erchia. I guess I am not clear on what the exact 
question is.
    Senator Levin. You made a comment about her evaluation, I 
believe, is that not true----
    Mr. D'Erchia. My evaluation.
    Senator Levin. Yes.
    Mr. D'Erchia. Yes.
    Senator Levin. Of you.
    Mr. D'Erchia. I responded.
    Senator Levin. Who evaluated you?
    Mr. D'Erchia. Who evaluated me?
    Senator Levin. Was she evaluating you?
    Mr. D'Erchia. She wrote that evaluation.
    Senator Levin. That is what I am saying. And you had 
previously had a disagreement with her about the issue of 
downgrading subprime mortgages and the rapid deterioration, in 
your judgment, which was occurring, and she and you had a 
disagreement about that, and you have acknowledged that you did 
have a disagreement. Did you not write in your comment about 
her evaluation that you had a disagreement over subprime debt 
deterioration? Did you not write that in your reaction?
    Mr. D'Erchia. Yes, Mr. Chairman.
    Senator Levin. OK. The bottom line is that the credit 
rating agencies continued to issue AAA ratings on new subprime 
RMBS and CDOs in 2007 despite warnings, despite a large 
percentage of the 2007 vintage turning out to be problematic 
and downgraded, and it is a pretty sad story. A sad chapter in 
the history of credit rating agencies, folks. People put a lot 
of reliance, maybe too much reliance, on what you do, but that 
is a fact and it is no longer as much of a fact as it was a 
couple of years ago and there was a real failure here.
    How we deal with it, we will know in the next few weeks. 
There are some structural problems here in terms of conflict of 
interest, but there are some other issues, as well. We, I 
think, see some of it in the history which are in these 
exhibits. As much as exhibits can come to life, these problems 
are coming to life.
    I thank you all.
    Mr. D'Erchia. Thank you, Mr. Chairman.
    Ms. Yoshizawa. Thank you, Mr. Chairman.
    Ms. Barnes. Thank you, Mr. Chairman.
    Senator Levin. We are going to recess for 10 minutes.
    Senator Levin. OK. We will come back to order.
    Our third and final panel of witnesses for today's hearing 
is Raymond McDaniel, Jr., Chairman and Chief Executive Officer 
of Moody's Corporation, and Kathleen A. Corbet, the former 
President of Standard and Poor's from 2004 to 2007.
    I don't know if you were with us before when we said that 
under Rule 6 of our Subcommittee, all of our witnesses are 
required to be sworn. So I would ask you both to stand, raise 
your right hand, and answer the following question. Do you 
swear that all the testimony you are about to give will be the 
truth, the whole truth, and nothing but the truth, so help you, 
    Mr. McDaniel. I do.
    Ms. Corbet. I do.
    Senator Levin. Thank you. And under our timing system, we 
will give you one minute notice. The light will turn from green 
to yellow. It will become red in 5 minutes, so we would ask 
that you try to limit your oral testimony to no more than 5 
minutes. I know that sometimes that goes over, and if it does, 
it does, but we would ask you to make that effort.
    Mr. McDaniel, I think we will have you go first, followed 
by Ms. Corbet, and then we will turn to questions. Thank you 
both for being here today. Mr. McDaniel.


    Mr. McDaniel. Thank you, Mr. Chairman and Senator Kaufman. 
I am Ray McDaniel, Chairman and CEO of Moody's Corporation, the 
parent of the credit rating agency Moody's Investor Service. I 
want to thank you for the opportunity to contribute Moody's 
views today.
    \1\ The joint prepared statement of Mr. McDaniel and Ms. Yoshizawa 
appears in the Appendix on page 186.
    The global financial crisis has sparked a necessary debate 
about the role and performance of numerous participants in the 
financial markets. With respect to credit rating agencies, many 
market observers have expressed concerns that ratings did not 
better predict the deteriorating conditions in the subprime 
mortgage market.
    Let me assure you that Moody's is not satisfied, and I am 
not satisfied, with the performance of our ratings during the 
unprecedented market downturn of the past 2 years. We did not 
anticipate the extraordinary confluence of forces that drove 
the unusually poor performance of subprime mortgages. We were 
not alone in this regard, but I believe that we should be at 
the leading edge for predictive opinions about credit risk.
    Some key issues influencing the unanticipated performance 
included the steep and sudden nationwide decline in home prices 
and the sharp contraction that followed in credit available 
from banks for mortgage refinancing. Moody's did observe a 
trend of loosening mortgage underwriting and escalating home 
prices. We highlighted that trend in our reports and 
incorporated it into our analysis of mortgage-backed 
securities. And, as conditions in the U.S. housing market began 
to deteriorate beyond our expectations, we took the rating 
actions that we believed at the time were appropriate based on 
the information we had.
    Let me summarize our actions during the 2003 to 2007 time 
frame. First, starting in 2003, we identified and began 
commenting on the loosening of underwriting standards and 
escalating housing prices through our sector publications.
    Second, we tightened our ratings criteria in response to 
these loosening standards. In fact, between 2003 and 2006, we 
steadily increased our loss expectations and the levels of 
credit protection required for a given rating level. In 
practical terms, this meant that by 2006, half the mortgages in 
a pool would have to default and provide a recovery of just 
half the appraised value of the home before a subprime RMBS 
bond rated AAA by Moody's would suffer its first dollar of 
loss. This is a level of anticipated loss that far exceeded the 
losses that actually occurred in the past four real estate 
recessions. But even these conservative assumptions proved 
    Third, we took steps to watch and analyze the unprecedented 
market conditions and the behavior of various market 
participants as the crisis continued to unfold. For example, 
one question before the market was how borrowers, servicers, 
and banks would respond to the resetting of mortgage interest 
rates and how that behavior would affect default rates. Faced 
with extraordinary conditions, we saw market participants, 
including borrowers, mortgage servicers, mortgage originators, 
and the Federal Government, behave in historically 
unprecedented ways.
    Fourth, we took rating actions when the mortgage 
performance data warranted. Moody's monitors the actual 
performance of the mortgages and the securities that we rate 
throughout the life of the security. The early performance of 
the 2006 loans was, in fact, comparable to the performance of 
similar subprime loans during the 2000 and 2001 recession. And 
not until performance data from the second quarter of 2007 was 
available did it become clear that many of the 2006 vintage 
bonds might perform worse than those from the prior recession.
    In short, Moody's did see the loosening of some prime 
lending standards. We reported our observations to the market 
and we incorporated our increasingly unfavorable views into the 
ratings we assigned. However, let me emphasize again that we, 
like most other market participants, did not anticipate the 
severity or the speed of deterioration that occurred in the 
U.S. housing market, nor did we anticipate the behavior of 
market participants in response to the housing downturn, 
including the speed of credit tightening by financial 
institutions that followed and exacerbated the situation.
    The unprecedented events of the last few years provide 
critical lessons to all market participants, certainly 
including us. At Moody's over the past 2 years, we have 
undertaken a wide range of initiatives to strengthen the 
quality, transparency, and independence of our ratings. Some of 
these measures include establishing common macroeconomic 
scenarios for rating committees, publishing volatility scores 
and sensitivity analysis on structured finance securities, 
consolidating surveillance activities and structured finance 
under one leadership, and further bolstering the independence 
of and resources for our credit policy function.
    Moody's is firmly committed to meeting the highest 
standards of integrity in our rating practices. We 
wholeheartedly support constructive reforms and we are eager to 
work with Congress, regulators, and other market participants 
to that end.
    I am happy to respond to your questions.
    Senator Levin. Thank you very much, Mr. McDaniel. Ms. 

                   2007), STANDARD AND POOR'S

    Ms. Corbet. Thank you, Mr. Chairman and Senator Kaufman.
    \1\ The prepared statement of Ms. Corbet appears in the Appendix on 
page 210.
    My name is Kathleen Corbet and my career spans over 25 
years of experience within the financial services industry. For 
a 3-year period during my career, I served as President as 
Standard and Poor's, a division of the McGraw-Hill Companies, 
from April 2004 until my voluntary departure in September 2007.
    Before turning to the substantive issues raised by the 
Subcommittee's investigation, I would like to acknowledge the 
important work of the Subcommittee and Congress more broadly in 
its examination of the causes and consequences of the financial 
    It is difficult not to feel personally touched by the pain 
experienced by many as a result of the turmoil in the subprime 
market and the financial crisis that followed. Many people feel 
anger, and in my view, that anger is understandable. 
Accordingly, I believe strongly that we should collectively use 
the lessons from this crisis to focus on effective reforms, 
stronger investor protections, better industry practices, and 
    As background, I was recruited to join the McGraw-Hill 
Companies as an Executive Vice President of its Financial 
Services Division in April 2004 and served as President of 
Standard and Poor's until my successor, Deven Sharma, took over 
that position in September 2007. During my 3-year tenure, I led 
an organization of 8,000 employees based in 23 countries which 
provided financial information and market analysis to its 
customers and the broader market as a whole.
    The company was organized across four primary business 
units, including Rating Services, Equity Research Services, 
Index Services, and Data and Information Services. Each 
business unit was led by a seasoned executive having direct 
operating responsibility in the respective area and reporting 
directly to me.
    One of those units was Rating Services, which issued credit 
ratings on hundreds of thousands of securities across the 
globe, including corporate securities, government securities, 
and structured finance securities. Rating Services was led by 
an Executive Vice President for Ratings, an executive with over 
30 years of experience in the ratings business, who had day-to-
day operational responsibility for that business. Among her 
direct reports was the Executive Managing Director of 
Structured Finance Ratings, who was responsible for the day-to-
day operations of the Structured Finance Ratings Group, the 
group that issued the ratings that are the subject of this 
Subcommittee's focus.
