[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]


 
                     OVERSIGHT OF THE CREDIT RATING 
                        AGENCIES POST-DODD-FRANK 

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               ----------                              

                             JULY 27, 2011

                               ----------                              

       Printed for the use of the Committee on Financial Services

                           Serial No. 112-51

















        OVERSIGHT OF THE CREDIT RATING AGENCIES POST-DODD-FRANK






























                     OVERSIGHT OF THE CREDIT RATING
                        AGENCIES POST-DODD-FRANK

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 27, 2011

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 112-51

                               ----------
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                   SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice          BARNEY FRANK, Massachusetts, 
    Chairman                             Ranking Member
PETER T. KING, New York              MAXINE WATERS, California
EDWARD R. ROYCE, California          CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma             LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas                      NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois         MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina      GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois               BRAD SHERMAN, California
GARY G. MILLER, California           GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia  MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
JOHN CAMPBELL, California            JOE BACA, California
MICHELE BACHMANN, Minnesota          STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan       BRAD MILLER, North Carolina
KEVIN McCARTHY, California           DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico            AL GREEN, Texas
BILL POSEY, Florida                  EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK,              GWEN MOORE, Wisconsin
    Pennsylvania                     KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia        ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri         JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan              ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin             JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York         GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio               JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee

                   Larry C. Lavender, Chief of Staff
              Subcommittee on Oversight and Investigations

                   RANDY NEUGEBAUER, Texas, Chairman

MICHAEL G. FITZPATRICK,              MICHAEL E. CAPUANO, Massachusetts, 
    Pennsylvania, Vice Chairman          Ranking Member
PETER T. KING, New York              STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota          MAXINE WATERS, California
STEVAN PEARCE, New Mexico            JOE BACA, California
BILL POSEY, Florida                  BRAD MILLER, North Carolina
NAN A. S. HAYWORTH, New York         KEITH ELLISON, Minnesota
JAMES B. RENACCI, Ohio               JAMES A. HIMES, Connecticut
FRANCISCO ``QUICO'' CANSECO, Texas   JOHN C. CARNEY, Jr., Delaware
STEPHEN LEE FINCHER, Tennessee


























                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    July 27, 2011................................................     1
Appendix:
    July 27, 2011................................................    61

                               WITNESSES
                        Wednesday, July 27, 2011

Gellert, James H., Chairman and Chief Executive Officer, Rapid 
  Ratings International, Inc.....................................    33
Kroll, Jules B., Executive Chairman, Kroll Bond Rating Agency, 
  Inc............................................................    35
Ramsay, John, Deputy Director, Division of Trading and Markets, 
  U.S. Securities and Exchange Commission........................     6
Rowan, Michael, Global Managing Director, Commercial Group, 
  Moody's Investors Service......................................    31
Sharma, Deven, President, Standard & Poor's......................    29
Smith, Gregory W., General Counsel and Chief Operating Officer, 
  Colorado Public Employees' Retirement Association..............    38
Van Der Weide, Mark E., Senior Associate Director, Division of 
  Banking Supervision and Regulation, Board of Governors of the 
  Federal Reserve System.........................................     8
White, Lawrence J., Professor of Economics, Stern School of 
  Business, New York University..................................    36
Wilson, David K., Senior Deputy Comptroller, Bank Supervision 
  Policy, and Chief National Bank Examiner, Office of the 
  Comptroller of the Currency....................................    10

                                APPENDIX

Prepared statements:
    Neugebauer, Hon. Randy.......................................    62
    Gellert, James H.............................................    64
    Kroll, Jules B...............................................    89
    Ramsay, John.................................................    95
    Rowan, Michael...............................................   102
    Sharma, Deven................................................   118
    Smith, Gregory W.............................................   129
    Van Der Weide, Mark E........................................   209
    White, Lawrence J............................................   216
    Wilson, David K..............................................   242

              Additional Material Submitted for the Record

Neugebauer, Hon. Randy:
    Written statement of the Federal Deposit Insurance 
      Corporation................................................   259
Fitzpatrick, Hon. Michael:
    Letter to Chairman Neugebauer from Hon. Timothy Geithner, 
      Secretary of the Treasury, with attachments................   266
Stivers, Hon. Steve:
    Letter from John Ramsay, FDIC, providing additional 
      information for the record.................................   320


                     OVERSIGHT OF THE CREDIT RATING

                        AGENCIES POST-DODD-FRANK

                              ----------                              


                        Wednesday, July 27, 2011

             U.S. House of Representatives,
                          Subcommittee on Oversight
                                and Investigations,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 10:02 a.m., in 
room 2128, Rayburn House Office Building, Hon. Randy Neugebauer 
[chairman of the subcommittee] presiding.
    Members present: Representatives Neugebauer, Fitzpatrick, 
Pearce, Hayworth, Renacci, Canseco; Capuano, Miller of North 
Carolina, Himes, and Carney.
    Ex officio present: Representative Bachus.
    Also present: Representatives Garrett and Stivers.
    Chairman Neugebauer. Good morning. This hearing will come 
to order.
    We will have opening statements, and I remind Members that 
your opening statements will be made a part of the record. I am 
going to ask unanimous consent today that we allow Mr. Garrett 
to participate in the hearing. Also, without objection, written 
testimony submitted by the FDIC will be made a part of the 
record.
    We will now have opening statements, and the Chair yields 
himself 4 minutes.
    Today's hearing is about the rating agencies. And I guess 
that the topics will be fairly broad, and we will cover a lot 
of ground. I think this is a very important time to have this 
hearing.
    If you look back to the financial crisis and the Dodd-Frank 
Act and all of the things that followed, some people indicated 
that they felt that the rating agencies had some culpability in 
the credit crisis, that the ratings did not actually reflect 
the risks that were being taken.
    Subsequent to that, we passed Dodd-Frank, and a lot of 
attention was given to the rating agencies in Dodd-Frank. Some 
of those regulations have now come out, and some of them have 
not come out.
    One of the things was that there was deemed to be too much 
dependence on the rating agencies in the markets, and 
particularly in some of the financial institutions. And Dodd-
Frank asked that the references to those ratings be really 
expunged and that the agencies, the regulators, would come up 
with new criteria for measuring risk that was not necessarily 
tied to the rating agencies.
    One of the things we will want to hear from our regulators 
today is where we are in that process.
    The other thing that still is of concern to some folks is 
the fact that there still continues to be a concentration in 
just three of those agencies. Between Moody's, Standard & 
Poor's, and Fitch, they have covered about 98 percent of the 
ratings and 90 percent of the revenue, and some people are 
concerned that access for other entities to become Nationally 
Recognized Statistical Rating Organizations (NRSOs) is still 
limited, particularly when you look at some of the regulation 
that is coming out and making it more and more burdensome and 
more difficult for other firms to come into that. And I think 
we will hear something about that today.
    Also of interest to me is that when we look at the fact 
that some people say that we ended too-big-to-fail with Dodd-
Frank, some of us do not believe that actually ended too-big-
to-fail, but many of us somewhat believe that it probably 
contributed to furthering too-big-to-fail.
    When you look at the major financial institutions in this 
country, a lot of people thought that they should be smaller 
after Dodd-Frank. What we have seen is that many of these 
institutions are actually larger.
    And what we also now see within the rating industry is that 
there is still a reward for being considered one of those 
systemically risky financial institutions and, in fact, that 
these institutions are getting somewhat of a bump or upticks 
over other financial institutions, which may in fact have a 
better baseline financial rating.
    So these are some of the things that we are going to want 
to look at today. My guess is that some of my colleagues will 
want to discuss something that is relevant to these times and 
that is the role of the rating agencies as it pertains to the 
United States sovereign debt. And I suspect there will be some 
questions along those lines as well.
    But I look forward to a very robust hearing. This is a very 
important part of our economy. A lot of people still put a lot 
of credence into these ratings. Some people feel like they have 
lost their credibility. And as we are moving forward, one of 
the things that we feel is going to be extremely important is 
restoring a little bit more certainty in the marketplace.
    And so, with that, I will then recognize my good friend, 
the ranking member, Mr. Capuano.
    Mr. Capuano. Thank you, Mr. Chairman.
    First of all, welcome to all our panelists.
    I know that a lot of people today are going to want to talk 
about the removal of references. Though I am interested in 
that, I am more interested in other aspects.
    It is well known by everybody, actually, including all the 
testimony, the Majority memo on today, that faulty ratings 
contributed significantly to the recent economic problems that 
we have had. We all know that. It is accepted. There is really 
no debate about that any further.
    I am particularly interested in where we are now and how we 
go forward. And I am particularly interested in how the 
budgetary constraints might have impacted some of your agencies 
relative to implementing some of Dodd-Frank and whether, even 
in implementing Dodd-Frank, it has hurt other parts of your 
activities.
    I think that is a very important aspect to this. It doesn't 
do any good to have the greatest regulations in the world if 
you cannot enforce them or oversee them.
    I am interested in the overall report as to whether the 
credit rating agencies are doing their job, whether we should 
be concerned any further about--at least currently, I know 
things can change tomorrow, but as of the moment--whether they 
have finally done what we had all hoped and wanted them to do.
    And I, from where I sit, think they have done a better job. 
They are more reliable, more independent, and have changed 
their model significantly. But I would like to hear your 
opinions as to whether or not that is a fair assessment.
    I am also interested in your opinions as to how we are 
doing with the bill that we passed. Like any bill, like 
particularly a major bill, I have always known, we have always 
known, that any major bill, no matter how good or bad you think 
it is, needs to be tweaked as you go forward. What did we do 
wrong? What can we do better? What should we be doing that we 
didn't think of?
    Because the truth is our economic situation right now, the 
debt limit obviously is the crisis of the moment. Hopefully, we 
will pass that in the next few weeks or so, but that doesn't 
solve all our problems. I think everybody here knows that.
    We have other problems. We have other things we have to 
address. And we have other economic issues that are related to 
the credit rating agencies. And if they do their job, I believe 
our entire system will work better, and that is really what I 
am interested in hearing today.
    So with that, I will yield back.
    Chairman Neugebauer. I thank the gentleman.
    I now recognize the chairman of the full committee, Mr. 
Bachus, for 3 minutes.
    Chairman Bachus. I thank the chairman for convening this 
hearing to examine the future of credit rating agencies post-
Dodd-Frank.
    The credit rating agencies failed spectacularly in the 
years leading up to the financial crisis. A government seal of 
approval for credit rating agencies led to a mispricing of risk 
and the subsequent collapse in market confidence.
    House Republicans identified this as a significant problem 
and proposed removing references to credit ratings in Federal 
statutes. Unlike most of our proposals, which were rejected by 
the then-Majority, this one was adopted and incorporated into 
the final legislation with bipartisan support. I commend all 
the members of the committee for that.
    Section 939A of Dodd-Frank requires all Federal agencies to 
review and replace references to credit ratings in their 
regulations with alternative measures of creditworthiness. The 
significance of Section 939A cannot be overstated. Because the 
provision had overwhelming bipartisan support throughout the 
regulatory reform debate, I fully expect the regulators to 
implement it consistent with legislative intent.
    This provision has been discussed and debated within this 
committee and on the House Floor and the Senate Floor since 
2009. If the regulators had concerns prior to Dodd-Frank's 
enactment about their ability to develop suitable alternatives 
to credit rating, I am unaware of them having articulated any 
of those concerns to Members of Congress.
    While Section 939A is an important step to de-emphasize 
credit rating, the Dodd-Frank Act, in some cases, lacks 
consistency in its approach to credit rating. Provisions such 
as Section 939F, the so-called Franken Amendment, works against 
the intent of Section 939A. The Franken Amendment reinforces 
the significance of credit rating by requiring the government 
to establish a system for the SEC to choose a rating agency to 
evaluate an issuer's structural financial product.
    Regulations adopted by the SEC under Dodd-Frank appear to 
also contradict the goals of an earlier credit rating agency 
reform law authored by our colleague from Pennsylvania, Mr. 
Fitzpatrick. That was the Credit Rating Agency Reform Act, 
which sought to reduce the barriers to entry for credit rating 
agencies seeking the Nationally Recognized Statistical Rating 
Organization designation (NRSRO).
    However, the 517 pages of rules adopted by the SEC in May 
to implement sections of Dodd-Frank erect new barriers to entry 
for prospective NRSROs. SEC Commissioner Kathleen Casey stated 
that these rules may be life-threatening to smaller credit 
rating agencies.
    Finally, Dodd-Frank removes the expert liability exemption 
under the Securities Act for credit rating agencies. In 
addition to causing a dislocation in the asset-backed security 
market, a new liability standard further discourages new 
entries to the rating agency arena. I am pleased that last week 
this committee approved legislation authored by the gentleman 
from Ohio, Mr. Stivers, to repeal this counterproductive 
provision of Dodd-Frank.
    Mr. Chairman, all this shows why today's hearing is very 
important. I look forward to hearing from our witnesses.
    Chairman Neugebauer. I thank the gentleman.
    And now I would like to recognize the vice chairman of the 
subcommittee, Mr. Fitzpatrick, who has done a lot of work in 
this area and has been a great advocate for making sure that we 
have more competition. And so with that, I recognize the 
gentleman for 2 minutes.
    Mr. Fitzpatrick. Thank you, Mr. Chairman. Thanks for your 
leadership in convening this hearing. I know that we are all 
really looking forward to the testimony coming of both panels.
    Credit rating agencies have a role to play in our financial 
system. The problem is that the system has not always worked, 
especially for all of the users. In 2006, as the chairman 
indicated, I wrote legislation, the Credit Rating Agency Reform 
Act, designed to open the door to more participation and more 
competition in your industry. It began a process that has led 
to this day. However, in the interim, we had a catastrophic 
failure in the system that actually hastened the reform.
    I think it is striking that one of the few bipartisan 
understandings to come out of Dodd-Frank was that reliance on 
credit ratings have become too ingrained and too pervasive in 
our statutes. However, Dodd-Frank instituted additional 
provisions that seem to contradict our bipartisan agreement 
and, in fact, now create additional barriers to competition in 
the industry.
    It is timely that we are having this discussion in the 
midst of our debt negotiations here in the Nation's Capital. 
The full faith and credit of the United States is on the line. 
We are at a crossroads where we need to decide if we are going 
to heed the economic warnings and get our fiscal house in order 
or just continue to have the Federal Government make the easy 
choices.
    So I think today's hearing will contribute to that debate 
as well, and I look forward to participating.
    Thank you, Mr. Chairman.
    Chairman Neugebauer. I thank the gentleman.
    I now yield 1 minute to the gentleman from Texas, Mr. 
Canseco.
    Mr. Canseco. Thank you, Mr. Chairman.
    The financial crisis of 2008 reinforced the fact that the 
largest credit rating agencies carry a tremendous amount of 
influence over our economy. Largely because of a government 
stamp of approval, the ratings assigned to securities from 
Nationally Recognized Statistical Rating Organizations were 
used as regulatory benchmarks for determining appropriate 
capital standards.
    NRSRO's designation was also a cause of investor 
complacency when these rating agencies began to rate complex 
asset-backed securities and collateralize debt obligations, 
even though they had no experience rating such instruments, and 
as we now know, these instruments were not really understood by 
anybody.
    In order to help decrease the dependence on a few 
organizations to have such an outsized influence in our 
financial system, a bipartisan proposal was added to the Dodd-
Frank bill that required regulators to cease their reliance on 
credit ratings and instead adopt their own standard of 
creditworthiness. Unfortunately, some banking regulators have 
not fully embraced this common-sense proposal, and I have great 
concern over the impact of their decision.
    I look forward to hearing from our witnesses today on this 
very important matter.
    Thank you.
    Chairman Neugebauer. I thank the gentleman.
    And now the gentleman from New Jersey, Mr. Garrett, for 1 
minute.
    Mr. Garrett. Thank you. And I thank the chairman for 
holding this very important and timely hearing today.
    The consideration of regulatory reform legislation that 
Congress passed last year unfortunately was very partisan, and 
the overreach that resulted from that partisan structure is now 
needlessly restricting our economic growth and limiting job 
creation.
    However, as was just pointed out, one significant area of 
bipartisanship did emerge through deliberation, that dealt with 
credit rating agencies. There was broad agreement that 
investors, because of the government's explicit requirement of 
ratings, had become basically overreliant on the rating 
agencies and failed to do their due diligence. And so by having 
the government require these ratings, investors believed that 
the ratings had a stamp of approval from the Federal 
Government.
    In order to refute this, Ranking Member Frank, Chairman 
Bachus and I crafted language to remove all rating requirements 
from the statutes and the regulations. So, I am pleased to see 
that in some regards, the regulatory community has been moving 
forward on implementing that.
    I understand that changing from that old system to a new 
system can be difficult for all involved, but I know with 
bright minds, we have a regulatory community that can figure 
out a way to make this system work in the future.
    As we can see by the discussion going on this week 
surrounding the debt debate, however, the rating agencies' 
opinion still does carry quite a bit of weight. And while 
ratings can play a role in evaluating the credit of a company, 
security, or even a country, it should not be the sole 
determinant.
    In conclusion, we must continue to work to lessen 
investors' reliance on these rating agencies and disconnect any 
belief that the government somehow stands behind their 
opinions.
    And with that, I yield back.
    Chairman Neugebauer. I thank the gentleman.
    And now we will go to our panel. I remind the panelists 
that your full written statements will be made a part of the 
record.
    Our first panel consists of: Mr. John Ramsay, Deputy 
Director, Division of Trading and Markets, U.S. Securities and 
Exchange Commission; Mr. Mark Van Der Weide, Senior Associate 
Director, Division of Banking Supervision and Regulation, 
Federal Reserve Board; and Mr. David Wilson, Senior Deputy 
Comptroller and Chief National Bank Examiner, Office of the 
Comptroller of the Currency.
    Mr. Ramsay, you are recognized for 5 minutes.