    Consistent with S&P's longstanding and publicly disclosed 
practice, ratings decisions were and are solely the province of 
committees comprised of experienced analysts in the relevant 
area. This practice is based on the principle that the highest 
quality analysis comes from the exercise of independent 
analytical judgment free from both undue external or internal 
pressure. Accordingly, during my tenure, I did not participate 
in any rating or analytical criteria committee meetings 
regarding ratings on any type of security, including mortgage-
backed securities.
    All that said, I do hope to be able to provide a business 
perspective that is helpful to the Subcommittee, and in my 
view, it is clear that many of the ratings S&P issued on 
securities backed by subprime mortgages have performed 
extremely poorly. S&P has publicly stated its profound 
disappointment with that performance, and I deeply share that 
    From my personal perspective, I believe the primary reason 
for these downgrades is that, despite its efforts to get the 
rating right and despite rooting its analysis in historical 
data, S&P's assumptions did not capture the unprecedented and 
unexpected outcomes that later occurred with respect to the 
housing market, borrower behavior and credit correlations.
    S&P, along with others, has been criticized for its failure 
to predict what happened in the subprime market, and in many 
ways, that criticism is justifiable. Moreover, the subsequent 
outcome of the severe economic downturn and downgrades of 
securities backed by subprime mortgages highlight the 
challenges inherent in the nature of ratings. At their core, 
ratings are opinions about what may happen in the future, 
specifically, the likelihood that a particular security may 
    I think that most people agree that predicting the future 
is always challenging and outcomes can often turn out very 
differently than even the most carefully derived predictions 
anticipate. The key from my perspective is to learn from these 
experiences and to take specific actions to improve. The credit 
rating industry has begun to respond in a constructive fashion, 
but there is much more to be done.
    Through the course of history and through many market 
cycles, the credit rating industry has played an important role 
in the financial system for nearly a century, and I do believe 
that it has the opportunity to continue to do so through the 
commitment to continual improvements and from appropriate 
regulatory reform.
    Again, I appreciate the goals of the Subcommittee's work 
and would be glad to answer any questions that you have.
    Senator Levin. Thank you, Ms. Corbet. Thank you both.
    Before we start with questions, let me put into the record 
a statement of the Attorney General of the State of 
Connecticut, Richard Blumenthal. He has made a very powerful 
statement about the topic of the hearing today, which is ``Wall 
Street and the Financial Crisis: The Role of Credit Rating 
Agencies,'' and that will be made part of the record at an 
appropriate place.\1\
    \1\ The prepared statement of Mr. Blumenthal appears in the 
Appendix as Exhibit 109, on page 1201.
    Were you both here earlier?
    Ms. Corbet. Yes, I was.
    Senator Levin. Mr. McDaniel, were you here, too?
    Mr. McDaniel. I was here for the second panel.
    Senator Levin. The second panel.
    Mr. McDaniel. Yes.
    Senator Levin. OK. Well, in that case, I may have to repeat 
some of the questions.
    The first exhibit that we have used is Exhibit 94b,\1\ 
where a Standard and Poor's analyst wrote--maybe, Ms. Corbet, 
you could take a look at Exhibit 94b--``Vertical is politically 
closely tied to Bank of America and is mostly a marketing shop 
- helping to take risk off books of Bank of America. Don't see 
why we have to tolerate lack of cooperation. Deals likely not 
to perform.'' This deal was rated by Standard and Poor's 
anyway, even though the analyst said that the deal was not 
likely to perform.
    \1\ See Exhibit No. 94b, which appears in the Appendix on page 599.
    Then the next transaction that I want to look at with you 
was Fremont, which is Exhibit 93b.\2\ Standard and Poor's was 
asked to rate an RMBS with subprime loans issued by Fremont 
Investment. This was a subprime lender known for poor quality 
loans. An email was sent by an S&P ratings analyst to his 
supervisor saying, ``I have a Goldman deal with subprime 
Fremont collateral.'' He says, ``Fremont collateral has been 
performing not so good. Is there anything special I should be 
aware of?'' One supervisor says, ``No, we don't treat their 
collateral any differently.'' Another one says, ``if the 
current FICO scores are there, the answer is good to go.''\3\
    \2\ See Exhibit No. 93b, which appears in the Appendix on page 589.
    \3\ See Exhibit No. 93c, which appears in the Appendix on page 590.
    Now, there was a whole lot of evidence, a whole lot of 
evidence beside evidence right inside of S&P that Fremont 
collateral was problematical, to put it mildly. Fremont had 
stopped using 8,000 brokers--that is Exhibit 93d\4\--due to the 
loans that those brokers were forwarding, which had some of the 
highest delinquency rates in the country. As a matter of fact, 
there was an exhibit where--Exhibit 93a\5\--a Moody's analyst 
in late December 2006, before the Fremont deal was rated, said, 
``Holy cow . . . Fremont is such an outlier,'' talking about 
their delinquency rates being one of the worst in the country. 
That is Exhibit 93a at the bottom. This analyst almost couldn't 
believe it. ``Holy cow--is this data correct? I just graphed it 
and Fremont is such an outlier!!''
    \4\ See Exhibit No. 93d, which appears in the Appendix on page 592.
    \5\ See Exhibit No. 93a, which appears in the Appendix on page 587.
    It was well known, publicly, inside of the credit rating 
agencies, that Fremont collateral was problematical. There had 
also been a California Court of Appeals decision described in 
an 8(k) filing by Fremont where there was sufficient evidence 
in a lawsuit by the California Insurance Commissioner talking 
about Fremont. There was a cease and desist order at the FDIC 
involving Fremont. But all we get internally here is, you are 
good to go. The fact that we know that they are problematical 
does not affect us.
    And I am just wondering--first, let me start with you, Ms. 
Corbet. Your own employees know that Fremont issued poor 
quality loans, high delinquency rates, and yet they handle 
Fremont loans the way they do any other loans. Shouldn't that 
kind of a history be taken into account by S&P?
    Ms. Corbet. Well, first of all, Mr. Chairman, I am not 
familiar with this particular transaction or the people that 
wrote this email or corresponded with this email. I would say, 
however, that in the analysis of any transaction in terms of 
both the quantitative analysis and qualitative model, that all 
factors are considered in the consideration of a rating.
    Senator Levin. Should be.
    Ms. Corbet. All factors should be considered, yes.
    Senator Levin. So that Standard and Poor's assigns lower 
ratings to lenders that are known for poor quality loans with 
high delinquency rates? Does Standard and Poor's assign lower 
ratings to lenders that are known for poor quality loans?
    Ms. Corbet. I would suggest to you that in this particular 
case, in terms of discussing the collateral, again, this is 
perhaps just one piece of a larger discussion around a 
transaction, but I think the question was, should anything be 
considered about the FICO scores, and that is something that 
has nothing to do necessarily with, in this particular case, 
the provider of this transaction, and I believe that whoever 
this person was that was responding said that shouldn't make a 
difference. That is another element of data. It doesn't mean 
that not everything was considered. It is just that means that 
it shouldn't be changed in terms of treating it any 
differently. That would be my observations. Again, I don't know 
anything specific about this transaction.
    Senator Levin. Well, I am asking you generically. In this 
transaction, you have got an analyst who says, ``I have a 
Goldman deal with subprime Fremont collateral. Since Fremont 
collateral has been performing not so good, is there anything 
special I should be aware of?'' Answer, ``we don't treat their 
collateral any differently.''
    My question, when you got Fremont, which has been not only 
publicly, but now internally an analyst says Fremont collateral 
has not been performing good, was that the right answer, don't 
treat their collateral any differently?
    Ms. Corbet. I am not sure what they were referring to, 
whether they are treating it in a model, whether they are 
considering it in any other context, so I couldn't say----
    Senator Levin. Is that the right answer?
    Ms. Corbet. Again, I think it is----
    Senator Levin. That is the whole answer.
    Ms. Corbet [continuing]. In a small context. It is not 
clear whether he is suggesting that it should be different in 
any other kind of model. It is the underlying collateral that I 
think he is referring to.
    Senator Levin. Should the collateral be treated differently 
where the collateral is coming from a company that is not 
performing so good?
    Ms. Corbet. Again, in the context of all the different 
variables that need to be considered, I could not comment as to 
whether or not the particular query that he is asking about----
    Senator Levin. No, I am asking you a generic question. 
Should collateral that is coming from a company whose 
collateral in general is not performing so good, should that 
collateral be treated differently?
    Ms. Corbet. I think that certainly should be taken into 
    Senator Levin. It wasn't here. That is all I can tell you. 
It is your company, and I don't know if anyone cares to do 
anything about it when you get that kind of an answer, but I 
would think that the message ought to go from the leadership of 
an agency--that is something which should be looked at, not, it 
doesn't make any difference. The answer is here from a 
supervisor, it doesn't make any difference that their 
collateral is not performing well.
    Ms. Corbet. No.
    Senator Levin. You just said finally, after the fourth time 
I asked, it should be looked at differently.
    Ms. Corbet. And it doesn't mean that it wasn't.
    Senator Levin. You don't know that it wasn't. I don't know 
that it wasn't.
    Ms. Corbet. I don't----
    Senator Levin. All we know is what the response was, and 
you are saying it was the wrong response. It should be a factor 
in how it is treated, right?
    Ms. Corbet. And it very well might have been.
    Senator Levin. I am not asking you whether it might have 
been or was. It got a AAA rating. My question is, should it be 
treated differently?
    Ms. Corbet. I would expect it would be considered----
    Senator Levin. And should?
    Ms. Corbet. I would expect that it would be considered, 
yes, sir.
    Senator Levin. And would you believe it should be 
considered differently?
    Ms. Corbet. I would expect that all of the different 
provisions of the transaction should be considered, yes, 
    Senator Levin. Thank you.
    Now let me ask you, Mr. McDaniel, does Moody's assign lower 
ratings to lenders that are known for poor quality loans with 
high delinquency rates?
    Mr. McDaniel. Do you mean to the lenders themselves?
    Senator Levin. No, to the loans of those lenders.
    Mr. McDaniel. Clearly, pools of lower-quality loans versus 
higher-quality loans is a credit factor, absolutely.
    Senator Levin. No, I am not asking you that. I am asking 
you whether or not you assign a lower rating if you know that 
the lender involved is known for poor quality loans with high 
delinquency rates. Is that something you look at when you rate 
their loans?
    Mr. McDaniel. It absolutely is something we look at, yes.
    Senator Levin. Senator Kaufman.
    Senator Kaufman. Thank you very much.
    Just so I get it clear, it is in your statements, I mean, 
but just to kind of concentrate on what it is, we know that 
thousands of RMBSes that were rated AAA in 2006-2007 are now 
rated as junk. Mr. McDaniel, what would you give precisely as 
what you think are the main reasons why that happened?
    Mr. McDaniel. I think there were a number of reasons. Among 
the principal or the most proximate reasons would be that we 
went from a period where there was a long period of home price 
appreciation. There was low interest rates and low credit 
spreads so that there was a lot of credit availability. We had 
the introduction of--when we had the introduction of a 
softening in the housing market, the loose credit that had been 
available tightened very rapidly and that curtailed refinancing 
opportunities for many borrowers who were anticipating that 
they were going to be able to refinance their mortgages.
    Senator Kaufman. OK. Ms. Corbet.
    Ms. Corbet. I would concur with all of that statement. 
Indeed, it was predicting what the likely outcome would be, not 
only in terms of the housing market, but also unemployment, 
borrower behavior, also credit correlations. All of those in 
terms of the forecast were certainly not as great as the 
outcome that actually transpired.
    Senator Kaufman. So essentially it was the housing market. 
I mean, it was the housing market, all the things that were 
    Ms. Corbet. It was the confluence, many factors----
    Senator Kaufman [continuing]. The meltdown of all the 
    Ms. Corbet. Yes.
    Senator Kaufman. Mr. McDaniel, is that----
    Mr. McDaniel. That was it.
    Senator Kaufman. Mr. McDaniel, as you said in your 
testimony, and as you mentioned here earlier, as early as 2003, 
you were talking about the housing market. You were saying that 
the housing market--on page 18 of your testimony. So you knew 
as early as 2003 this was going to be a problem. This just 
didn't come on you in 2006 and 2007 like I think sometimes it 
is characterized by certain people, as kind of like a natural 
disaster. It was like a volcano or a hurricane. This housing 
thing happened, and you have just got to understand when things 
like that happen. We had years and years and this never 
happened before. Therefore--I mean, this is a constant theme we 
are hearing in these hearings.
    But as early as 2003, you knew the housing market was a 
problem and you lay out what your concerns are. So you are now 
at 2006 and 2007, and I understand you have tightened your 
standards, but when it is all over, an incredible number of 
these thousands--they said something like 10,000 RMBSes from 
2002 to 2007, the majority of AAA ratings are now rated as 
junk. How does that happen?
    Mr. McDaniel. First, Senator, we did not identify a housing 
bubble in 2003. We certainly----
    Senator Kaufman. No. I mean you saw the oncoming.
    Mr. McDaniel. Yes, we saw loosening underwriting 
    Senator Kaufman. Right.
    Mr. McDaniel [continuing]. And we were certainly aware that 
home price appreciation was occurring through this period.
    Senator Kaufman. So, it is hard--Ms. Corbet, I will get 
back to it and maybe the two of you can work together. There is 
the chart. Oh, that bubble just came on.
    Look, I am not saying we are all victims of our own 
personal experience. In 2005, I sent my children a printout 
from Merrill Lynch of essentially that chart, and I sent with 
them what Merrill Lynch said. People say that this is because 
there are so many more people buying houses, but if that was 
true, they showed another chart and it showed then rental use 
would go up, too, and rental use was rock solid. So we have a 
housing bubble. That is what Merrill Lynch sent out to me as a 
Merrill Lynch investor and I sent it to my kids.
    The fact that we were coming onto a bubble, as you say, you 
didn't say it in 2003, but you are talking about it generally 
and you are still--do you see my point? These products are 
still rolling off the assembly lines with AAA on them.
    Mr. McDaniel. That is exactly why we were raising the 
credit protection levels associated with the highly-rated 
securities. I acknowledge they proved to be insufficient upward 
adjustments in credit protection. Those adjustments were 
overwhelmed by the actual performance of the mortgages that 
were created in the 2006-2007 period.
    Senator Kaufman. Ms. Corbet, does that agree with some of 
your position?
    Ms. Corbet. Yes. In fact, Standard and Poor's was reporting 
on what they saw was the increasing risks of the housing 
bubble, and throughout the course of 2004, 2005, through 2007, 
those analyses and research vis-a-vis publications and 
teleconferences were provided to the market, as well as what 
the expected impact might be on subprime mortgages.
    Senator Kaufman. But you must admit, and I understand and I 
have understood for a long time that what most people think is 
AAA and most people think is what you do is not what you do, 
but it is fair to say that if you are sending out all kinds of 
advisories and putting all kinds of prints, but the AAAs are 
still rolling off the assembly line, that is really what 
affects investors, right? I mean, we have a problem here, but 
by the way, I am just going to send another group of AAAs down 
the old pike. And the argument is kind of like, well, 
historically, we really did well. This never happened before.
    But you had to have some kind of seeing that there is a 
dark cloud on the horizon, and you didn't see those in the 
corporation. You get up every day kind of thinking about it. 
How am I going to make this work? How am I going to protect my 
brand? How am I going to make money? How am I going to make all 
this work?
    And, Ms. Corbet, I know you don't take any part in doing 
the ratings, but was there any--I mean, did either of you feel 
a little bit uncomfortable? Did you get up in the morning and 
say, we are still rating these things AAA and it doesn't look 
good, Mr. McDaniel? Let me put it this way, when did it hit you 
that maybe we ought to really take a hard look at what we are 
rating AAA, not what we are sending out, not that we are 
setting up credit backup, but what we are actually--RMBSes that 
we are rating AAA? About when did you start feeling, there is a 
problem here and I am the CEO. I am going to have to address 
    Mr. McDaniel. We endeavor to take a hard look at everything 
we rate----
    Senator Kaufman. No, but, I mean----
    Mr. McDaniel [continuing]. Regardless of the rating level--
    Senator Kaufman. No, I know, but there are some----
    Mr. McDaniel [continuing]. Including AAA.
    Senator Kaufman. But somewhere in here, there was a point 
at which you did something differently, didn't you? Or did this 
just kind of peter out on its own? Was there any modification 
of behavior as you--did you ever go to any of the people on 
your board or people that were working for you and say, look, 
this is a bad situation. We ought to start doing something a 
little different than what we did yesterday.
    Mr. McDaniel. We certainly were aggressively monitoring the 
market and looking at the performance of mortgages and 
associating that performance with the credit protection levels 
in these deals. If you are asking what was probably the most 
important point in time, at least for me----
    Senator Kaufman. Yes.
    Mr. McDaniel [continuing]. It was when we saw that the 
delinquency and default trends for the mortgages originated in 
2006 departed from the delinquency and default trends that we 
had seen in prior recessions, most recently the 2000-2001.
    Senator Kaufman. And when would you think that was?
    Mr. McDaniel. That was in the second quarter of 2007. Until 
then, they had been tracking almost identically to the default 
and delinquency trends we saw in the previous recession, and we 
knew that the transactions had more than sufficient credit 
protection to withstand that kind of a downturn.
    Senator Kaufman. So if I went back and looked, the number 
of AAAs rolling out the door as a percentage after the first 
quarter of 2007 would have begun to change?
    Mr. McDaniel. The credit protection levels were raised, and 
then the market shut down very quickly after that.
    Senator Kaufman. Ms. Corbet, when did you first pull your 
management team together and say, I don't think this is like 
what has happened in the past. We are producing products--way 
too many of our AAAs are defaulting. We should really change 
the way things are going.
    Ms. Corbet. Well, I think Standard and Poor's, concurrent 
with its own research and publications of some of the stresses 
that they were beginning to see in the marketplace back in 
2005, they began to make, as earlier testified by the S&P 
folks, that they began to make changes in their criteria and 
their credit enhancement levels in 2005 and in 2006, as well. 
In fact, in 2006, the number of downgrades exceeded the number 
of upgrades for subprime residential mortgage-backed 
securities. So the actions were following the research and the 
findings that were being reported to the marketplace.
    In 2007, following again the two previous credit 
enhancement increases, again, the performance data was 
suggesting that it was even more serious than was previously 
contemplated, and so, therefore, in February 2007 S&P made 
another change and announcement of downgrades to--credit watch, 
excuse me, for subprime mortgages.
    In March, we reported also in a teleconference about what 
our outlook was in terms of expectations for the housing market 
and what the impact may be in terms of downgrades----
    Senator Kaufman. And again, this reporting is great, but 
really, the key----
    Ms. Corbet. Is actions, yes.
    Senator Kaufman. Yes. But, I mean, the key is how many AAAs 
are we sending out the door that in retrospect, when you look 
back on it 2 years later, are not AAA but they are junk? I 
mean, that is really the key. I think--and, Ms. Corbet, were 
you here for the first panel?
    Ms. Corbet. I was in and out, yes.
    Senator Kaufman. OK. That is not what they said in the 
first panel. They said a number of things, and what I would 
like to do is kind of go through them and see what you say. 
They said it was incentives.
    Ms. Corbet. Yes.