STATEMENT OF JOHN RAMSAY, DEPUTY DIRECTOR, DIVISION OF TRADING 
      AND MARKETS, U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Ramsay. Chairman Neugebauer, Ranking Member Capuano, 
and members of the subcommittee, my name is John Ramsay, and I 
am a Deputy Director in the Division of Trading and Markets at 
the Securities and Exchange Commission. Thank you for the 
opportunity to testify on behalf of the Commission concerning 
its oversight of credit rating agencies and the regulatory 
treatment of ratings.
    The Commission first gained regulatory authority over 
rating agencies in 2006 with the passage of the Credit Rating 
Agency Reform Act, which mandated that the Commission establish 
a registration and oversight program for Nationally Recognized 
Statistical Rating Organizations, or NRSROs.
    Yet, it is important to note that the Commission is 
prohibited from regulating the substance of credit ratings or 
rating agency procedures or methodologies.
    From 2007 to 2009, the Commission adopted rules under this 
authority to address conflicts of interest, establish 
recordkeeping and reporting requirements, and require rating 
agencies to publish historical and performance data on the 
ratings they issue.
    Following the financial crisis, which highlighted problems 
in the performance of credit rating agencies, the Dodd-Frank 
Wall Street Reform and Consumer Protection Act mandated a 
comprehensive additional set of rules in this area. In May of 
this year, the Commission proposed rules under this new 
authority.
    In all of its efforts in this area, the Commission has 
strived to achieve three general goals: to address conflicts of 
interest and improve the integrity of rating processes and 
methodologies; to provide more transparency so that investors 
have more and better information about ratings and can better 
compare the performance of rating agencies; and to promote 
competition in the market for rating agency services.
    While my written testimony details the Commission's 
significant regulatory efforts to date, I would like to 
highlight just a few of those actions.
    Many of the existing rules are directed to the integrity of 
the rating process. For example, the Commission's rules require 
the rating agencies to have procedures to manage conflicts of 
interest and that prohibit certain other conflicts.
    The agencies are prohibited from structuring the same 
products that they rate, and employees who participate in 
determining credit ratings are not allowed to participate in 
fee negotiations. Under the rules we recently proposed, these 
requirements would be strengthened by prohibiting credit 
analysts from being involved in any way in sales or marketing 
activities.
    In order to promote better transparency, the Commission's 
rules require NRSROs to make various disclosures about rating 
histories, methodologies, and performance statistics among 
other items. Our recent proposals aim to strengthen these 
requirements by increasing the amount of public data and 
standardizing the way performance information is provided so as 
to be more useful to investors.
    In addition, each published rating would need to be 
accompanied by information to make the ratings more 
understandable, and the rating agencies would be required to 
adopt procedures to clearly define each rating symbol and to 
make sure that symbols are applied consistently.
    The Commission also has sought to improve competition for 
rating agency services. For example, our rules provide a 
mechanism for a ratings agency that has not been hired to rate 
a structured finance security to be able to access the 
information it would need to rate the security on an 
unsolicited basis.
    In May of this year, the Commission issued a request for 
public comment as part of the effort to complete a study 
required by the Dodd-Frank Act addressing the process for 
rating structured finance products and the conflicts of 
interest that arise from the way the rating agencies are paid 
for these ratings.
    The study will focus specifically on the feasibility of 
establishing a system in which a public or private utility or 
self-regulatory organization would assign agencies to determine 
ratings for these products.
    The Commission is also seeking to eliminate references to 
credit ratings in its rules, in order to reduce reliance on 
credit ratings. As required by Dodd-Frank, already this year 
the Commission has proposed to remove numerous rule references 
to credit ratings and to substitute other standards of 
creditworthiness where necessary.
    Finally, the Dodd-Frank Act requires the Commission to 
conduct examinations of each NRSRO at least annually and to 
issue a report summarizing the findings. The staff is currently 
in the process of completing the first cycle of these exams.
    I would be pleased to answer any questions you may have.
    [The prepared statement of Mr. Ramsay can be found on page 
95 of the appendix.]
    Chairman Neugebauer. Thank you.
    Mr. Van Der Weide?

STATEMENT OF MARK E. VAN DER WEIDE, SENIOR ASSOCIATE DIRECTOR, 
   DIVISION OF BANKING SUPERVISION AND REGULATION, BOARD OF 
            GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Mr. Van Der Weide. Chairman Neugebauer, Ranking Member 
Capuano, and members of the subcommittee, thank you for the 
opportunity to discuss credit ratings and Section 939A of the 
Dodd-Frank Act.
    To help achieve the important goal of reducing governmental 
and private sector reliance on credit ratings, Section 939A of 
the Act requires all Federal agencies to remove references to 
credit ratings from their regulations and replace them with 
appropriate alternative standards of creditworthiness.
    For many years before the introduction of credit ratings 
into Federal regulations, investors had used credit ratings to 
assist them in making investment decisions. Credit ratings 
provided a uniform, market-driven third-party assessment of the 
creditworthiness of countries, State and local governments, and 
companies.
    Federal agencies later incorporated credit ratings into 
their regulatory frameworks in part because of these same 
attributes.
    The recent financial crisis, however, made plain serious 
flaws with the methodologies and processes around the 
determination of credit ratings, particularly ratings for 
structured finance positions. These flaws contributed to the 
issuance of credit ratings that severely underestimated the 
credit risk of many mortgage-backed securities.
    Investors for their part relied too heavily and 
uncritically on these ratings for making their investment 
decisions. And downward revaluations of many of these 
securities by market participants between 2007 and 2009 and the 
resulting loss of confidence in the accuracy of credit ratings 
contributed meaningfully to the destabilizing dynamics of the 
crisis.
    Section 939A of the Dodd-Frank Act is one of a number of 
provisions of the statute that are intended to address problems 
with credit ratings and rating agencies.
    The Board has identified 46 references to credit ratings in 
its regulations. Most of these references are in the Board's 
risk-based capital requirements for State member banks and bank 
holding companies. And the Board's greatest challenge in 
implementing Section 939A is completely removing those credit 
ratings from our risk-based capital rules.
    To protect the safety and soundness of individual banking 
firms and financial stability more broadly, we are striving to 
develop alternative standards of creditworthiness for use in 
our capital rules that possess the virtues of credit ratings, 
but not the vices.
    There are several key characteristics of a good 
creditworthiness standard. First, and most importantly, the 
standard should be reliably risk sensitive. It should 
effectively measure the relative credit risk of various types 
of financial instruments.
    Second, the standard should result in a consistent and 
transparent application across different types of financial 
instruments.
    Third, the standard ideally should auto adjust on a timely 
basis to reflect changes in the credit risk profile of 
instruments and should auto adapt to cover new financial market 
practices.
    Finally, the standard should be relatively simple to 
implement and should not increase regulatory burden for banking 
firms, particularly small banks.
    Obviously, credit ratings themselves do not meet all of 
these criteria and developing good replacements for credit 
ratings is a particularly difficult task.
    Since the Dodd-Frank Act was signed into law last July, the 
Board has been working with the OCC and the FDIC to carry out 
the 939A mandate. In August of 2010, 1 month after the Act was 
passed, the banking agencies issued an Advance Notice of 
Proposed Rulemaking (ANPR) on alternative standards of 
creditworthiness for use in our capital rules. In November of 
last year, the Board hosted a roundtable discussion with the 
other banking agencies, academics, and private sector 
participants to solicit views on this issue.
    Public commenters on our 939A efforts have expressed 
concern about the statutory mandate, have suggested it could 
lead to competitive distortions across the global banking 
system and across the domestic banking landscape, and have 
urged the agencies to develop alternatives that are risk 
sensitive, consistent across banks, and easy to implement.
    We continue to work closely with the other banking agencies 
to develop our appropriate alternative standards. We are 
considering a number of approaches, including approaches that 
rely on market-based indicators such as bond spreads, 
approaches that rely on balance sheet financial ratios, and 
approaches that rely on internal assessments of credit risk by 
banking firms.
    Each of these approaches, like the use of credit ratings, 
has strengths and weaknesses. The Board anticipates that it 
will propose amendments to remove references to credit ratings 
from our regulations in the near future.
    The Board also has been active in the international efforts 
by the Financial Stability Board and the Basel Committee to 
encourage reduced dependence on credit ratings across the 
global financial system.
    Although the international financial regulatory community 
is working to reduce reliance on credit ratings, the Basel 
capital framework continues to incorporate credit ratings in 
material ways. Accordingly, we will need to find ways to 
synchronize our 939A changes with the global bank capital 
accords.
    The Board welcomes input from the public and from members 
of the subcommittee on this important issue of public policy. 
Thank you for the chance to describe the Board's efforts to 
date to implement Section 939A. And I am happy to answer any 
questions.
    [The prepared statement of Mr. Van Der Weide can be found 
on page 209 of the appendix.]
    Chairman Neugebauer. Thank you.
    Mr. Wilson?

 STATEMENT OF DAVID K. WILSON, SENIOR DEPUTY COMPTROLLER, BANK 
SUPERVISION POLICY, AND CHIEF NATIONAL BANK EXAMINER, OFFICE OF 
                THE COMPTROLLER OF THE CURRENCY

    Mr. Wilson. Chairman Neugebauer, Ranking Member Capuano, 
and members of the subcommittee, I appreciate the opportunity 
to testify about the initiatives the OCC has undertaken and the 
challenges that we are facing in our work to implement Section 
939A of the Dodd-Frank Act.
    Section 939A does require each Federal agency to review its 
regulations that refer to and require the use of credit 
ratings. And each agency must then modify its regulations to 
remove any reference to, or requirement for reliance on credit 
ratings to, and substitute alternative standards of 
creditworthiness that the agency determines is appropriate. 
Section 939A also requires each agency to transmit a report to 
Congress, and the OCC will be submitting that report today.
    OCC regulations affected by this provision include the 
interagency risk-based capital regulations and also OCC-
specific regulations pertaining to national bank investment 
securities activities, securities offerings, and international 
banking activities.
    The banking agencies' risk-based capital standards use 
credit ratings to determine appropriate capital requirements 
and assign risk weights to securitizations and exposures to 
qualifying securities firms.
    Credit ratings are also used to assign risk add-ons under 
the agency's market risk rule and to determine the eligibility 
of certain guarantors and collateral for credit risk mitigation 
purposes.
    Section 939A could also significantly affect future 
implementation of other Basel Accord capital requirements in 
the United States. These include the standardized approach for 
credit risk, which relies extensively on credit ratings to 
assign risk weights, as well as the 2009 revisions made by the 
Basel Committee to enhance and strengthen international risk-
based capital standards.
    The OCC's investment securities regulations use credit 
ratings for determining credit quality, marketability, and 
appropriate concentration levels of investment securities 
purchased and held by national banks.
    Credit ratings are also referenced and used in our 
regulations governing securities offerings by national banks 
and the types of assets Federal branches and agencies can hold 
as a capital equivalency deposit.
    The OCC has issued two Advance Notices of Proposed 
Rulemaking to seek input on how to revise our regulations to 
implement 939A. An interagency ANPR sought comment on several 
approaches for developing creditworthiness standards for 
agencies' risk-based capital rules, and these approaches varied 
in complexity and risk sensitivity.
    We also issued a similar ANPR on alternative 
creditworthiness standards for our noncapital regulations.
    The agencies, as Mark said, also hosted a roundtable 
discussion attended by bankers, academics, asset managers, 
credit rating staff, and others to discuss alternatives to 
credit ratings. Commenters on the ANPRs and roundtable 
participants generally expressed concerns with the removal of 
credit ratings from our regulations and asserted that credit 
ratings can be a valuable tool for assessing creditworthiness.
    Many commenters believe that the simple approaches outlined 
in the option, due to their lack of risk sensitivity, create 
incentives for inappropriate risk arbitrage. However, 
commenters were also concerned that the more complex and risk 
sensitive an approach is, due to the depth and types of 
analysis that would be required, pose a disproportionate burden 
on small banks.
    Commenters also expressed concern that certain alternatives 
could create competitive inequities and inconsistencies with 
the international capital standards established by the Basel 
Committee.
    These comments reflect the challenges that the OCC and the 
other Federal banking agencies are facing as we work to 
implement 939A. We believe that with appropriate operational 
and due diligence requirements, credit ratings can be one 
valuable factor to consider when evaluating the 
creditworthiness of financial instruments.
    In our view, an approach that precludes undo or exclusive 
reliance on credit ratings rather than imposing an absolute 
prohibition on their use would strike an appropriate balance 
between the need to address the problems created by the 
overreliance on credit ratings with the need to enact sound 
regulations that can be consistently implemented.
    Notwithstanding these challenges, we are continuing our 
work to revise our regulations to be consistent with Section 
939A. We are being careful and thorough in order to ensure that 
the result is not a step backward in assuring that banks of all 
sizes conduct their activities in a safe and sound manner and 
that reflect sound credit judgment and adequate capital for the 
risk they take.
    Thank you.
    [The prepared statement of Mr. Wilson can be found on page 
242 of the appendix.]
    Chairman Neugebauer. Thank you.
    So we have heard your testimony. Section 939A basically 
says that we are going to move away from the references to 
rating agencies in our financial institutions as a part of 
regulatory capital.
    And, Mr. Ramsay, I think you said that--have you all 
published a definition for your standards of creditworthiness? 
Where are you all in that process?
    Mr. Ramsay. Mr. Chairman, we have currently, I think, 
proposed to remove references from 11 separate rules or sets of 
rules--in some cases, nine different forms.
    Actually, just yesterday the Commission adopted the removal 
of ratings as a criterion for so-called short form or shelf 
registration. So we are coming along in the process of adopting 
some of our proposals.
    It is tricky because each rule has to be looked at 
individually. The right sort of alternative for 
creditworthiness is not going to be the same in all cases. It 
has to be sort of calibrated, if you will, to the purpose for 
the particular rule.
    Chairman Neugebauer. Thank you.
    Mr. Van Der Weide, where is the Federal Reserve in this 
process? Have you all developed a definition of 
creditworthiness?
    Mr. Van Der Weide. We are working on that. We issued a 
first proposal on that last summer. We have been engaging over 
the past year in extensive discussions with the OCC and the 
FDIC on this topic.
    Part of our particular challenge that is causing us to take 
a little more time is the core regulation set that we have to 
worry about is the bank capital rules. And the bank capital 
rules, as I think we have learned in part through the financial 
crisis, are extremely important to ensuring the safety and 
soundness of banks and the financial stability of the United 
States.
    We have to be very careful about how we amend our capital 
rules. We need to take our time and make sure it gets done 
right. The capital rules are also an area where a fair amount 
of risk sensitivity is required. It is not an on/off switch, 
investment grade or not. So it requires a little bit more work 
to make sure that we have a more granular system like that.
    Other complexities that we are working on are it is an 
interagency process. The bank capital rules are importantly 
interagency. So there are a number of us working on it. It is 
not one agency. That will result in a better product at the 
end, but it will lengthen the processing time a little bit for 
this effort.
    And the final complication that we have is, the capital 
rules are negotiated internationally at the Basel Committee, so 
there is an international bank capital accord which we have 
been implementing in the United States. And as you know, there 
is some tension between the international capital accord, which 
does contain references to ratings and what we are trying to do 
under 939A. So we also need to synchronize our efforts with the 
international accord.
    We are working very hard on it. We don't have concrete 
proposals to propose at this time, but we will have some in the 
near future.
    Chairman Neugebauer. Mr. Wilson?
    Mr. Wilson. The capital rules are an interagency process, 
so my answer is very similar to Mark's.
    But the other thing in the capital rules, in addition to 
what Mark mentioned, is we are trying to implement an accord 
that has been done internationally. There is extensive reliance 
on credit ratings and the standardized approach. There is 
extensive reliance on securitizations.
    But also importantly, some of them, like securitizations, 
are very granular. So it is hard to come up with definitions 
that provide that level of granularity to put risk weights into 
buckets like the Basel accord did.
    But in addition to that, as I have mentioned, we have OCC-
specific rules primarily in investment securities. That is more 
of an on/off switch, and we can take an approach, and we have 
proposed an approach similar to what the SEC is proposing and 
just having a descriptive standard of creditworthiness.
    Chairman Neugebauer. I appreciate the fact that you are 
looking at an interagency approach to this. And, of course, I 
think there needs to be some standardization. I think there is 
a feeling here that this process is not moving extremely 
swiftly.
    One of the concerns that I have is that under FSOC, the 
Treasury Secretary is supposed to provide some leadership to 
this coordination among the regulators. And I would mention 
that the Secretary was--we did ask Treasury to provide a 
witness today, and this is the second hearing in a row that we 
have had that the Treasury has elected not to send a 
representative.
    And so we think it is very important for the Treasury 
Secretary to be very engaged in this disharmonization within 
the regulatory framework, because we can't go and talk about 
harmonization with Basel and these other countries if we don't 
have our own plan. And so, I would encourage you to make sure 
that we move along in that process and make sure that happens.
    I would just close with this interesting concept and just a 
quick question. If we are going to expunge that from our 
capital rules and some of the other rules, what would be the 
response if we just did away with the NRSRO designation?
    Mr. Ramsay?
    Mr. Ramsay. I think I should maybe use some background, and 
indicate that the NRSRO designation has been used for quite 
some time. It used to be used as part of an informal, no-action 
letter process, which for many years is the way that agencies 
were recognized.
    Chairman Neugebauer. I am sorry to interrupt you here. My 
time is, unfortunately, expiring. Could you just give me the 
short answer? Would you support doing away with the NRSRO 
designation?
    Mr. Ramsay. I guess the short answer, Mr. Chairman, is that 
I think there are arguments that could be made for and against, 
but the Commission certainly hasn't taken a position on--
    Chairman Neugebauer. Mr. Van Der Weide?
    Mr. Van Der Weide. The Fed also does not have a position on 
that question.
    Chairman Neugebauer. Could you develop one?
    Mr. Van Der Weide. I will take that back.
    Chairman Neugebauer. Yes.
    Mr. Wilson? I guess your answer is going to be the same?
    Mr. Wilson. Yes.
    Chairman Neugebauer. Thank you. And with that, my time has 
expired.
    The gentleman from North Carolina, Mr. Miller, is 
recognized for 5 minutes.
    Mr. Miller of North Carolina. Thank you, Mr. Chairman.
    One of the lessons I took from the financial crisis is when 
the folks in the financial sector say, ``Everything is under 
control; there is nothing to worry about,'' but they have a 
desperate look in their eyes, I worry, because I think maybe 
they know something they are not telling.
    What really happened in September of 2008 was described in 
the press as interbank lending freezing up. And in fairness to 
the press, it is going to be pretty hard to explain it any more 
deeply than that.
    But in a part of the shadow banking system that hardly any 
American knows anything about, hardly anyone in Congress knows 
anything about, and those who know something about it don't 
know very much, was the repo market. And as much money was 
moving around every night in the repo market as there was in 
bank deposits.
    Bear Stearns was getting $70 billion a night in repo market 
lending, every night. What they were doing with that money was 
making longer-term loans. Using very short-term borrowing for 
longer-term loans is not a formula for financial stability. And 
what happened was that there was an old-fashioned run, like 
what you saw in, ``It's a Wonderful Life,'' that used to happen 
to depository institutions before there was deposit insurance 
in the repo market.
    U.S. Treasuries seemed to be the principal collateral for 
the repo market and for the derivatives market. If our debt is 
downgraded, have any of you given any thought, do any of you 
have any clue what effect that might have on the repo market, 
on the derivatives market and the use of that debt as 
collateral in those markets?
    Mr. Wilson. Yes, it is something that we have considered. 
It is one of many things as we try to look at what the impact 
might be. The best guess is that there would be an adjustment 
of the margin required. So you wouldn't be able to borrow as 
much through the repo market. There would be more margin for 
the given amount of collateral that you have.
    We think that is manageable in the short-term because, for 
example, going from AAA to AA, you still have a very high 
quality security. And it is still considered one of the safest 
instruments in the world, but who knows what will happen long 
term.
    Mr. Miller of North Carolina. I have gotten a letter from 
my State's treasurer saying, ``Please, please, please, don't 
allow Federal Government debt to be downgraded because North 
Carolina's State debt will almost certainly be downgraded as 
well if that happens.'' I understand the same is likely true of 
all manner of other kinds of debt--Fannie's debt, Freddie's 
debt, Federal Home Loan Bank debt, and on and on.
    Do you have any sense of what the ripple effect will be in 
other forms of debt if Treasuries are downgraded?
    Mr. Wilson. Yes. The only sense is that will probably 
happen. The extent of it, just like in 2008, what we saw, some 
of our predictions and what might happen in some of these 
markets were just blown away with what actually happened. So we 
believe there will be an effect, but the size of the effect is 
hard to measure.
    Mr. Miller of North Carolina. Okay. And also--somebody 
else? Did you--
    Mr. Van Der Weide. If I could address a little bit your 
previous question on the repo markets. The repo markets are not 