    Senator Kaufman. Mr. McDaniel, they said that there were 
incentives in the organization, in Moody's, to get more 
business out the door, to not worry so much about what the 
rating is going to be, just move it out there, quantity over 
quality, I think, is the term that one of the gentlemen used. 
Clearly, you haven't raised that as one of the problems.
    Mr. McDaniel. Ratings quality is paramount at Moody's. It 
has been, I think, throughout our history and it continues to 
be. We rate according to published methodologies. Our thinking 
is as transparent as we can make it, to provide the market the 
opportunity to----
    Senator Kaufman. So, basically, you just think that there 
was no incentive problem inside Moody's, that essentially 
everything went just exactly as you just said. This is an 
operation that was smoothly functioning and there was no--the 
incentives--to the extent there were incentives for people to 
do things other than what you said, to take a cold eye view at 
everything, you just didn't see it and you had no reports of 
anyone in your organization saying, maybe we are incentivizing 
people to maybe move the process a little bit one way or the 
    Mr. McDaniel. We have many business objectives at the firm. 
None of those objectives are permitted to compromise ratings 
quality. People actively talk about whether our protocols and 
procedures are sufficient, whether they are best practice, 
should they be changed, and if they can be and we can improve 
ourselves, we do.
    Senator Kaufman. Yes. So I am just saying, in terms of what 
these four gentlemen were up here saying uniformly is something 
that you didn't hear about at the time, don't see it being a 
problem in terms of incentives, and that, essentially, 
everything was working smoothly from your view as CEO?
    Mr. McDaniel. I was not aware of any incentives being 
    Senator Kaufman. When you talked about incentives in 
business meetings, did you ever say, look, we had better be 
careful that we don't create too many incentives for market 
share and profits, that maybe someone down in the organization 
might get the wrong message and begin to kind of--especially 
when you had the explosion of business that you had during this 
period? Can you put the chart up that shows how much business 
grew?\1\ I mean, this was literally an explosion of business. 
And what they said was, this was a market. This is great. Look 
at this.
    \1\ See Exhibit No. 1g, which appears in the Appendix on page 242.
    Mr. McDaniel. Well----
    Senator Kaufman. That usually happens in every business 
organization I have been involved in, management comes to me 
and says--let us get it out the door. Let us watch our profit 
line. Let us get this business. Let us be competitive. There 
were stories about market share where managers were in trouble 
if their market share dropped, and when they checked on why the 
market share dropped, the person said, look, these were just 
bad loans. We didn't do them. And the manager came back and 
said, well, look, other people are doing it. You have dropped 
three points. We can't have that. Do you believe any of that 
went on at Moody's?
    Mr. McDaniel. I have been with Moody's 23 years. I am 
unaware of any employee at Moody's ever being removed or 
terminated for a market share----
    Senator Kaufman. Or how about just basically said, get with 
the program?
    Mr. McDaniel. As I said, we are interested in----
    Senator Kaufman. What would you attribute the incredible 
growth during this period to, great management practices?
    Mr. McDaniel. The growth in the debt markets.
    Senator Kaufman. Right.
    Mr. McDaniel. That is what I attribute that growth to.
    Senator Kaufman. OK. Ms. Corbet, in S&P, did you----
    Ms. Corbet. In S&P, certainly the growth in the credit 
markets, but also in the three other businesses that S&P is 
involved in. The index services business is a very large and 
growing business with indices and ETFs, the data and 
information business, and, as well as equity research, and all 
four contributed to the growth at S&P.
    Senator Kaufman. Mr. McDaniel, I am not asking about this 
specific email because it was a long time ago, it was October 
2007, but it says, analysts--this is from Moody's Chief Risk 
Officer--``Analysts and managing directors are continually 
pitched by bankers, issues, and investors, all with reasonable 
arguments. These views can color credit management judgments, 
sometimes improving it, other times degrading it. We call it, 
drinking the Kool-Aid. Coupled with strong--and this is a 
market share, market focus--this does constitute a risk to 
ratings quality.''\1\
    \1\ See Exhibit No. 24b, which appears in the Appendix on page 319.
    And I am not asking you about this specific thing, but you 
still say that you never had any feelings in the organization 
that the incentives and desire for short-term profits had any 
impact on your ratings?
    Mr. McDaniel. I am aware of the passage that you just read 
and the author of that passage was talking about the fact that 
we are gathering information from many different sources in the 
marketplace, issuers, investors----
    Senator Kaufman. Yes.
    Mr. McDaniel [continuing]. Bankers, all with point of 
    Senator Kaufman. Right.
    Mr. McDaniel [continuing]. And that runs the risk of having 
our thinking match the consensus thinking in the marketplace--
    Senator Kaufman. Right.
    Mr. McDaniel [continuing]. And that the strength of the 
work that we do is to have independent points of view.
    Senator Kaufman. Sure. No, I got that.
    And, Ms. Corbet, I didn't get a chance for you to answer 
the question. When you were CEO of Standard and Poor's, did you 
ever run into someone coming to you and saying, I feel under 
pressure to do some things, maybe in order to build business, 
in order to increase profitability? Never once, right?
    Ms. Corbet. No.
    Senator Kaufman. OK. One of the men on the first panel who 
had been there for a number of years said the whole time he is 
worried, aren't they going to see that they are destroying our 
brand? Aren't they seeing by doing these short-term things we 
are destroying our brand? Mr. McDaniel, you never felt any 
problem during this period that what was going on--clearly, 
since you don't think anything was going to hurt the Moody's 
    Mr. McDaniel. The ability to run a successful business in 
the credit ratings industry is first and foremost dependent on 
having predictive ratings. And so business success is very 
tightly aligned with the quality of the ratings, which is----
    Senator Kaufman. That is the point he was making. He is 
saying that our whole business depends on this.
    Mr. McDaniel. And that is why the performance of the 
subprime mortgage securities, particularly in 2006 and 2007, is 
so frustrating to me as a CEO, among other reasons.
    Senator Kaufman. Well, I don't see why it would be 
frustrating, because basically, what happened was we had this 
housing market blow-up, and through no fault of our own, 
everything went south. There was nothing--you have not 
identified a single thing that was going on at Moody's other 
than just you guys got caught in a bad housing market, not in a 
bad business market, a bad housing market.
    Mr. McDaniel. There are a number of things that, in 
hindsight, I wish we had done differently, absolutely.
    Senator Kaufman. That is really what I was trying to get at 
with the first question. What are some of the things that, in 
hindsight, you would have done differently?
    Mr. McDaniel. There are a number. I think at the macro 
level, we were insufficiently rigorous in thinking about trends 
in housing at an overall system level, and even more 
importantly, having thought about that, pushing that 
macroeconomic, macro housing perspective down into the rating 
committee deliberations.
    Senator Kaufman. How would you have done that? I mean, the 
system that you have laid out was, as Ms. Corbet even said--I 
didn't have anything to do with this rating thing. I think your 
testimony is essentially--how would you have done that? How 
would you have, in this system, been able to communicate down 
and you say, look, we are not being rigorous enough in this 
analysis? What would you do mechanically? Would you send a memo 
to everybody and say, while we are doing this thing, let us 
take a look at these?
    Mr. McDaniel. What we are doing now is a formal macro risk 
perspective series. It is updated every 6 months. This is done 
on a global basis. And we are taking the relevant components of 
that macro risk perspective and the stress scenarios around 
that and delivering those to--not only to our own employees, 
but to the marketplace, as well, and instructing the managers 
and rating analysts that they should utilize the relevant parts 
of that macro analysis.
    We are also using, particularly in the mortgage sector, we 
are relying much more heavily on work done by a company that we 
purchased back in, I think it was late 2005, perhaps early 
2006, Moody'seconomy.com, which provides housing analysis 
nationwide, housing demographic and econometric analysis.
    Senator Kaufman. Is there anything else just short, any 
other thing you think in retrospect----
    Mr. McDaniel. Yes. As I said, there are a number of things.
    Senator Kaufman. Right.
    Mr. McDaniel. In addition, we determined that we had to 
have more cross-disciplinary expertise in the rating 
committees, that there are other elements operating in the 
credit markets that may affect housing, that bringing different 
disciplines to bear in the rating really brings a richer 
    We have changed governance practices in the ratings 
business. We have changed our methodologies and our 
enhancements. We have added different types of research to try 
and communicate our views as clearly as possible. There is a 
very long list and I am trying to hit on----
    Senator Kaufman. I have got it. No, that is not good 
    Ms. Corbet, is there anything in retrospect that you would 
have done differently?
    Ms. Corbet. Well, similarly to Moody's, Standard and Poor's 
has taken increased steps in terms of governance, in terms of 
including in their forecasts and ratings elements of stability, 
the stability of ratings, the comparability of ratings----
    Senator Kaufman. How about have you thought at all about 
the way you incentivize people within the organization? Has 
that been a concern at all?
    Ms. Corbet. Well, historically, and I believe that is the 
case today, that analysts have never been incentivized based 
    Senator Kaufman. No, I am not talking about analysts. I am 
talking about people from top to bottom in the organization, 
the business part of the organization.
    Ms. Corbet. At Standard and Poor's throughout--certainly 
during my tenure--it has always been about the analytical 
quality and independence of the ratings being first and 
foremost and not being compromised.
    Senator Kaufman. Yes. I am sorry you didn't hear the first 
panel because it was pretty unanimous that it stopped at some 
point and moved to a situation where the business part of--and 
by the way, just so you don't feel bad, the hearing we had last 
week, Washington Mutual, exactly the same discussion went on, 
is it fair to say, that people that were involved in it feel 
that the incentives were such and the disincentives were such 
within the organization that things were done that they wish 
they hadn't done, that quality was overlooked, that it was more 
about quantity than quality.