what they were in 2006 and 2007. There has been a reduction in 
the amount of short-term funding financing long-term assets 
through the repo markets over the past few years.
    There has also been a lot of work done, both at the private 
sector level and on an interagency regulatory basis, to make 
the infrastructure of the repo markets stronger.
    There is also recognition going forward of the reality now 
that the borrowers in the repo market are much more well-
capitalized than they were leading into the crisis.
    And there is also a new regulatory framework that is coming 
on line, the Basel Accord. The new capital requirements under 
Basel, the new liquidity requirements that are under Basel, are 
all designed to make that repo market safer and sounder and 
more stable to deal with potential adverse effects.
    Mr. Miller of North Carolina. Okay. Also, I understand a 
great many funds require that all the debt they hold be AAA. Do 
you have any idea of what effect may be on funds? Will they 
have to dump Treasuries? What effect will that have on the 
financial system?
    Mr. Ramsay. I guess I should say that my understanding is 
that, at least according to our rules, the rules don't require 
a AAA rating generally for money market funds. They require 
where funds hold government securities or securities that are 
guaranteed by the full faith and credit, that is sufficient 
now. Individual funds may have investment guidelines that would 
require a AAA rating. And I think they are in the process of 
looking at those guidelines and determining whether they should 
make changes.
    Mr. Miller of North Carolina. I guess one summary question, 
since my time has technically expired, but the chairman has not 
brought the gavel down yet, am I right to worry that this could 
be really bad if our debt was downgraded?
    Mr. Wilson. It is hard to measure, but I think you are 
right to worry. It could happen. It could be a big thing.
    Mr. Miller of North Carolina. Okay. My time has expired.
    Chairman Neugebauer. I thank the gentleman.
    And now the chairman of the full committee, Mr. Bachus, is 
recognized for 5 minutes.
    Chairman Bachus. I thank the chairman.
    And the gentleman from North Carolina, I think, is right to 
be concerned about a default. I think he would also be prudent 
to worry about unsustainable spending. Although a default may 
be a more immediate problem, the overwhelming problem is 
structural long-term changes. And both of those ought to be 
addressed, and until both of them are, there won't be a lasting 
solution.
    I have listened to your testimony, and I acknowledge that 
939A is giving you some problems, particularly the bank 
regulators, the OCC and the Federal Reserve. You have not moved 
very quickly on implementing it.
    If you read it, it asks you to replace the reliance on 
credit rating agency as the sole basis with alternative systems 
of creditworthiness, which could include credit rating. It 
could include credit rating, but it would be an alternative 
which would suggest other criteria.
    If you notice the--you have mentioned your coordination 
with our European brethren, our international coordination. The 
European countries of the E.U. are making great efforts to end 
their reliance or overreliance on credit rating. In fact, they 
have followed, I think, our example.
    And I noticed on July 11, 2011, European Commissioner 
member Michael Barnier stated that the Commission's credit 
rating legislation would address overreliance on credit 
ratings. The Financial Times just this week said that Europe 
intends to end its reliance on credit ratings. And I think that 
means overreliance, not reliance.
    Have you been in discussions with them as they are moving 
towards implementing provisions, or are you aware and are you 
coordinating your efforts with theirs?
    Mr. Wilson. Yes, absolutely. And I want to be clear, I 
don't think anybody disagrees that we shouldn't reduce reliance 
on credit ratings. That is a Financial Stability Board 
pronouncement. It is something we agree with, something that we 
all think is a good thing.
    But to address your earlier comment, if we can read 939A to 
use a credit rating as one component in an overall credit 
analysis with appropriate due diligence and appropriate 
verification, that would make our job easier in order to 
conform to the Basel Accord because--but even the enhancements 
that were done in 2009 by the Basel Committee recognizes this 
and put in additional due diligence and requirements before you 
could rely on a credit rating.
    Chairman Bachus. Yes, I think what one of the goals behind 
it was that you heard investors, you heard particularly in 
residential mortgage-backed securities, I think, that was the 
spectacular failure. On municipal bonds, corporate debt, 
municipal debt, I think the credit rating agencies did a much 
better job.
    I think that is part of your hesitancy, that, in fact, on 
other asset-backed securities, they had a mixed record, but it 
was of more value.
    I think what we didn't want is people telling us that they 
were required by the regulators to basically make purchases or 
allocate their assets or their reserves based on that sole 
criteria.
    But I will say this: I did not hear any expressions from 
either the OCC or the Federal Reserve during the entire debate. 
I don't recall anyone coming to us and saying, ``This is a real 
problem.'' So I would say going forward, I would encourage you 
to have discussions with us.
    This is not a holy grail, as we very much know up here. And 
I will just ask you to work with us on this.
    I have one final suggestion. I have 30 seconds left. I know 
it is a complicated job, and it is easy to criticize, but you 
are the professionals, and we did intend to give you 
discretion, but we also intended to give you direction.
    And one of those directions is Section 112, where we said 
that as you cooperate, that the FSOC, which you are members of, 
may be used as a coordinating body. And I don't know whether 
you have done that or you are aware of Section 112, but I would 
say, take a look at that in your efforts.
    Thank you very much.
    Chairman Neugebauer. I thank the chairman.
    And now, Mr. Carney is recognized for 5 minutes.
    Mr. Carney. Thank you, Mr. Chairman. Thank you for having 
this panel today. It is timely, given all the things that we 
are looking at here with the debt ceiling.
    It is also timely with respect to a hearing that we had in 
the Financial Institutions Subcommittee last week about H.R. 
1539, which as you may know, strikes 939G of Dodd-Frank, which 
would have required a higher level of liability for the rating 
agencies. And the effect, as my colleague from Ohio said, was 
to dry up the asset-backed security market for a big employer 
in his district, and that was the motivation behind his bill.
    The SEC apparently had a regulation or has a regulation 
that requires that ratings be part of the prospectus for such a 
security. And I understand that they suspended that regulation 
so that the market, I guess, would come back.
    The former chairman, the ranking member, said that the 
provision of Dodd-Frank would require the SEC to withdraw that 
regulation to be consistent with the current law. Is that your 
understanding, Mr. Ramsay? Or could you elaborate on this 
situation?
    Mr. Ramsay. Sure. I will try to briefly do so, although it 
is a little bit of a complicated issue.
    Mr. Carney. Which is why I asked the question.
    Mr. Ramsay. We previously, actually, the Commission 
proposed at one point or put out for comment the idea of 
removing this special exemption, if you will, for rating 
agencies from the higher liability standard. So I think we 
recognize that there are arguments that could be made for or 
against. The Commission never came to a consensus on that.
    The Congress essentially made the decision for us. As you 
noted, because the ABS market, because our rules require that 
the rating be included in the prospectus, the result of 
removing the exemption meant that rating agencies would have to 
consent to have the rating information included in the 
prospectus.
    They refused to consent. As a result, there was the 
potential that the registered ABS market would be shut down or 
that there wouldn't be any deals being done. We thought that 
that was a bad result for the markets and for investors, and so 
we issued a no-action letter to allow that business to 
continue. And that no-action letter was recently extended.
    So that is where we are at this point.
    Mr. Carney. How about the last part, the claim by Ranking 
Member Frank that the SEC would be required to make its rules 
and regulations consistent with Dodd-Frank and thereby, I 
guess, withdraw that requirement?
    Mr. Ramsay. We haven't done anything to alter 436G or what 
was done in the statute. The only thing that we did was to 
issue a no-action letter with respect to the ABS market.
    Mr. Carney. Do you have a view or do other panelists have a 
view on whether the rating agencies should be subject to that 
expert standard? People do listen to the rating agencies. We 
are seeing that right now.
    When I was in State government, we listened. In fact, when 
the rating agencies said, ``Jump,'' we said, ``How high?'' And 
we would go--I was secretary of finance--we would go to the 
legislature and say, ``You can't do that, because if you did 
that, it could affect our rating.'' Now, we have the debate 
over the debt ceiling and, of course, the big argument is, we 
don't want to default. We don't want to downgrade.
    And so people do listen. Some of the discussion and 
argument is, do they rely on the ratings too much? But what 
about the standard? The liability standard has a way of 
disciplining what might be put in a rating and included in a 
prospectus.
    Mr. Wilson. We don't have a view on it. I think both of 
those statements are correct.
    Mr. Carney. Does anybody else have a view? And if you 
don't, or you don't want to offer one, that is fine, too.
    Let me ask this question, then. What does a different world 
look like if we have too many people--I, frankly, think ratings 
and the opinions that go with them are very meaningful and have 
always been in the world that I live in--so what does a 
different world look like where we don't rely so heavily on 
ratings?
    Going back to the chairman--he is not here--Mr. Bachus' 
question, does anybody have a view of what that world looks 
like?
    Mr. Wilson. Back to Mr. Bachus' comments about where the 
real problems were with the securitization structures. And the 
view of the world is there will be some reliance on credit 
ratings, but there should be additional due diligence. There 
should be an understanding on the parts of the banks we 
regulate and other investors on what is actually underlying 
that securitization.
    That is not a new view for the OCC. We had guidance in that 
area. We reaffirmed it and strengthened it in 2009. Arguably, 
we didn't enforce it as much as we should have, but I think 
that the view is again back to this idea of reducing reliance 
on credit ratings.
    Mr. Carney. Thank you. I see my time has expired. I thank 
the Chair for the additional seconds.
    Chairman Neugebauer. I thank the gentleman.
    And now, the vice chairman, Mr. Fitzpatrick, for 5 minutes.
    Mr. Fitzpatrick. Thank you, Mr. Chairman.
    Mr. Ramsay, I want to follow up on Chairman Neugebauer's 
line of questions earlier having to do with the designation 
process of the SEC for recognizing the Nationally Recognized 
Statistical Rating Organizations. I think you testified that 
for years the Commission had a policy of issuing a no-action 
letter. Can you expand on that, what the process was and what 
it currently is?
    Mr. Ramsay. Sure. I think beginning in 1975, if I am not 
mistaken, the Commission, when the first use of the term 
``NRSRO'' was included in the Commission's rules, essentially 
the Commission granted what we call no-action relief, which is 
essentially a letter issued by the staff that says it would not 
recommend enforcement action if a private market participant 
operated in such a particular way.
    So these letters were essentially ways of recognizing 
individual rating agencies, and those ratings would then be 
recognized in particular rules.
    That process was criticized as being not very transparent, 
I think probably rightfully so. And so as a result, in 2006, 
the Congress created a structure that created a much more 
transparent process for applicants to come in and register.
    Since that authority was granted, we have registered 10 
different entities. We have only turned down one. The only one 
that we turned down was unable under the laws of its local 
jurisdiction to be able to say that it could provide us with 
the documents and examination authority that we would need.
    So we have been trying to use the registration process and 
the authority that we have been given to encourage competition, 
but recognizing that we have to be able to make some baseline 
findings that are required by the statute that the agencies 
that come to us qualify.
    Mr. Fitzpatrick. Is it your sense that the additional 
market participants are increasing the quality of the 
information, increasing the quality of what is out there for 
investors, but also may be even decreasing the cost?
    Mr. Ramsay. I would be hesitant about talking about quality 
because, of course, as I mentioned, we are prohibited from 
regulating the substance of ratings. I think we do believe that 
the rating process that exists now is more--substantially 
more--transparent, that the rating agencies are more 
accountable now.
    We think the proposed rules that we have put out there will 
make that much more the case. And, hopefully, more competition 
will exist as well.
    So we recognize that the rules that we proposed will impose 
some compliance costs. And those rules are still out for 
comment. We have asked for comment about if there are ways that 
our rules can be crafted so they don't impose so much in the 
way of the costs.
    We certainly think that more competition is a healthy 
development.
    Mr. Fitzpatrick. How about the opportunity for smaller 
rating agencies to participate in the market? Are you guys 
taking a look at the definition of what a small agency would 
be?
    Mr. Ramsay. We are. And, I think the rules are relatively 
new. The authority is relatively new.
    And so, we have had some people come in to us, and we have 
been in discussions with them. There is not much of a precedent 
or a track record there, so it is a little hard to figure out. 
We are sort of going through that process for the first time.
    Mr. Fitzpatrick. Sir, there was an Executive Order and a 
memorandum from President Obama unequivocally calling for 
regulations to be applied in the least burdensome manner in 
order to reduce unnecessary regulatory obstacles to 
competitiveness in the industry.
    So, given that the three large NRSROs control over 80 
percent of the credit rating market and have significantly 
larger profit margins that allow them to sort of absorb the 
higher compliance costs, do you believe your proposed rules 
address the disproportionate impact of compliance on smaller 
rating agencies?
    Mr. Ramsay. Congressman, as I mentioned, I think, the rules 
are still out for comment, and we have asked for comment. We 
really do want to hear from people as to whether the costs are 
excessive, if there are ways that we could scale them back. I 
should be clear that the statute is fairly prescriptive in 
terms of the things, the kind of rules that we are required to 
adopt.
    We have tried in our proposed rules as much as possible to 
adopt what I call a ``policies-and-procedures approach,'' which 
is that we require agencies to adopt policies and procedures to 
achieve a specific objective rather than try to dictate the way 
in which they have to achieve it.
    And there are aspects of our rules by creating more 
information that allow investors to be able to compare 
performance of rating agencies that we hope over the long haul 
will actually spur competition.
    Mr. Fitzpatrick. Okay. Thank you.
    Chairman Neugebauer. I thank the gentleman.
    And now the ranking member, Mr. Capuano.
    Mr. Capuano. Thanks, Mr. Chairman.
    And thank you, gentlemen.
    I just want to jump into a quick couple of things. As I 
said at the beginning, the 939A stuff, though I think it is 
good, is there anything in any rule anywhere that prohibits the 
market from looking at a credit rating from anybody?
    Mr. Wilson. No.
    Mr. Capuano. So that you can't make them do it, but you 
can't stop them from doing it either? Is that a fair statement?
    Mr. Wilson. It has to be removed from the regulations. It 
doesn't mean that the investor can't--
    Mr. Capuano. That is what I am suggesting. The market is 
going to call for a credit rating no matter what we do. I think 
it is a good thing to get them out. I think it is a good thing 
to do. But I don't want to pretend that is going to be the end 
of all our troubles. The market is still going to be looking 
for a credit rating.
    Do you think that is a fair statement? Does anybody think 
it is an unfair statement?
    Mr. Van Der Weide. It seems fair.
    Mr. Capuano. Thank you. I guess on the, what, the 939G, the 
Section 11 section, again, it is not in the prospectus, but am 
I wrong to think that most credit ratings are available to the 
general public whether it is in the prospectus or not?
    Mr. Ramsay?
    Mr. Ramsay. I think generally the information does get into 
the market one way or the other. We prefer to have the--I 
should say this is a matter that is under review, so we have 
to--the advantage of having the--
    Mr. Capuano. Right now, as I understand it, credit rating 
agencies are not allowing their ratings to go into the 
prospectuses, because they are concerned about this rule, which 
is fine. But that doesn't mean that I can't find their rating 
as a private citizen in a thousand different places. Is that a 
fair statement?
    Mr. Ramsay. I believe that is a fair statement.
    Mr. Capuano. So we are talking about a real technical 
aspect where they don't do one thing and somehow prevent 
themselves from being held liable under one section of the law. 
That is all we are talking about.
    Mr. Ramsay. Yes. I think there is nothing that--we can't 
force rating agencies to consent under the scheme that we have. 
And so, as a result, the failure to consent means that--
    Mr. Capuano. But their ratings are still available to the 
public. Is that a fair statement?
    Mr. Ramsay. The ratings are still available to the public. 
That is correct.
    Mr. Capuano. So that by them simply not putting it into the 
prospectus, it doesn't mean that somehow they are hiding it and 
putting it in the bottom drawer. No one can see it.
    It just means it is not in a technical piece of a document, 
a technical document that is technically available. but yet, it 
is available every place else, other than that document.
    Mr. Ramsay. That is correct.
    Mr. Capuano. And there is nothing in this regulation or any 
other regulation that can supersede a law of the Congress. Is 
that a correct statement?
    Mr. Ramsay. I would say that is correct.
    Mr. Capuano. So Congress has said to get rid of this. The 
SEC has not done it yet. I would argue that it doesn't matter 
what your regulations say. What matters is what Congress says, 
whether people like it or not.
    Congress has said it no longer is relevant, so, therefore, 
do whatever you want. Section 11 doesn't apply. It is an 
illegal regulation that the SEC has hung onto for no 
particularly good reason. That is number one.
    Number two, relative to Section 11, it doesn't relate to 
the other liability that was put in place by Dodd-Frank that 
says the credit rating agency that can be held liable for 
knowingly or recklessly conducting their business. Is that a 
fair statement?
    Mr. Ramsay. I'm sorry?
    Mr. Capuano. Fair enough. I assume none of you are lawyers. 
Or are you all lawyers?
    Mr. Ramsay. I am a lawyer. We may all be lawyers, yes.
    Mr. Wilson. I am not.
    Mr. Capuano. I am a lawyer, too. So, two good guys and one 
so-so. So I am the only one who is going to defend you guys. 
Don't worry, because as far as I see it, one liability in 
Section 11 is a technical aspect. ``Knowingly and recklessly'' 
is still there for anybody to use. And nothing that anybody 
does can stop that.
    Now, I know it hasn't been used yet, but it is still there. 
So let us not pretend that Section 11 is the only thing that is 
out there protecting people from the credit rating agencies.
    Mr. Ramsay. Yes, I agree, Congressman, 10-b5 liability is 
there, and continues to be. And, in fact, the Dodd-Frank Act 
sort of made the pleadings standards easier with respect to 
rating agencies.
    Mr. Capuano. Right. I know it hasn't been used yet. And 
that is fair and well. I am not looking--
    Mr. Ramsay. But that is obviously for the courts to sort 
out.
    Mr. Capuano. Absolutely. And I will be honest with you, I 
hope it never gets used, because all I have ever wanted is for 
credit rating agencies to do their jobs.
    Now, I want to get back to my opening statement. As you 
have been going through this, I would like to--this is an 
opinion question, and you may or may not be comfortable 
answering it.
    Do you have an opinion as to whether credit rating agencies 
in general are doing their job more efficiently, more 
effectively, than they were prior to the crisis? That is a 
straight-up question. It puts you on the spot. I am not trying 
to, but what the heck, that is my job.
    Go ahead, Mr. Wilson. You seem--
    Mr. Wilson. Yes, as an opinion, there has obviously been 
lots of energy devoted to the problems that we all saw, 
including the rating agencies. In addition to that, there are 
going to be a lot of additional requirements--
    Mr. Capuano. Do you think they are doing a better job than 
they were before?
    Mr. Wilson. Yes.
    Mr. Capuano. Mr. Van Der Weide?
    Mr. Van Der Weide. I think they are doing a better job. I 
think they and many of us have reacted to the lessons learned 
by changing our ways and improving the way we estimate risks 
and model risks. So I think they are doing better.
    Consistent with comments that Dave made earlier, the 
crucial thing is that no matter how good we think they are 
doing, we not overrely on them, not the government, not the 
private sector. So I think that is the chief goal here.
    Mr. Capuano. That is a very good statement.
    Mr. Ramsay?
    Mr. Ramsay. I do think it is fair to say that because the 
regulations that are in place, they are more consistent in 
terms of their methodologies. And certainly, the amount of 
disclosure that is out there that investors can use is much 
greater.
    Mr. Capuano. Mr. Chairman, with your indulgence, one final 
question.
    Mr. Ramsay, if your agency was tasked with creating an 
office of credit rating, would you have been able to do this if 
you had been allowed to reprogram your money?
    Mr. Ramsay. My understanding, Congressman, is that the 
reprogramming authority that was required from the House has 
not been granted. And so as a result, what we have done is take 
resources from our other examination areas in order to complete 
the annual examinations that we are required to do this year.
    We have had to draw resources from the investment adviser, 
from joint investment adviser broker dealer exams. And those 
are exams we would like to do more of, so that has imposed some 
strain on our resources.
    Mr. Capuano. Thank you, Mr. Chairman.
    Chairman Neugebauer. I thank the gentleman.
    And now the gentleman from Texas, Mr. Canseco, for 5 
minutes.
    Mr. Canseco. Thank you, Mr. Chairman.
    Mr. Wilson, your testimony describes difficulty in 
identifying a workable replacement for credit ratings. Among 
other authorities, Section 112 of Dodd-Frank empowers the 
Financial Stability Oversight Council, FSOC, with the authority 
to coordinate rulemaking and recommend regulatory principles to 
FSOC members.
    Have you requested assistance from the chairperson of the 
Financial Stability Oversight Council, the FSOC, to use its 
authority under this section to provide assistance in 939A 
rulemaking?
    Mr. Wilson. To my knowledge, we have not in 939A.
    Mr. Canseco. Okay.
    Mr. Van Der Weide?
    Mr. Van Der Weide. No, we have not. I think we have 
concluded that the core coordination that is needed in this 
process is between the banking agencies, because we have a lot 
of common regulations, most importantly the capital rules. So 
it is critical that the banking agencies coordinate. We are 
coordinating fairly intimately, are meeting very frequently 
with our working groups to develop alternatives.
    We have also consulted with the SEC and the CFTC and the 
other agencies. I can't call it a coordination process, but we 
have consulted with them. So there is a lot of coordination and 
consulting going on. But we have not asked the FSOC to get 
involved.
    Mr. Canseco. Mr. Ramsay?
    Mr. Ramsay. I am not aware that the FSOC in particular has 
been involved in this issue. As Mark said, I think the agencies 
themselves have been talking to each other a fair amount.
    Mr. Canseco. Okay. Thank you.
    Mr. Wilson, the SEC has made significant progress in 
removing references to ratings and even began the process when 
this seemed a likely legislative possibility in 2009. Why is 
the SEC able to move forward while you are here only talking 
about the challenges? Are you going to fulfill your statutory 
duties?
    Mr. Wilson. Yes, we will have to. I will say that we talked 
before in our testimony about how there are a couple of 
challenges related to the capital rules that are different than 
a lot of the other rules, and that would include OCC-specific 
rules that are more similar to many of the SEC rules, where it 
is more of an on/off switch or maybe a two-bucket approach 
where it is either investment grade or it is not. And that is 
easier to address in a definitional way.
    But when you have capital rules, for example, our current 
advanced approach securitization rule that has, like, 12 
buckets, it is really hard to distinguish risk between those 
buckets without something fairly granular like a credit rating. 
So that is part of the difficulty that we have to find a 
solution for.
    Mr. Canseco. Thank you.
    Mr. Ramsay, in your opinion, how does making it easier to 
sue Moody's and S&P allow investors to better assess their own 
risks and reduce their reliance on ratings?
    Mr. Ramsay. Congressman, I guess I wouldn't want to proffer 
an opinion on what you specifically suggested. I think that the 
potential liability is something that exists for all actors in 
the markets. Section 11 liability is one sort of step up from 
10b liability. And as I said, I think there are policy 
arguments as to whether rating agencies should be treated like 
accountants for those purposes. The Commission hadn't sort of 
reached a result on that.
    But 10b-5 liability is available for a variety of actors, 
and that is basically for the courts to sort out, not for the 
SEC.
    Mr. Canseco. Do you think, Mr. Ramsay, that this cloud of 
liability improves the accuracy of the credit rating agencies?
    Mr. Ramsay. I guess I am not sure what the connection might 
be. I am not sure of any research on that. And so, I wouldn't 
want to proffer an opinion on what the connection might 
actually be.
    Mr. Canseco. Would you agree with me that the prospect of 
liability or exposure is a damp rag over the accuracy of a 
credit rating agency?
    Mr. Ramsay. I am not, as I said; I don't think I am in a 
position or qualified to offer an opinion on what the 
relationship between the level of liability and sort of the 
ultimate quality of the ratings might be.
    Mr. Canseco. Thank you, Mr. Ramsay.
    Mr. Wilson, one last question. Do you believe it is good 
public policy for the government to mandate the use of credit 
ratings by privately owned companies, then use those ratings as 
the basis for capital requirements?
    Mr. Wilson. It is one of those where it is the best option 
we have. And I think that is what the Basel Committee came to. 
So it is a hard answer. But until we can find a better option, 
I think that is at least what the Basel Committee decided.
    Mr. Canseco. Do you have an opinion, other than the Basel 
requirement?
    Mr. Wilson. Yes. I think it is difficult because I don't 
have another option that is better.
    Mr. Canseco. Okay.
    Mr. Wilson. If you want to be risk sensitive.
    Mr. Canseco. Thank you very much.
    I yield back.
    Chairman Neugebauer. I thank the gentleman.
    And now the gentleman from New Mexico, Mr. Pearce, for 5 
minutes.
    Mr. Pearce. Thank you, Mr. Chairman.
    Mr. Wilson, right as Mr. Miller was closing, he asked if it 
was right to worry about a potential downgrade, and your 
comment was something like that it could happen. Is that right?
    Mr. Pearce. The worry is that it could happen.
    Mr. Wilson. We have done a lot of work on this and talked 
with a lot of folks, and it is as you know very difficult to 
assess the impact--
    Mr. Pearce. But you said the problem is that it could 