    So it is not just at Standard and Poor's and Moody's, and I 
am sure we are going to find, from everything I can see, it has 
happened in loads and loads of organizations. Things are going 
great. Let us do it. We know what we are doing. Let us just get 
the stuff out the door. So anyway, I am just saying, it is of 
concern, that also at Washington Mutual, the head of Washington 
Mutual had no idea this was going on while many people in the 
organization felt that was going on, so----
    Ms. Corbet. Well, to the extent that was, and again----
    Senator Kaufman. And I am going to ask you to comment 
    Ms. Corbet [continuing]. I think that it is important that, 
and certainly was the case, I believe, at S&P, is that they 
should have had the ability to raise those concerns with their 
management team----
    Senator Kaufman. Sure.
    Ms. Corbet [continuing]. And hopefully those would have 
been addressed if those were----
    Senator Kaufman. Yes, I know, and they did and they 
weren't. A lot of people think it is CEO pay that makes 
Americans so upset. I have my own opinion that the CEO pay 
thing is. The average pay of a CEO as compared to the average 
working person has grown quite exponentially, and I know people 
are concerned about that.
    But I think it is more that when these things happen. I 
mean, the idea that one of the smartest people I ever met, 
Robert Rubin--one of the smartest people I ever met, I am not 
overstating that, smart from a standpoint of knowledge, smart 
in terms of politics, smart in everything else--is making $30 
million a year as the Vice Chairman of Citigroup and says, I 
didn't know there was this $49 billion bomb down in the bottom 
of my business. I mean, that is what I think people are really 
upset about. They are upset about the pay, but then they are 
upset that when these things are going on and when things are 
going on down in their business, as these four--and they seem 
to me dedicated employees, they are not disgruntled employees. 
They said it almost like they were as upset as anyone else. And 
I know the companies I worked at, people would have been upset 
if they felt like the brand was being hurt, because people live 
    But do either one of you want to comment a little bit on 
barbelling, the idea that FICO scores--that the way that you 
calculated FICO scores and used averages allowed ne'er-do-wells 
to kind of pick mortgages so that they could take advantage of 
the averages? Are you familiar with barbelling?
    Mr. McDaniel. As far as barbelling by taking strong and 
weak FICO scores----
    Senator Kaufman. Right.
    Mr. McDaniel [continuing]. And averaging those out, we do 
not look at FICO scores on an average basis, so that 
barbelling, I don't----
    Senator Kaufman. And you never have?
    Mr. McDaniel. I don't believe so, so I don't think that 
would have achieved what someone might have wanted to achieve.
    Senator Kaufman. And, Ms. Corbet, do you----
    Ms. Corbet. I am unfamiliar with the term.
    Senator Kaufman. Unfamiliar with the term. How about stated 
income loans? Mr. McDaniel, you are familiar with what a stated 
income loan is, aren't you?
    Mr. McDaniel. Yes.
    Senator Kaufman. And, Ms. Corbet, are you familiar with 
stated income loans?
    Ms. Corbet. Yes.
    Senator Kaufman. Did you feel at any point there was like 
an explosion of stated income loans throughout the business? 
With the explosion of the business went the explosion of stated 
income loans, and from the data we have, there are many 
companies that were going--it started out as just a small part 
of the business and becoming more. At any point, did you get 
concerned or would you be concerned, or is that part of the 
calculation of the ratings, that there were a lot of stated 
income loans in a particular security?
    Mr. McDaniel. Yes, that would absolutely be a credit factor 
for an analyst or rating committee to consider.
    Senator Kaufman. Do you know if any was, if it was?
    Mr. McDaniel. I have not participated in the rating 
    Senator Kaufman. Right.
    Mr. McDaniel [continuing]. But I would be extremely 
surprised if they hadn't.
    Senator Kaufman. Ms. Corbet.
    Ms. Corbet. I would expect the same.
    Senator Kaufman. Yes. OK. Mr. Chairman.
    Senator Levin. Thank you so much, Senator Kaufman.
    I think it is all well and good to look back and figure out 
what we would have done differently if we had known. Part of 
the responsibility is to look at what happened at the time. 
When we look at what happened at the time, we see the huge 
impact on the drive for market share on these companies, and 
there is just no getting away from it. The testimony this 
morning was very powerful about it.
    Just take a look at a few of the exhibits, Exhibit 3,\1\ 
first, in your book, if you would. It is August 17, 2004, 
importance, high. ``Rich, We are meeting with your group this 
week to discuss adjusting criteria for rating CDOs of real 
estate assets this week because of the ongoing threat of losing 
deals.'' Now, that is a Standard and Poor's exhibit, August 
2004, an ``ongoing threat of losing deals.''
    \1\ See Exhibit No. 3, which appears in the Appendix on page 250.
    Then you look at the next exhibit, Exhibit 2.\2\ This is 
Standard and Poor's, as well. ``We just lost a huge . . . RMBS 
deal to Moody's due to a huge difference in the required credit 
support level.'' Down a paragraph, ``Losing one or even several 
deals due to criteria issues, but this is so significant that 
it could have an impact in future deals. There's no way we can 
get back on this one but we need to address this now in 
preparation for future deals.'' That is Exhibit 2.
    \2\ See Exhibit No. 2, which appears in the Appendix on page 249.
    Then you look at Exhibit 5,\3\ the new S&P ratings model 
could have been released months ago, which is called Version 
6.0, and ``resources assigned elsewhere if we didn't have to 
massage the sub-prime and Alt-A numbers to preserve market 
share.'' Preserve market share. We could have done the right 
thing, in other words, months ago if we didn't have to massage 
the subprime and Alt-A numbers to preserve market share. This 
is contemporaneous. This isn't looking back. This isn't looking 
in the rearview mirror. This isn't benefit of hindsight. This 
is what is going on at the time.
    \3\ See Exhibit No. 5, which appears in the Appendix on page 258.
    Then you look at the testimony of Mr. Michalek this 
morning, a former analyst at Moody's, pretty compelling 
testimony. He testifies that the President of Moody's and the 
former head of Structured Finance, Brian Clarkson, who he 
believed was leading a change in culture at Moody's away from 
the more analytical environment to a profit-driven one, more to 
their customer, the investment bank, instead of the real 
customer, the investing public, but nonetheless what he says is 
that a number of bankers complained to Mr. Clarkson that Mr. 
Michalek was asking too many questions, doing too thorough a 
review. They wanted him removed from their deals, and they got 
their wish on future deals.
    Instead of rewarding Mr. Michalek for asking the probing 
questions and doing his job, he testified that Mr. Clarkson 
suggested that he provide an explanation for what he was doing 
and he ultimately was then not allowed to work on deals with 
certain banks. That message is a pretty clear message to 
employees. It is contemporaneous. It is at the time.
    Then you have another exhibit, Exhibit 11,\1\ email, May 
2006. A UBS banker writes to S&P, ``heard you guys are revising 
your residential [mortgage-backed securities] rating 
methodology - getting very punitive on silent seconds. [h]eard 
your ratings could be 5 notches back . . . [g]onna to kill your 
[residential business]. [m]ay force us to do moodyfitch only 
cdos!'' So, an S&P employee forwards the email to a colleague 
and he says, ``Any truth to this?'' The colleague responds, 
``We put out some criteria changes a couple of weeks ago that 
we will begin to use for deals closing in July. . . . We 
certainly did not intend to do anything to bump us off a 
significant amount of deals.'' God forbid we do something which 
bumps us off a significant amount of deals.
    \1\ See Exhibit No. 11, which appears in the Appendix on page 287.
    So, you want to look backwards, and we all do. When 
mistakes are made, we all love to just say, let us look 
forward. Don't look in the rearview mirror. But folks, there 
was huge pressure, according to these documents and testimony, 
to preserve market share contemporaneously at the time this 
    And one of the reasons according to testimony and according 
to the exhibits that there was not downgrading of existing 
RMBSes and CDOs, despite existing delinquencies, was you have 
got to hold on to market share. Analysts didn't have the data 
or the resources needed to do the volume of high-risk deals 
that they were asked to rate. You guys were making a lot of 
money. They didn't have enough resources. Investment bankers 
had excessive influence. Why? You needed their business.
    Now, I want to give some other testimony. The manager of 
the CDOs, a guy named Gus Harris, used to tell staff that if 
they lose market share, they are going to be fired. And we have 
that testimony, contemporaneous testimony. Were you troubled by 
it when you heard it? I don't know if you heard it all.
    Mr. McDaniel. As I said, no employee at Moody's has ever 
been fired for market share issues, ever.
    Senator Levin. Have they been threatened that they would be 
    Mr. McDaniel. Not that I am aware of.
    Senator Levin. Is there any evidence that market share 
drove ratings? Have you seen it? Have you looked at these 
exhibits? Have you listened to what I just told you?
    Mr. McDaniel. As I testified earlier, ratings quality is 
    Senator Levin. Of course. It is supposed to be paramount.
    Mr. McDaniel. We look at other things that are relevant to 
running a business. That includes market share, and in 
particular in ratings includes market coverage, whether we are 
paid for that coverage or not because we are operating a system 
in which the comparative elements are important. So being able 
to compare one security to another with a common view of credit 
or a common language for credit as expressed in the rating, I 
do think is important. That is different from market share for 
financial purposes.
    Senator Levin. Ms. Corbet, are you surprised to hear 
testimony and exhibits about the impact of market share at the 
    Ms. Corbet. Well, also, let me say, Mr. Chairman, that 
indeed, one of the things that Standard and Poor's, I think 
early on, recognized, that to mitigate any pressure if it came 
from externally, as some of the emails indicated, was really to 
separate the commercial from the analytical process, and so I 
think that was important in terms of--and exists today in terms 
of there is separation of the business from the ratings.