happen?
    Mr. Wilson. That is correct.
    Mr. Pearce. --and if it doesn't happen, then, whew, it is 
okay.
    Mr. Wilson. Yes, absolutely.
    Mr. Pearce. Okay. I am going to pursue that and drill down 
just a little bit on that, if you don't mind.
    Mr. Van Der Weide, on page 2, you described things that 
caused the ratings to be bad--untested models, flawed 
assumptions, limited, unverified data about underlying asset 
pools, default frequencies, potential conflicts.
    And then on page 3, you say these flaws contributed to 
issuance of credit ratings that severely underestimate the 
credit risk of the--anyway, they underestimate the risk.
    And so my question is, is it possible for us to 
underestimate the risk with regard to the Federal Government?
    Mr. Van Der Weide. I think there is a fair amount of 
uncertainty.
    Mr. Pearce. So even if we don't default on August the 2nd, 
are there uncertainties still lying out there?
    Mr. Van Der Weide. There certainly are uncertainties. And 
part of our job as bank regulators, the Fed, the OCC--
    Mr. Pearce. Who is in charge of making sure that those bond 
ratings, those rating agencies adequately correct the problems 
on the previous page? Who is responsible to make sure that 
doesn't happen again?
    Mr. Van Der Weide. It is a complicated question. Our 
specific responsibility--
    Mr. Pearce. Basically, if it is complicated, that means 
nobody is responsible.
    Mr. Van Der Weide. I'm sorry?
    Mr. Pearce. Nobody is responsible. Any time I hear the 
words, ``it is complicated'' in Washington, it means nobody is 
responsible.
    Mr. Van Der Weide. There are different agencies that are 
responsible for part of the solution.
    Mr. Pearce. And if we are all responsible, none of us are 
responsible. I already know that. I have six brothers and 
sisters. If we could ever make it a big deal, it was not a 
small deal. It wasn't us.
    Mr. Van Der Weide. Yes, sir. But the banking agencies are 
responsible for doing their part to remove the references from 
our regulations, and we are working on that.
    Mr. Pearce. Okay. So as we look then, I was going through a 
fascinating process yesterday looking at a failed bank. And it 
was really a solid-looking bank, solid, solid, solid, and they 
went in, and they realized they had not adequately judged the 
asset pool, not looked at things. And so all of a sudden, it 
skyrocketed in risk, because the rating agencies suddenly 
became aware of that.
    Then Mr. Miller made these very precise comments, and I 
know that they are accurate, about the repo accounts and Bear 
Stearns. And they were doing things that were risky. And you 
have said that we have cured that risk.
    So my question, Mr. Wilson, is would it worry you that the 
asset pool of the U.S. Government repaying our debt is actually 
being printed by the guy sitting next to you, a deal called 
quantitative easing? Chairman Bernanke came in the day before, 
or a few days before, and said he is fully ready to do it 
again, Quantitative Easing 3.
    You mention on page 2 of your testimony that you all do 
alternative creditworthiness standards. Now, I know they 
haven't been downgraded and they may not be downgraded on 
August the 2nd. But, you saw the falseness of Bear Stearns 
doing what they were doing, the repos. The oversight agencies 
have seen the falseness of what was going on in banks.
    Is anyone daring to speak--are you internally developing 
alternative creditworthiness standards for the U.S. Government?
    Mr. Wilson. We are not.
    Mr. Pearce. That is fine enough. But we are all 
participating in a little process here. We are going to print 
money and make sure that we can pay the bills, and we are going 
to make sure we pass that legislation so that we don't default, 
because that is a huge deal, and we can't stand that.
    I think in truth the creditworthiness of the U.S. 
Government has never been adequately looked at and is not being 
adequately looked at now. So if we pass August the 2nd, I think 
we still have a system that is very badly out of kilter, and we 
are printing money to make it work, and we are going to act 
like we can just continue to whistle while we work. And 
somewhere somebody ought to get some truth in the system.
    I yield back, Mr. Chairman.
    Chairman Neugebauer. I thank the gentleman.
    And now, I recognize Ms. Hayworth for 5 minutes.
    Dr. Hayworth. Thank you, Mr. Chairman.
    And, gentlemen, thank you for being here.
    The E.U. Commissioner in charge of financial reform is 
Michel Barnier. And I am going to quote something that he said: 
``The CRA ratings are too embedded in our legislation, and I 
intend to reduce as much as possible the references made to 
those ratings in our prudential rules. That is my first 
priority today.'' This was last week.
    ``I can already tell you that the first of these measures 
to limit overreliance will be integrated into the upcoming 
modification of the capital requirements directive--otherwise 
known as CRD 4--and which is the effective translation of Basel 
III into E.U. law. I will make these proposals on the 20th of 
July. To limit overreliance we will be strengthening the 
requirement for banks to carry out their own analysis of risk 
and not rely on external ratings in an automatic and mechanical 
way.''
    And, as I understand it, our current statutory requirements 
are to--on our side, as well--to limit the weight of CRA 
ratings in these capital requirements.
    Given that, of course, you rely on the statutory authority 
from our Congress and you work with our European counterparts 
to create the compliance with Basel III, what is your plan to 
advance--do you have a plan to advance the goal of not 
automatically and mechanically having CRA ratings be a part of 
how you evaluate bank capital?
    Any of you? Thank you.
    Mr. Van Der Weide. We do.
    I think it is important to note that there is an evolving, 
perhaps evolved, global consensus on this particular issue at 
this point. I think all the major jurisdictions are moving 
towards removing reliance by government and private sector 
reliance on credit ratings and removing them from the bank 
capital requirements.
    We are in extensive discussions with our international 
counterparts, both through the Financial Stability Board and 
the Basel Committee about what the right way to do that is.
    The focus of attention, I think, in the short term is where 
the rating agencies screwed up the worst, and that is in the 
structured finance area. So we are having active discussions in 
international fora about what the right way is to reduce 
international capital rules reliance on rating agencies. I 
think we are making some good progress on that.
    And we are also spending a lot of time--the OCC, the Fed, 
the FDIC--working through the different alternatives for 
removing those ratings from the U.S. implementation, the U.S. 
form of the global capital rules--
    Mr. Wilson. I just would echo almost everything Mark said.
    We all agree that this rote mechanical reliance on credit 
ratings was not the right way to go. There is global consensus 
on that. We are all looking for good ideas to reduce reliance. 
I think, again, the question is reducing reliance or just 
absolutely banning reliance on it, so--
    Dr. Hayworth. Thank you. Thank you both.
    It certainly sounds as though, of course, there is--
speaking as a consumer of information and as an investor in my 
own life, it is challenging. I trust that you are working on 
what we can offer to assure our consumers of financial products 
that there is, in fact, a way in which we can reliably use 
parameters to judge the quality of capital at our institutions.
    One appeal, obviously, of having credit rating agencies is 
that if it works right, then you have a standard. But the 
problem seems to have been that, unfortunately, that standard 
was not one on which we could rely as scientifically as we 
thought.
    Is that an accurate impression?
    Mr. Van Der Weide. Yes, I think that is pretty accurate.
    I think one of the core principles that we have in the 
interagency working group that has been looking at this issue 
is to try to find a replacement for credit ratings that is 
transparent and consistent across different banks, across 
different financial instruments.
    We think that is useful to the markets, useful to the 
banking system, useful to the regulatory agency, so 
transparency is one of the hallmarks that we are striving for.
    Dr. Hayworth. Thank you all.
    And I yield back my time, Mr. Chairman. Thank you.
    Chairman Neugebauer. I thank you.
    Mr. Stivers is recognized for 5 minutes.
    Mr. Stivers. Thank you, Mr. Chairman.
    I am Steve Stivers. I represent Columbus, Ohio, and the 
surrounding areas. In my district, we have a big Honda plant 
that makes about a half million cars a year and employs about 
4,400 people, and uses asset-backed bonds to finance the 
building and financing of cars. And so, I have some questions 
for Mr. Ramsay.
    The first question I have, the gentleman from Massachusetts 
earlier sort of embedded in a question, assumed that the 
ratings are not in prospectuses anymore of asset-backed bonds, 
but, in fact, they are indeed still in the prospectuses. And 
the SEC is still requiring that, aren't they, Mr. Ramsay?
    Mr. Ramsay. Our rules currently still, as I understand it, 
require ratings in prospectuses. But that is a topic that is 
out for public discussion and comment.
    Mr. Stivers. Great. And the status of that--is there a 
pending proposed rule out there? These are yes-or-no questions, 
if you could. It's really easy.
    Mr. Ramsay. Yes.
    Mr. Stivers. So it is a proposed rule, or is it in draft 
form?
    Mr. Ramsay. I believe there is a proposed rule.
    Mr. Stivers. Okay. And it would remove the ratings. Because 
I have not seen the proposed rule--I have heard there is a 
discussion draft, but I have not seen a proposed rule.
    Mr. Ramsay. I believe the Commission yesterday put out a 
proposed rule to remove, at least for shelf registration ABS, 
the requirement for ratings.
    Mr. Stivers. Great, thank you.
    And the next question I have goes to sort of how these 
things happen. So is the credit rating agency involved in 
preparing a prospectus, reviewing a prospectus, or is the 
credit rating agency just taken and inserted by attorneys and 
accountants in the prospectus?
    Mr. Ramsay. Congressman, you are getting out of my depth in 
terms of the way that those things are prepared. I think the 
rating agencies have--I am not aware that they are involved 
heavily in the preparation of the prospectus itself--
    Mr. Stivers. That is my understanding, as well. And I guess 
that just goes to the point that the prospectus is not their 
document.
    And so let us talk for a second about what you know about 
Section 932, 933 of Dodd-Frank. The gentleman from Delaware 
alluded to this, as well. Is there not indeed still liability 
for the credit rating agencies under those sections, even if 
939G were to go away?
    Mr. Ramsay. In general terms, Congressman, yes, there are 
two potential routes for liability. One is Section 11, which is 
the, sort of, higher standard of liability that exists for 
accountants and certain other experts. And then there also is, 
sort of, general anti-fraud liability under Section 10-b.
    Mr. Stivers. And even before Dodd-Frank, weren't the credit 
rating agencies sued before that new clause of liability was 
inserted?
    Mr. Ramsay. They have been from time to time--
    Mr. Stivers. And successfully sued in cases.
    Mr. Ramsay. I am not aware exactly what the court precedent 
is. I am not aware that there is any one pattern of decisions 
on this.
    Mr. Stivers. But it has not been universally unaccepted. 
That is the point. We didn't even need the new liability in 
section 932 and 933 of Dodd-Frank. Nobody is proposing that to 
go away. But certainly the 939 provision, I think, is of 
concern to a lot of us, because it has frozen up the asset-
backed market. The market is depending on an indefinite no-
action letter from the SEC.
    I am excited to hear that yesterday you proposed a new 
rule. I will have to go check that out, but I had not seen it. 
I had heard there was a discussion draft, but I hadn't seen it, 
so I will certainly go look for it today.
    Thank you. I yield back.
    Mr. Carney. Will the gentleman yield?
    Mr. Stivers. Sure.
    Mr. Carney. Yes, thank you to the gentleman from Ohio.
    I would just like clarification from Mr. Ramsay. You said--
I thought I heard you say that your requirement that the rating 
be in the prospectus is still enforced. Is that what you said?
    Mr. Ramsay. My understanding, Congressman, is that for 
asset-backed deals generally there is still a requirement that 
the rating information be included. There is a no-action letter 
that is out that is sort of--
    Mr. Carney. So the no-action letter, and you just mentioned 
that a minute ago, frankly, means that the ratings, as I 
understand it, are not being included in the prospectuses but 
they are being included in the selling documents. Is that your 
understanding?
    Mr. Ramsay. That is my understanding.
    Mr. Carney. I just wanted to clarify that for the record.
    Mr. Stivers. That is not my understanding, I will tell you. 
I believe that they are being included. And, frankly, the no-
action letter applies to the 939G provisions of holding people 
liable as experts. Is that not correct, Mr. Ramsay?
    Mr. Ramsay. Congressman, at this point perhaps I should 
have my friends in the Division of Corporation Finance get back 
to you with that before I--
    Mr. Stivers. I am pretty sure that--I have talked to them. 
I could be wrong, but I am pretty sure that is right.
    Thank you.
    I yield back, Mr. Chairman.
    Chairman Neugebauer. Thank you.
    I think that is all of the questions from both sides. We 
want to thank this panel. And with that, we will dismiss this 
panel and call up the second panel.
    I would like to welcome our second panel here: Mr. Deven 
Sharma, president of Standard & Poor's; Michael Rowan, global 
managing director, Commercial Group, Moody's Investors; Mr. 
James Gellert, CEO of Rapid Ratings; Mr. Jules Kroll, chairman 
and CEO, Kroll Bond Rating Agency; Mr. Lawrence J. White, 
Robert Kavesh professor or economics, Stern School of Business 
at New York University; and Mr. Gregory Smith, chief operating 
officer and general counsel, Colorado Public Employees 
Retirement Association.
    I would remind you that your written statements will be 
made a part of the record, and you will each be recognized for 
5 minutes.
    Mr. Sharma?

    STATEMENT OF DEVEN SHARMA, PRESIDENT, STANDARD & POOR'S

    Mr. Sharma. Thank you, Chairman Neugebauer, Ranking Member 
Capuano, and members of the subcommittee. Good morning.
    My name is Deven Sharma, and I am the president of Standard 
& Poor's and have served in that capacity since September 2007. 
I am pleased to appear before you today.
    Much has changed with regard to credit ratings and credit 
rating agencies over the past several years, both in terms of 
how we go about our work and the regulatory framework in which 
we operate. For our part, we at Standard & Poor's have 
undertaken a variety of initiatives in recent years designed to 
further our fundamental mission of providing the market with 
high-quality independent benchmarks about the creditworthiness 
of debt securities.
    These initiatives include measures designed to strengthen 
the governance and control framework and has the analytics and 
criteria we use to rate issues and issuers and clearly 
communicate the rationale behind our actions and better 
identify and report on key areas of risk in order to further 
transparency in the markets.
    These initiatives reflect the great lengths and significant 
efforts we have made to enhance the way we go about serving 
investors, regulators, and the capital markets. Put simply, 
with these added checks and balances and enhanced analytics, 
our organization today operates very differently than it did 
even just a few years ago.
    These changes include investing significantly in our 
compliance and quality operations, including significant staff 
additions; establishing an independent criteria review and 
approval process; supplementing existing controls against 
potential conflicts of interest, including implementing look-
back reviews and an analyst rotation program; and adopting 
enhanced ratings definitions and updating of criteria across 
major asset classes to map it to those definitions.
    This has enhanced ratings comparability across asset 
classes and across geographic regions. It has also led us, on 
balance, to look for stronger credit characteristics for 
securities seeking higher ratings, enhancing disclosure in the 
ratings reports of applicable factors and variables, applicable 
criteria and the assumptions underlying their analysis, and 
finally, increasing analytical training of our analysts, 
including a new analytical certification program.
    A more comprehensive list of these initiatives can be found 
in my written submission, as well as on our Web site, 
www.standardandpoors.com.
    Of course, the regulatory landscape of credit ratings has 
also undergone major change. Through legislation and related 
rulemaking, regulatory measures have reinforced and 
strengthened the integrity of the ratings process through 
increased oversight, greater transparency and accountability, 
and improved analyst training.
    Specifically, the passage of the Credit Rating Agency 
Reform Act in 2006, together with a rigorous set of governing 
rules adopted by the SEC, established the first comprehensive 
regulatory scheme governing credit rating agencies.
    NRSROs are now required to make extensive disclosures of 
procedures and methodologies for determining ratings, 
performance measures, and statistics for credit ratings, 
policies for addressing and managing potential conflicts of 
interest.
    The CRA Act also empowered the SEC to conduct detailed and 
lengthy examinations of rating agencies' practices and 
procedures and lowered barriers to entry for other credit 
rating agencies to register with the SEC. Indeed, several new 
ratings agencies have been registered in recent years, 
including those that employ the investor-paid business model 
and the rating agencies that use different analytical 
approaches in deriving ratings. S&P believes increased 
diversity of approaches and views benefits the markets with 
more information.
    Dodd-Frank represented another significant event in the 
evolving landscape for rating agencies. One notable aspect of 
Dodd-Frank is its requirement that Federal agencies review the 
use of credit ratings in rules and regulations and remove 
references to ratings from several areas of Federal law. S&P 
has long supported addressing undue reliance on ratings by the 
market through elimination of legal mandates in the use of 
ratings.
    Standard & Poor's welcomes many of the regulatory changes 
and enhancements that have been put in place in recent years. 
We also firmly believe that perhaps the most important value of 
ratings is the independence and forward-looking view they 
express about future creditworthiness.
    For the markets to have confidence in those ratings, they 
must ultimately represent the independent view of rating 
agencies. That means, of course, that they should be free of 
commercial considerations, and S&P is fully committed to that 
principle. But it also means that they must be free of 
regulatory or governmental influence as to their analytical 
substance.
    As Dodd-Frank rulemaking progresses, we believe it is 
critical that new regulations preserve the ability of NRSROs to 
make their own analytical decisions without fear that those 
decisions will be later second-guessed, if the future does not 
turn out to be as anticipated or that in publishing a potential 
controversial view, they will expose themselves to regulatory 
retaliation.
    Pressures of that sort could only undermine the significant 
progress we believe has been made over the years by rating 
agencies and regulators alike to provide the market with 
transparent, quality, and generally independent views about the 
creditworthiness of issuers and their securities.
    I thank you for the opportunity to participate in the 
hearing, and I would be happy to answer any questions you may 
have. Thank you.
    [The prepared statement of Mr. Sharma can be found on page 
118 of the appendix.]
    Chairman Neugebauer. Thank you.
    Mr. Rowan?

     STATEMENT OF MICHAEL ROWAN, GLOBAL MANAGING DIRECTOR, 
          COMMERCIAL GROUP, MOODY'S INVESTORS SERVICE

    Mr. Rowan. Good morning, Mr. Chairman, and members of the 
subcommittee. My name is Michael Rowan, and I am the global 
managing director of the Commercial Group at Moody's Investors 
Service.
    On behalf of my colleagues, I would like to thank you for 
the opportunity to participate in today's hearing and to speak 
to you about Moody's, the role credit rating agencies can play 
in the markets, our competitive landscape, and the impact of 
Dodd-Frank on the credit rating agency industry so far.
    In providing you with our perspective on these questions, I 
would like to outline two principles that have guided us over 
the years.
    First, Moody's believes that the legislative initiatives 
that periodically review and update the regulatory regime under 
which market participants operate are both necessary and 
healthy. They can increase market confidence that rules are 
fair and the playing field is level. They also encourage best 
practices among and across industries.
    Second, we think that markets thrive when the regulatory 
landscape allows for and encourages numerous differing views 
while permitting market participants to choose opinion 
providers based on quality.
    It is equally important that contrarian opinions not only 
be tolerated, but encouraged.
    For these reasons, Moody's has been a strong advocate of 
competition in our industry, so long as that competition occurs 
on the basis of quality.
    Moody's has developed our reputation over a long period of 
time. We are, however, also well aware of the loss of 
confidence in the credit rating industry, largely driven by the 
performance of the U.S. residential mortgage-backed securities 
sector and related collateralized debt obligations.
    Over the past several years, Moody's has adopted and will 
continue to adopt a number of measures to regain confidence of 
our ratings in that sector.
    The actions and initiatives that we have pursued in the 
recent past can be categorized into five broad areas: 
strengthening the analytic integrity of credit ratings; 
enhancing consistency across ratings groups; improving 
transparency of credit ratings and the ratings process; 
increasing resources in key areas; and bolstering measures to 
mitigate conflicts of interest.
    One initiative that I wish to underscore is the creation of 
the department which I head, Moody's Global Commercial Group. 
Our mandate builds on prior measures through which Moody's had 
first prohibited rating analysts from discussing fees with 
issuers and then extended that prohibition to their managers.
    Last year, we took those efforts one step further and 
created the Commercial Group to strengthen separation between 
our credit rating and credit policy functions on the one hand 
and our commercial functions on the other. My position in 
particular was established to bring the commercial functions 
under common leadership.
    The Commercial Group is responsible for business strategy 
and planning, new business origination, and managing the 
relationships with issuers for the rating agency. The employees 
of the Commercial Group have no involvement in determining or 
monitoring credit ratings or developing or approving rating 
methodologies.
    Equally as important, Moody's analytic employees are not 
involved in the commercial activities of the company, which 
adds another layer of protection against the potential of 
conflict.
    In addition to our own internal efforts, Moody's supports 
regulatory reform and believes that effective regulation of 
credit rating agencies is positive for our industry and the 
broader market.
    For example, the Credit Rating Agency Reform Act of 2006 
and Title 9 of the Dodd-Frank Act call upon nationally 
recognized statistical rating organizations to be transparent 
about their rating opinions and methodologies and to 
effectively address conflicts of interest.
    Dodd-Frank also introduced measures to enhance credit 
rating agencies' accountability and reduce the regulatory use 
of credit ratings.
    In particular, Moody's has long supported removing 
references to credit ratings in regulation. We believe that 
mechanical triggers, regardless of whether they are ratings 
based on market signals or another type of measure, can 
inadvertently harm markets by amplifying rather than dampening 
the risks in the system.
    Finally, over the past year, the Securities and Exchange 
Commission has been proposing rules and seeking comments for 
studies related to the credit rating agency industry, as 
mandated by the Dodd-Frank Act.
    Moody's has submitted comments on these proposed rules and 
studies and will continue to provide our views throughout the 
SEC's public comment process. We anticipate that the new rules 
will spur various changes in Moody's processes and operations, 
as well as lead to the codification and deepening of some of 
Moody's existing practices.
    While we anticipate that the evolving regulatory landscape 
will lead to further change, our objective remains what it has 
been for the past 100 years: to provide the highest quality 
credit opinions, research and analysis.
    Thank you, again, for inviting me to testify on this 
important matter. And I look forward to answering your 
questions.
    [The prepared statement of Mr. Rowan can be found on page 
102 of the appendix.]
    Chairman Neugebauer. I thank the gentleman.
    Mr. Gellert?

  STATEMENT OF JAMES H. GELLERT, CHAIRMAN AND CHIEF EXECUTIVE 
           OFFICER, RAPID RATINGS INTERNATIONAL, INC.

    Mr. Gellert. Thank you. On behalf of Rapid Ratings' 
employees and shareholders, I would like to thank Chairman 
Neugebauer, Ranking Member Capuano, and the members of the 
subcommittee for asking me to join you today. My name is James 
Gellert, and I am the chairman and chief executive officer of 
Rapid Ratings.
    As we arrive at the 1-year anniversary of Dodd-Frank, we 
face essentially the same or worse ratings landscape as 1 year 
ago. S&P, Moody's, and Fitch have undiminished influence, 
competitors that are NRSROs have even more challenges and 
costs, and non-NRSRO rating agencies are even less likely to 
apply to be one.
    Rapid Ratings is neither an NRSRO nor a traditional rating 
agency. We are a subscriber-paid firm. We utilize a proprietary 
software-based system to rate the financial health of thousands 
of public and private companies and financial institutions from 
70 countries. We re-rate all U.S. filers quarterly. We use only 
financial statements, no market inputs, no analysts, and have 
no contact with issuers, bankers or their advisers.
    In a recent third-party academic paper, we are identified 
as being 2.9 years earlier than Moody's in downgrading to below 
investment grade companies that ultimately fail. We represent 
innovation and competition in ratings.
    Dodd-Frank has positive and negative initiatives, but 
ultimately it penalizes the wrong players, creates 
disincentives for new players to enter the business, and misses 
opportunities to truly change the ratings industry.
    The biggest positive initiative is the removal of NRSRO 
references from Federal regulations. Many have covered that, 
and I think will, so I will skip that for the moment and refer 
you to my written testimony on that subject.
    The negative developments can largely be grouped as 
increased reporting, oversight, board construction, 
administrative and compliance duties.
    I do not disagree with prudent governance and compliance, 
but I am discouraged by the immense costs associated with 
complying. Many of these rules were implemented to address the 
conflicts of interest and behavioral issues of the big three, 
and ironically those companies are the only ones that can 
easily afford to comply.
    Increased liability dominated the reform debate throughout 
2009 and into the enacting of Dodd-Frank. It is perhaps the 
most politically charged and roundly understood concept for 
reform by the public at large.
    It may be fair to levy stricter liability standards on 
those agencies that contributed directly to the crisis, but 
Dodd-Frank changed the relevant language from NRSRO to credit 
rating agency at the last minute. This change was the only 
material instance where non-NRSROs were captured by this new 
statute. I wonder why. I suspect to prevent NRSROs from 
unregistering. If so, this is quite a statement about how the 
drafters felt Dodd-Frank would go over with the big three 
rating agencies.
    I suggest that CRAs that have never been NRSROs should be 
given safe harbor from these liability provisions. Section 932 
of Dodd-Frank covers the disclosure of ratings methodologies in 
the attempt to measure ratings accuracy. The SEC's 
implementation regulations, which are out for comment, propose 
so much disclosure of underlying methodology that they put at 
risk the intellectual property of a firm like Rapid Ratings 
that is innovation-driven. This is overkill.
    On accuracy, without question, more accurate ratings are 
good for the market. However, regulatory enforcement of a 
prescription of accuracy--of accurate ratings--is not. Markets 
drive innovation, not regulations.
    If a standard for ratings accuracy is prescribed by 
regulation, over time agencies will engineer ratings to the 
standard by which they are being measured. This means fewer 
diversified opinions, not more. Homogenizing ratings only 
correlates risk-taking and increases systemic risk.
    A major shortcoming of Dodd-Frank is it does nothing to 
expand NRSROs' access to data used by other NRSROs in the 
ratings process. Firms can now access due diligence data on 
some forms of structured products, but not nearly enough. 
Collateralized loan obligations are the perfect example, as 
detailed in my testimony.
    Next week, I will propose in a comment letter to the SEC a 
simple yet potentially wide-reaching initiative to assist in 
the improvement of this industry. All NRSROs should be required 
to file an affirmative statement with the SEC that they confirm 
or change each previously issued and outstanding rating on a 
quarterly basis.
    This initiative would force firms to think more carefully 
about their initial ratings and ensure they stand by their 
product, promote some confidence in the ratings process among 
users, make asset managers more responsible for understanding 
more frequent ratings changes instead of arbitraging stale 
ratings, and ensure that the SEC has more performance data.
    Effective reform will only come with the following: not 
stifling competition through compliance costs; removing 
references from regulations to decrease dependence on NRSROs; 
promoting innovation and avoiding the homogenization of 
ratings; and increasing the flow of data critical to providing 
new ratings into the market.
    Why take a young, hungry competitor in the rating space and 
subject it to all manner of change, increased scrutiny, costs, 
liabilities, uncertainties and a playing field that changes and 
then changes again? Until there are benefits that outweigh the 
costs, we will build our business outside the NRSRO network.
    Thank you.
    [The prepared statement of Mr. Gellert can be found on page 
64 of the appendix.]
    Chairman Neugebauer. Thank you.
    Mr. Kroll?