    Market share in many different ways can be a measure of the 
market's acceptance of the quality of the ratings, and so to 
the extent that market share declined, it could be many 
different things that would be looked into in terms of whether 
or not--and first and foremost, in any respect, that the 
quality of the ratings was in any way not useful to the 
    Senator Levin. If you look at Exhibit 24a,\1\ this is a 
Moody's exhibit. This is the one we talked about before. 
``Market share by deal count dropped to 94%.'' Any lower--
``It's lower than the 98+% in prior quarters. Any reason for 
concern . . .?''
    \1\ See Exhibit No. 24a, which appears in the Appendix on page 318.
    And then you have this Exhibit 24b.\2\ If you look at that, 
Mr. McDaniel, I think that exhibit was put together by your 
Chief Credit Officer, is that correct, Mr. Kimball?
    \2\ See Exhibit No. 24b, which appears in the Appendix on page 319.
    Mr. McDaniel. Yes. That is correct.
    Senator Levin. He says that--he disputes that quality is 
king. He says it is at risk due to pressure from bankers. 
``Analysts and managing directors are continually `pitched' by 
bankers, issuers, investors--all with reasonable arguments--
whose views can color credit judgment, sometimes improving it, 
other times degrading it. (we drink the `kool-aid'). Coupled 
with strong internal emphasis on market share & margin focus, 
this does constitute a `risk' to ratings quality.'' That is his 
    And then he says--I don't know if you followed what I was 
reading on page two, ``Analysts and MDs are continually pitched 
by bankers, issuers, investors.'' Continually pitched. This 
constitutes ``a risk to ratings quality.'' Do you agree with 
    Mr. McDaniel. As I had commented before, the observation 
that our information sources oftentimes have points of view, 
whether it is issuers or investors, they have the risk of 
causing us to think on a consensus basis with the market and we 
want to have independent views. So I appreciate that Chief 
Credit Officer is thinking about these issues. I appreciate 
that he is raising them to my attention. And I have reacted by 
implementing many of the recommendations and thoughts that are 
included in his comments.
    Senator Levin. When you say, you shouldn't operate from 
consensus, it says that there is a strong internal emphasis on 
market share.
    Mr. McDaniel. Yes. That is--as I said, we have market 
    Senator Levin. And that constitutes a risk to ratings 
quality. Does your emphasis on market share constitute a risk 
to ratings quality?
    Mr. McDaniel. If we are not attentive----
    Senator Levin. That is what he is saying. He says it is 
coupled with an emphasis.
    Mr. McDaniel. He is saying----
    Senator Levin. He is not saying if. He is saying, coupled 
with an emphasis. ``With a strong internal emphasis on market 
share . . . this does constitute a risk to ratings quality.'' 
That is him.
    Mr. McDaniel. Those are risks and they must be managed 
properly so that the rating system is not compromised in any 
    Senator Levin. It says it is coupled with a strong internal 
emphasis, and you are saying that there is no such coupling?
    Mr. McDaniel. I am saying that is a risk and it must be 
managed properly so that the ratings are not compromised.
    Senator Levin. You say there is a strong internal emphasis, 
then, on market share? You agree to that?
    Mr. McDaniel. I pay attention to market share----
    Senator Levin. I know you pay attention to it, but do you 
agree there is a strong internal emphasis on market share?
    Mr. McDaniel. I believe he thinks there is----
    Senator Levin. Did you agree with him when you read that?
    Mr. McDaniel. I believe that attention to market share is 
one thing we must pay attention to in running the business.
    Senator Levin. Well, that is not my question.
    Mr. McDaniel. It is not as important as ratings quality, 
but I pay attention to it and I care about it.
    Senator Levin. But that wasn't my question.
    Mr. McDaniel. I apologize, Mr. Chairman, I am trying to 
    Senator Levin. Well, let me try again. Was he right that 
there is a strong internal emphasis on market share?
    Mr. McDaniel. There is a strong internal emphasis on market 
coverage, yes.
    Senator Levin. So you would not word it the way he does?
    Mr. McDaniel. I would not, but I understand that market 
coverage and market share can be conflated.
    Senator Levin. Can be what?
    Mr. McDaniel. Conflated.
    Senator Levin. Does that mean confused?
    Mr. McDaniel. No, used interchangeably.
    Senator Levin. But you would not phrase it that way?
    Mr. McDaniel. No. As I said, I think the market coverage 
issue is the more important issue.
    Senator Levin. Did he prepare this at your request?
    Mr. McDaniel. I actually don't remember if he prepared it 
at my request or independently, but I do remember receiving it.
    Senator Levin. Ms. Corbet, were you familiar with an FBI 
report that came out in 2004 that said that mortgage fraud was 
becoming more prevalent?
    Ms. Corbet. I am not specifically aware of that particular 
    Senator Levin. Were you aware that the FBI in 2006 reported 
that the number of suspicious activity reports surrounding 
mortgage fraud rose by 700 percent?
    Ms. Corbet. Again, I am not familiar with that specific 
    Senator Levin. And in the period 2004 to 2006, were you 
aware of the growth of interest-only loans, the broad use of 
interest-only loans? Do you know what I mean by interest-only 
    Ms. Corbet. I believe so, yes.
    Senator Levin. Were you aware that there was a large use of 
interest-only loans during that period?
    Ms. Corbet. I don't know that I was aware of the amount, 
but I was aware that there were different types of loans being 
offered in the marketplace, yes.
    Senator Levin. Were you aware that there was a large growth 
in the utilization of interest-only loans during that period?
    Ms. Corbet. I am not aware of what percentage of growth. I 
was aware that those loans existed.
    Senator Levin. Were you aware that there was a large 
growth? I am not asking you for a percentage. Were you aware?
    Ms. Corbet. Yes. I was aware that those were new products 
in the marketplace, yes.
    Senator Levin. Were you aware in 2004 to 2006 of the 
growing use of no doc and low doc loans?
    Ms. Corbet. I am aware of that, yes.
    Senator Levin. Do you know what silent seconds are?
    Ms. Corbet. Honestly, I do not.
    Senator Levin. That is OK. I didn't know a few months ago, 
either. Were you aware of the second liens? Do you know what 
second liens are?
    Ms. Corbet. I am familiar with the term----
    Senator Levin. Second mortgages?
    Ms. Corbet. Yes.
    Senator Levin. This is Standard and Poor's, an email--this 
is Exhibit 14\1\--from Richard Koch to Michael Gutierrez. Do 
you know who those folks are or were?
    \1\ See Exhibit No. 14, which appears in the Appendix on page 293.
    Ms. Corbet. No, I don't.
    Senator Levin. OK. That email says, ``[T]here has been a 
rampant appraisal and underwriting fraud in the industry for 
quite some time as pressure has mounted to feed the origination 
machine.'' Would you agree that there was great pressure to 
feed the origination machine?
    Ms. Corbet. I am not aware of this specific email----
    Senator Levin. No, I know that, but in general, were you 
aware that there was a huge demand for mortgages, to securitize 
    Ms. Corbet. I was certainly aware of the growth in 
securitized mortgages, yes.
    Senator Levin. And the great demand for mortgages for that 
    Ms. Corbet. And the demand from investors to invest in 
those securities, yes.
    Senator Levin. And from Wall Street to securitize----
    Ms. Corbet. Yes.
    Senator Levin. You were aware of that?
    Ms. Corbet. Yes.
    Senator Levin. Were you aware of this Exhibit 5?\1\ I don't 
know if I asked you specifically or not, Ms. Corbet. ``Version 
6.0 could've been released months ago and . . . assigned''--I 
don't know if I asked you specifically about that--if they 
``didn't have to massage the subprime and Alt-A numbers to 
preserve market share.'' Did I ask you what your reaction is to 
    \1\ See Exhibit No. 5, which appears in the Appendix on page 258.
    Ms. Corbet. You did not ask, but I can say----
    Senator Levin. What is your reaction?
    Ms. Corbet. I am not familiar with what the topic that they 
are referring to or the people who they are addressing.
    Senator Levin. What is your reaction now that you read 
that, that something that would have been done otherwise could 
not be done because the writer, a Standard and Poor's employee, 
had to ``massage the subprime and Alt-A numbers to preserve 
market share?'' What is your reaction now that you read that?
    Ms. Corbet. Well, it is certainly troubling, but to the 
extent--again, it is probably--in the larger context, I am not 
sure what the subject might be addressing. But to the extent 
that was a concern, I would expect that would be reviewed, and 
to the extent it wasn't addressed, it should have been raised 
to my attention.
    Senator Levin. Exhibit 87\2\ is the subject we talked about 
with an earlier panel. There was a message from Ms. Warner in 
Exhibit 87 pleading for resources. They are short-staffed, 
analyzed, overwhelmed. That is Exhibit 91.\3\ There are a 
number of exhibits that show the overwhelming shortage of 
staff, both to do the ratings, but also to do the reviews. Were 
you aware of that kind of shortfall of staff at that time?
    \2\ See Exhibit No. 87, which appears in the Appendix on page 535.
    \3\ See Exhibit No. 91, which appears in the Appendix on page 541.
    Ms. Corbet. Well, certainly in early 2007, as the number of 
securities were, again, starting to show deteriorating 
performance data, that indeed, the number of employees needed 
for this particular group needed to be increased. As I 
understand from Mr. D'Erchia's testimony, this group did 
receive the needed resources.
    Senator Levin. Well, that is not the part of the testimony 
he finally acknowledged, which is they were short of resources 
and didn't get what they requested. He tried to say that they 
shuffled back and forth, but they were short of resources.
    Exhibit 90, Mr. McDaniel, take a look at Exhibit 90.\4\ 
This is a document from a Moody's employee, January 2006. ``. . 
. I think we need full functionality with M3''--that is the 
Moody's model--``first, especially if we're to remain short-
staffed for yet another year.'' Were you short-staffed in 
January 2006?
    \4\ See Exhibit No. 90, which appears in the Appendix on page 539.
    Mr. McDaniel. Yes.
    Senator Levin. Were you aware of that?
    Mr. McDaniel. We had stress on our resources in this 
period, absolutely.
    Senator Levin. And you were making pretty good profit at 
that time, though, weren't you?
    Mr. McDaniel. We were profitable, yes.
    Senator Levin. And take a look at Exhibit 91, another 
Moody's employee in May 2007, if you would, Mr. McDaniel. The 
second paragraph. ``Our analysts are overwhelmed.'' This is Mr. 
Kolchinsky's email.
    Mr. McDaniel. As I remarked, there were definitely resource 
stresses at this point in time. People were working longer 
hours than we wanted them to, working more days of the week 
than we wanted them to. It was not for lack of having open 
positions, but with the pace at which the market was growing, 
it was difficult to fill positions as quickly as we would have 
    Senator Levin. Did Moody's reevaluate wholesale or just 
certain transactions?
    Mr. McDaniel. We monitor in our surveillance all 
    Senator Levin. But did you reevaluate, for instance, an 
entire CDO or an entire RMBS?
    Mr. McDaniel. I apologize. I am not following----
    Senator Levin. All right. If you have a new metric, you 
have got a new model that you are using to rate new securities, 
will you go back and use that model on existing securities?
    Mr. McDaniel. It would depend.
    Senator Levin. You didn't retest the old deals, did you?
    Mr. McDaniel. In many cases, we do. In other cases, we do 
    Senator Levin. And what about Standard and Poor's?
    Ms. Corbet. There are two different processes once a 
security was issued. The surveillance group was looking at 
actual loan performance data to determine whether or not there 
would be any impact to the rating.
    Senator Levin. And you didn't go and take a look at the 
entire rating for an entire issue?
    Ms. Corbet. Every issue was looked at for--in terms of the 
actual performance data.
    Senator Levin. So you went back and used the new model, or 
did you grandfather the old rating? Which one?
    Ms. Corbet. It was a different procedure for existing 
transactions, to look at actual performance data. And to the 
extent that criteria was changed on new issues, it would always 
be disclosed to the marketplace as to what extent any past 
transactions needed any criteria change or modification.
    Senator Levin. So you didn't retest your old deals. You 
just disclosed the new rating to the marketplace?
    Ms. Corbet. We disclosed the new criteria and how it would 
impact securities that were to be rated going forward, that is 
    Senator Levin. In the future, going forward.
    Ms. Corbet. That is correct.
    Senator Levin. Is one of the reasons that you didn't go 
back and apply your new model, what you now knew, to the old 
deals was because of a shortage of resources to do that?
    Ms. Corbet. No.
    Senator Levin. Was that one of the reasons that you didn't 
do that, Mr. McDaniel? When you didn't do that, was that 
shortage of resources?
    Mr. McDaniel. There are a number of reasons not to go 
    Senator Levin. Was that one of them?
    Mr. McDaniel. I don't believe it would be.
    Senator Levin. OK. This is Exhibit 62.\1\ This is a 
Standard and Poor's exhibit. It is at the bottom of page one. 
``How do we handle existing deals especially if there are 
material changes that can cause existing ratings to change?'' 
And if you look at the top of page two, again, this is Standard 
and Poor's, it says, ``I do not know of a situation where there 
were wholesale changes to existing ratings when the primary 
group changed assumptions or even instituted new criteria. The 
two major reasons why we have taken this approach is, (i) lack 
of sufficient personnel resources.'' Are you familiar with that 
document, Ms. Corbet?
    \1\ See Exhibit No. 62, which appears in the Appendix on page 471.
    Ms. Corbet. No, I am not. This is the first--I just 
reviewed it this week.
    Senator Levin. All right. But this is not accurate This is 
not true? You said that----
    Ms. Corbet. This is not my understanding of how securities 
were surveiled.
    Senator Levin. OK. And then if you take a look at Exhibit 
92a,\2\ Mr. McDaniel.
    \2\ See Exhibit No. 92a, which appears in the Appendix on page 543.
    Mr. McDaniel. Yes.
    Senator Levin. This is a focus group associate survey. If 
you take a look at page three, you apparently were there at a 
series of interviews and focus groups. If you look at that 
first dot. And if you look at the findings, most indicated that 
SFG business objectives included increasing market share and/or 
coverage. Do you see that?
    Mr. McDaniel. Yes.
    Senator Levin. Now, after your mass downgrades in 2007, 
during the last 6 months, Moody's rated about 500 subprime RMBS 
securities and S&P rated over 700. So you are still allowing 
these dubious mortgages to be put into the market. Hadn't you 
already decided that these securities were high-risk in July? 
Hadn't you already reached that conclusion?
    Mr. McDaniel. I don't believe there were new RMBS 
transactions in late 2007----
    Senator Levin. You don't? In the last 6 months?
    Mr. McDaniel. Not that I recall.
    Ms. Corbet. I actually departed S&P at the beginning of 
September, so I am not familiar what the last 6 months of 
transactions were.
    Senator Levin. All right. Well, Moody's did rate RMBS----
    Mr. McDaniel. OK. I apologize. I did not recall that.
    Senator Levin. And in July, I guess, there was that massive 
downgrade of securities. Were you consulted when that happened?
    Mr. McDaniel. I was aware of the downgrade, yes.
    Senator Levin. Were you consulted?
    Mr. McDaniel. I was not consulted from a credit perspective 
in terms of whether it should happen or not. I was informed so 
that I would have an understanding of the action the rating 
committees were taking.
    Senator Levin. All right. But it was not your job to be 
part of that decision?
    Mr. McDaniel. That is correct.
    Senator Levin. Did you see the impact of those downgrades, 
those mass downgrades, on the market? Were you aware of the 
huge impact it had on the market when it happened?
    Mr. McDaniel. We were observing deterioration in 
performance of mortgages. That is what had the impact on the 
market, I believe----
    Senator Levin. Yes. The subprime market just collapsed, 
    Mr. McDaniel. And we were recognizing the deterioration 
with the rating downgrades, not causing the deterioration.
    Senator Levin. Well, if you would have done them a year 
earlier when you had information that the market was going 
under and was in trouble, if you would have done that over the 
year period and taken those early warning signs seriously and 
done your downgrading then, there wouldn't have been such a 
mass downgrading a year later. That is the whole issue that we 
are looking at.
    I am sure you won't agree with that, but it is, 
nonetheless, factually the case, that you had the information, 
you were applying the new model to new securities that you were 
rating. You did not re-rate the old securities, according to 
one of the documents, because you didn't want to apply the 
resources to do it and some other reasons. In any event, you 
didn't do it. And as a result, you did it in a massive way and 
it had a huge effect. If you would have done it in a different 
way when you first got the information and first had those 
storm warnings, I think the argument, which is much more 
persuasive at that point, is that you would not have had this 
massive downgrading which had such a huge impact in July 2007.
    And again, I am happy to have your comment on that, if you 
want, but I don't think you will probably want to agree with 
that. Maybe you do want to agree with it.
    Mr. McDaniel. We were managing the ratings system to react 
to actual performance data, and when it deviated from what we 
had seen in the previous recessions, that is when we took our 
    Senator Levin. In July 2007, did you know who David 
Goldstein was?
    Mr. McDaniel. No, I didn't.
    Senator Levin. OK. Do you know who Dania Corledo was?
    Mr. McDaniel. No.
    Senator Levin. How about David Oman?
    Mr. McDaniel. No. I am sorry.
    Senator Levin. That is OK. How about David Bawden?
    Mr. McDaniel. No.
    Senator Levin. OK. Ms. Corbet, take a look at Exhibit 
52c,\1\ if you would. This is an email dated March 20, 2007. 
This is an S&P employee who writes that, ``In a meeting with 
Kathleen Corbet today, she requested we put together a 
marketing campaign around the events in the subprime market''--
now, this is March 2007--``the sooner, the better.'' Why would 
you want to put together a marketing campaign in March 2007?
    \1\ See Exhibit No. 52c, which appears in the Appendix on page 439.
    Ms. Corbet. I would not use the term marketing campaign. 
What I did ask was for a more responsive communications 
campaign around the subprime market, and again, this followed 
along with a teleconference, an investor teleconference that we 
put on just about this time, shortly thereafter.
    Senator Levin. So you didn't use the term that they said 
you used?
    Ms. Corbet. I don't think that I would have used that term. 
It was clearly a communications effort.
    Senator Levin. Going back to this question of what happened 
late in 2007, in the last 6 months of 2007, after the crunch 
came, one of the last subprime RMBS deals that was rated was 
called Citigroup Mortgage Loan Trust, and both S&P and Moody's 
rated this deal in December 2007. I don't have any exhibits for 
you to look at, so I will just have to read this more slowly. 
December 2007, that was months after both of your companies had 
downgraded thousands of subprime RMBSes.
    First of all, were you aware that your agency, each of you, 
gave a AAA rating to four tranches of a $386 million Citibank 
subprime deal in December 2007? Were you aware of that?
    Mr. McDaniel. No, I was not.
    Ms. Corbet. I was no longer with the company.
    Senator Levin. OK. And the press release from your firm--
and I will just address this to you, Mr. McDaniel--when you 
rated the Citibank deal stated that you expected heightened 
losses and had accounted for that in the structure of the deal, 
but there was a 37 percent loss. That is the actual losses as 
of today. They exceeded any expected loss, obviously, when you 
rated the deal. But does it surprise you that you were still 
rating those subprime RMBSes in December 2007, after what 
happened in July? Does that come as any surprise to you?
    Mr. McDaniel. I am surprised that there was a subprime RMBS 
security issued in the market. To the extent that we had 
updated our views and felt that those views would now be 
sufficient to provide protection for the ratings assigned, I 
can understand why the rating committee would do so.
    Senator Levin. Let me go back again to Exhibit 24b.\1\ 
There are a lot of interesting things there that your Chief 
Credit Officer, Mr. Kimball, wrote in October 2007 about issues 
and weaknesses that the organization needs to address after the 
subprime market had collapsed.
    \1\ See Exhibit No. 24b, which appears in the Appendix on page 319.
    One of the things he wrote, and this is under market share, 
he says in paragraph five, ``Ideally, competition would be 
primarily on the basis of ratings quality''--that is ideally--
``with a second component of price and a third component of 
service. Unfortunately, of the three competitive factors, 
rating quality is proving the least powerful.''
    Then two lines down, he says, ``The real problem is not 
that the market does underweights rating quality but rather 
that, in some sectors it actually penalizes quality by awarding 
rating mandates based on the lowest credit enhancement needed 
for the highest rating. Unchecked competition on this basis can 
place the entire financial system at risk. It turns out that 
ratings quality has surprisingly few friends; issuers want high 
ratings; investors don't want rating downgrades; short-sighted 
bankers labor short-sightedly to game the rating agencies for a 
few extra basis points on execution.''
    Would you agree with that?
    Mr. McDaniel. In this section, he is talking about the 
issue of rating shopping, and I agree that existed then and 
exists now.
    Senator Levin. All right. He is analyzing in paragraph 
seven. He says, ``[T]he market share pressure persists'' in 
certain areas. This is near the top. ``Moody's has erected 
safeguards to keep teams from too easily solving the market 
share problem by lowering standards. These protections do help 
protect credit quality. Ratings are assigned by committee, not 
individuals. However,'' he says, ``entire committees, entire 
departments are susceptible to market share objectives.'' Do 
you agree with that?
    Mr. McDaniel. Well, in terms of financial incentive, the 
analysts would not be rewarded for market share or penalized 
for lack of market share. At management levels, there is more 
incentive associated with how the overall firm does 
financially, and so to the extent that there is a greater paid 
market share as opposed to just market coverage, that would 
have some impact on compensation at management levels, which is 
why we need appropriate safeguards and checks and balances.
    Senator Levin. Do you agree that entire committees are 
susceptible to market share objectives?
    Mr. McDaniel. Actually, no, I don't agree----
    Senator Levin. All right.
    Mr. McDaniel [continuing]. The committees are susceptible 
to that----
    Senator Levin. Fair enough.
    Mr. McDaniel [continuing]. Because they are not standing 
committees. They are ad hoc committees.
    Senator Levin. In Exhibit 24b,\1\ paragraph 7(b), he says, 
``Methodologies and criteria are published and thus put 
boundaries on rating committees' discretion.'' Then he says, 
``However, there is usually plenty of latitude within those 
boundaries to register market influence.'' Do you agree with 
    \1\ See Exhibit No. 24b, which appears in the Appendix on page 319.
    Mr. McDaniel. I am not sure what he means by market 
influence, so I don't know if I agree or not.
    Senator Levin. OK. In paragraph 23 of that same exhibit, 
``From a credit policy perspective, we want to be in a position 
to just say no to a market opportunity when imperative to do so 
from a quality perspective. We have done that in the past.'' He 
gives some examples. ``How to do it more aggressively without 
simply exiting whole market sectors is an unsolved problem.'' 
Would you agree it is an unsolved problem?
    Mr. McDaniel. It is an unsolved problem to the extent that 
the market is not rewarding ratings quality. If we don't have 
customers for the highest quality ratings, this is an ongoing 
    Senator Levin. OK. You have a Town Meeting, Exhibit 98.\1\ 
It is a transcript of Moody's managing directors. You spoke at 
that Town Meeting in September 2007. On page 63, you said that 
``What happened in 2004 and 2005 with respect to subordinated 
tranches is that our competition, Fitch and S&P, went nuts. 
Everything was investment grade. It didn't really matter. . . . 
No one cared because the machine just kept going.'' What do you 
mean by that? Pretty powerful stuff. Do you stand by that?
    \1\ See Exhibit No. 98, which appears in the Appendix on page 684.
    Mr. McDaniel. I was talking about the subordinated tranches 
in the mortgage-backed securities area. We had a different 
opinion from our competitors, and we were obviously not being 
persuasive with the investor community in our more conservative 
opinion and it was having an impact.
    Senator Levin. Having an impact on what?
    Mr. McDaniel. On our business. We didn't have as much 
coverage as a result.
    Senator Levin. Does that mean as much market share?
    Mr. McDaniel. Both. But really, I was talking about 
coverage in that case. There were--and the reason I keep making 
the distinction between market share and market coverage is, I 
think, that most people would associate market share with paid 
coverage, and I am talking about the coverage necessary to 
provide a comparative rating system, comparing one security to 
    Senator Levin. Well, you were part of the competition 
there, Ms. Corbet.
    Ms. Corbet. Yes.
    Senator Levin. It says here that S&P ``went nuts. 
Everything was investment grade.''
    Ms. Corbet. I don't know what he is referring to.
    Senator Levin. ``It really didn't matter. No one cared, 
because the machine just kept going.'' Is that true? I wish you 
would just say, yes, I stand by that, and that is what got us 
into trouble.
    Mr. McDaniel. For the sector I was talking about, I do 
stand by it.
    Senator Levin. Ratings kept churning out with poor models. 
Now, I will use your words. I think that the agencies really 
went overboard here and really went off the deep end, and here 
is the reason. You had poor models for these new structures. 
You had too few resources you were willing to commit. You had 
too much pressure from investment bankers. And the nuts didn't 
end until these mass downgrades of July 2007, when it cratered 
the market for structured finance.
    This is what one of your managing directors said at that 
Town Meeting, Exhibit 98, and this is what he or she wrote. 
``[W]hy didn't we envision that credit would tighten after 
being loose, and housing prices would fall after rising, after 
all most economic events are cyclical and bubbles inevitably 
burst.'' And then he said, what happened in 2004--he asked 
then, too, for the leaders to be candid and to acknowledge what 
the problems were and what had happened, and I think you have a 
long way to go in acknowledging what happened to your agencies.
    And this is what he is saying, and I happen to agree with 
him, that ``Moody's franchise value is based on staying ahead 
of the pack.'' I would apply this, though, to both. It just 
happened you guys had a Town Meeting at Moody's. I think the 
truth of this manager applies to both. He said, ``Moody's 
franchise value is based on staying ahead of the pack on credit 
analysis and instead we are in the middle of the pack. I would 
like more candor from senior management about our errors and 
how we will address them in the future.''
    That is one of the best comments that I have seen, and I 
hope you would see it that way, but I could understand that may 
not be the case.
    The SEC, Ms. Corbet, I think is conducting an investigation 
of S&P. They conducted an investigation. They found many 
problems, including staffing levels may have impacted various 
aspects of the ratings process. Is that true, that the SEC made 
that finding?
    Ms. Corbet. I don't know, sir.
    Senator Levin. OK. They found that S&P made changes to its 
rating criteria without publishing those changes, that S&P, 
like Moody's, had undocumented policies--I am quoting here--
``and procedures for rating RMBSes and CDOs.'' Were you 
familiar with that finding of the SEC?
    Ms. Corbet. I am not familiar with that finding, no.
    Senator Levin. The SEC found relative to Moody's that you 
had inadequate staffing levels which impacted the rating 
process, that Moody's analysts were using unpublished models, 
that Moody's analysts could be influenced in their rating by 
the fees charged to the issuers, that they were unable to find 
all the records surrounding a Moody's rating, that Moody's 
failed to retain or document certain significant steps in the 
rating process which made it difficult for the staff to assess 
compliance with its rating policies and procedures, and to 
identify the factors that were considered in developing a 
particular rating. Are you familiar with that?
    Mr. McDaniel. I am familiar with the SEC examination and 
the overall findings, yes.
    Senator Levin. Did you agree with them?
    Mr. McDaniel. The actions that the SEC asked us to take, we 
said we would take, so we are complying.
    Senator Levin. This is going to complete this panel, but I 
just have one very brief statement.
    The Subcommittee now has completed three of its four 
hearings examining some of the causes and consequences of the 
2008 financial crisis. Last week, on Tuesday, we looked at the 
role of high-risk mortgages. Last Friday's hearing looked at 
the failures of the bank regulators. Today, we looked at the 
role of credit rating agencies. It hasn't been a pretty picture 
so far and I don't think it is going to improve, although, 
frankly, the beginning of the Senate debate on strong financial 
reform next week does give us some hope.
    The final hearing of this quartet will be next Tuesday, 
when we are going to look at the role of investment banks, with 
Goldman Sachs being the case history. Our investigation has 
found that investment banks, such as Goldman Sachs, were not 
market makers helping clients. They were self-interested 
promoters of risky and complicated financial schemes that were 
a major part of the 2008 crisis. They bundled toxic and dubious 
mortgages into complex financial instruments, got the credit 
rating agencies to label them as AAA safe securities, sold them 
to investors, magnifying and spreading risk throughout the 
financial system, and all too often betting against the 
financial instruments that they sold and profiting at the 
expense of their clients.
    I am introducing into the record now four exhibits that we 
will be using at the Tuesday hearing to explore the role of 
investment banks during the financial crisis. We will be 
putting those exhibits up on the Subcommittee's Website either 
tonight or tomorrow.
    We thank this panel. We appreciate your being here. You 
have given us a great deal of documents. You have cooperated 
with this Subcommittee and we appreciate it.
    We will stand adjourned.
    Ms. Corbet. Thank you.
    Mr. McDaniel. Thank you, Mr. Chairman.
    [Whereupon, at 3:41 p.m., the Subcommittee was adjourned.]

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