  STATEMENT OF JULES B. KROLL, EXECUTIVE CHAIRMAN, KROLL BOND 
                      RATING AGENCY, INC.

    Mr. Kroll. Thank you for the opportunity of speaking with 
you this morning, Chairman Neugebauer, Mr. Capuano, and other 
Members of Congress.
    My statement is a very personal statement. I built my 
previous company starting 40 years ago focused on the concept 
of due diligence, and focusing on the concept of fighting 
corruption in the corporate world and ultimately in the 
government world.
    It was all about bringing professionalism to an industry 
which was not held in very high repute in those days, called 
the private detective industry. So unlike James, I can't take 
on the attributes of the young, hungry competitor, so consider 
me an old, hungry competitor.
    Thank you, Larry.
    A couple of things I would like to say personally. I had 
sold my company. I was in pretty good shape. My wife was 
complaining I was hanging around the house a little too much. 
And I began to look at things where I might apply my experience 
and the experience of my colleagues to an important public 
policy issue, as we had with corruption and payoffs and 
kickbacks in the 1970s, 1980s, and 1990s.
    I had always marveled at the racket that these big rating 
agencies had. It was beautiful. Charge whatever you want. Take 
no responsibility. Hide behind the First Amendment. Make a lot 
of money. It looked like a good business model to me. So I 
began to study it and to see whether our skills and our history 
and our knowledge could be applied here.
    Now, this is a personal statement from me. My view is the 
whole concept that you hide behind the First Amendment and 
accept no accountability for your work is irresponsible, and it 
is scandalous. I have yet to hear people say at the big three 
that they are sorry. They have said they underestimated the 
depth of the housing crisis in America. Who do you think 
contributed to it?
    I don't want to whine about that. I want to tell you what I 
am doing about it and the traction that we are getting, but 
some of the obstacles we face. So I don't know about the rest 
of you, but when I read a novel, I cheat. I go to the end. I 
want to see is the hero or the heroine still alive. So I won't 
hold you in suspense in my remaining 2 minutes and 34 seconds.
    We became an NRSRO because we felt when it came to public 
pension funds and it came to corporate pension funds and 
university endowments and other foundations, there was no 
official status to your rulings unless you were an NRSRO. So as 
long as there is an NRSRO, we had to become one.
    So we bought the tiniest one there was. It was a little 
company doing $1 million a year. We developed a marvelous 
business model. We managed to spend more money on lawyers and 
compliance in the last year than that little company had 
revenue. Now, my wife has informed me this is not a good 
business strategy, but it is an essential one, because we 
needed a better foundation to build on.
    So here are my asks. Number one, let us go back to the 
Fitzgerald bill and its attempt to encourage competition. And 
there were a few little firms that came in. One of them, we 
bought. Another one, Egan-Jones, is still in business. And then 
there is Realpoint that was acquired by Morningstar.
    Those are the three smaller ones. And by the way, there is 
nothing that James has said that I don't completely endorse. 
Whether an NRSRO or not an NRSRO, he has gotten it right.
    So number one, we have to look at the 500 pages of 
regulations that the SEC promulgated in response to Dodd-Frank, 
no less on my birthday, May 18th, and I was meeting with them 
on May 19th. They have made an effort to comply. They have 
tried in each and every way to be in sync with the legislation 
from Dodd-Frank.
    But when you are making rules for, in effect, an oligopoly, 
with massive numbers of people who are working in every 
discipline and opining on which countries should be downgraded 
or not downgraded, that is a different species. The mice can't 
run and compete with the elephants, if we have the burdens and 
the expense that are laid on because of this.
    And I have some sympathy for the big three, but frankly not 
much, given the amount they make. These are among the most 
profitable companies in America. It is time for them to 
reinvest in the quality of what they do.
    Our business is totally focused on where the problem was. 
We are totally focused in the structured finance area. And we 
are building it silo by silo, and we are making headway. So my 
ask is lighten up on the burdens from a regulatory point of 
view and let us just get on the field and compete face to face 
on the accuracy and the quality of our ratings and let us not 
hide behind the First Amendment. Let us be accountable for our 
work.
    Thank you.
    [The prepared statement of Mr. Kroll can be found on page 
89 of the appendix.]
    Chairman Neugebauer. Thank you, Mr. Kroll.
    Mr. White?

 STATEMENT OF LAWRENCE J. WHITE, PROFESSOR OF ECONOMICS, STERN 
            SCHOOL OF BUSINESS, NEW YORK UNIVERSITY

    Mr. White. Chairman Neugebauer, Ranking Member Capuano, and 
members of the subcommittee, my name is Lawrence J. White. I am 
a professor or economics at the NYU Stern School of Business. I 
represent solely myself at this hearing. Thank you for the 
opportunity to testify today on this important topic.
    The three large U.S.-based credit rating agencies--Moody's, 
Standard & Poor's and Fitch--and their excessively optimistic 
ratings of subprime residential mortgage-backed securities in 
the middle years of the past decade played a central role in 
the financial debacle of the past 2 years.
    Given this context and history, it is understandable that 
there would be strong political sentiment, as expressed in 
Section 932 of the Dodd-Frank Act, for more extensive 
regulation of the credit rating agencies in hopes of 
forestalling future debacles.
    The advocates of such regulation want figuratively, perhaps 
literally, to grab the rating agencies by the lapels, shake 
them, and shout, ``Do a better job.''
    This urge for greater regulation is understandable and 
well-intentioned, but it is misguided and potentially quite 
harmful. The heightened regulation of the rating agencies is 
likely to discourage entry, rigidify a specified set of 
structures and procedures, and discourage innovation in new 
ways of gathering and assessing information, new technologies, 
new methodologies, and new models, possibly including new 
business models, and may well not achieve the goal of inducing 
better ratings from the agencies.
    Ironically, these provisions will also likely create a 
protective barrier around the larger credit rating agencies and 
are thus likely to make them even more central to and important 
for the bond markets of the future.
    Why would we want to do that?
    You just heard from Mr. Gellert and Mr. Kroll about all the 
problems that Section 932 creates, especially for the smaller 
agencies.
    There is a better route. That route is also embodied in the 
Dodd-Frank Act. It is sections 939 and 939A. These are the 
sections that remove statutory ratings--references to ratings--
and that instruct Federal agencies to review and modify their 
regulations so as ``to remove any reference to or requirement 
of reliance on credit ratings and to substitute in such 
regulations such standards of creditworthiness as 
appropriate.''
    Doing so would really open up this bond information 
industry in a way that it has really not been open since the 
1930s.
    Unfortunately, financial regulators, especially the bank 
regulators, have been slow to implement these provisions. You 
heard from them earlier today. They have been slow, especially 
the bank regulators.
    On one level, this slowness, this reluctance is 
understandable. Regulatory reliance on an existing set of 
rating agencies is easy. It is a check-the-box kind of 
approach. It is easy for the regulator. It is easy for the 
regulated.
    But at another level, this is not rocket science we are 
talking about. The approach of the regulators ought to follow 
the same approach that bank regulators already use--they 
currently use--for assessing the safety and soundness of the 
other kinds of loans that are in bank portfolios.
    That approach basically says, ``Place the burden directly 
on the bank or other financial institution to demonstrate and 
justify the safety and soundness of their bond portfolios.'' 
That is essential. That safety must--and the regulatory 
approach to that safety must--remain.
    The financial institutions can do this either by doing 
their own research and analysis themselves in-house, or they 
can rely on third-party sources of creditworthiness 
information. Third-party sources might encompass the existing 
incumbent NRSROs or other sources of creditworthiness 
information--and there are other sources: There are the smaller 
non-NRSROs. Mr. Gellert represents one of them. There are 
creditworthiness fixed-income analysts at securities firms. And 
in a more open environment, these analysts might be encouraged 
to hang out their own shingles and start doing more independent 
analysis on their own.
    Of course, regulators have to check on the competence of 
the financial institutions in doing that research or in 
employing the services of those creditworthiness advisers, but 
it can be done.
    So Section 939 and 939A are the direction to go. When they 
are fully implemented, then there wouldn't be any need for the 
NRSRO system, to address a question you raised earlier, Mr. 
Chairman.
    And if we can somehow avoid the dangers of Section 932--
ideally, if it were my choice, I would repeal 932 in a 
heartbeat--then the bond information market, and that is really 
what we are talking about, would be opened to innovation and 
entry in ways that have not been possible since the 1930s.
    My written statement expands on these ideas. Thank you, 
again, for the opportunity to testify this morning. I would be 
happy to answer questions from the committee.
    [The prepared statement of Dr. White can be found on page 
216 of the appendix.]
    Chairman Neugebauer. Thank you, Mr. White.
    Mr. Smith, you are recognized for 5 minutes.

   STATEMENT OF GREGORY W. SMITH, GENERAL COUNSEL AND CHIEF 
   OPERATING OFFICER, COLORADO PUBLIC EMPLOYEES' RETIREMENT 
                          ASSOCIATION

    Mr. Smith. Thank you. Mr. Chairman, Ranking Member Capuano, 
and members of the subcommittee, thank you for having me. Good 
afternoon. I am Greg Smith, general counsel and COO of the 
Colorado Public Employees Retirement Association (PERA). I am 
also a member of the board of directors of the Council of 
Institutional Investors.
    I appreciate the opportunity to speak to you today. My 
testimony is going to emphasize three points: first, the 
systemic risk being created by the premature removal of credit 
ratings from all regulations from the perspective of an 
investor; second, the SEC's role in oversight of credit rating 
agencies and what it takes to accomplish that goal; and, 
finally, the critical nature of the provisions making credit 
rating agencies accountable, as are others, for their products 
that they sell.
    Colorado PERA is a pension fund with more than $40 billion 
in assets. And, as general counsel and COO, I am responsible 
for protecting the retirement security of more than 475,000 
participants and beneficiaries in that system.
    In that capacity and as a board member of the council, I 
have had the opportunity to study the issues surrounding the 
credit ratings industry and the ways in which ratings agencies' 
actions impact institutional investors and pension funds.
    At the outset, it is important to note that neither prior 
to the financial crisis nor subsequent to the passage of Dodd-
Frank has Colorado PERA ever relied on rating as a sole source 
of buy-sell decisions. Rather, ratings are used as a part of a 
mosaic of information we consider during the investment 
process. That is the way all responsible institutional 
investors have done it and continue to do it.
    Our investment process involves risk budgeting, an effort 
to ensure that investment managers are generating appropriate 
returns within a specified range of risk. A consistent and 
reliable risk measure is critical to institutional investors in 
order to manage those risk budgets. In addition, ratings are an 
important factor in our decision to participate in short-term 
credit facilities, such as cash accounts and money market 
funds.
    We fully agree with the conclusions of the Financial Crisis 
Inquiry Commission and many others that, ``the failures of 
credit rating agencies were an essential cog in the wheel of 
financial destruction.''
    In light of those failures and the credit rating agency 
provisions of Dodd-Frank that followed, Colorado PERA has begun 
a process of consulting with internal fund managers and outside 
experts in order to identify appropriate alternative measures 
of risk.
    We are hopeful that, once identified, such measures can 
also help to define in our investment management agreements the 
level of risk to be taken on by our individual portfolio 
managers. The process, however, as we have heard from the OCC 
as well as the Fed today, is a challenging one. And to date, 
identifying cost efficient measures that could comprise a 
robust, objective evaluation of credit risk remains elusive.
    In the meantime and to the extent that credit rating 
agencies continue to act as gatekeepers for the financial 
markets, we strongly believe that rating agencies should have 
an appropriate level of government oversight and accountability 
to investors at least as rigorous as auditors, investment 
banks, and other financial gatekeepers.
    Providing an appropriate level of government oversight for 
credit rating agencies requires sufficient funding of the SEC 
so that they can implement and enforce the provisions of Dodd-
Frank that begin to address credit rating agency conflicts of 
interest, lack of transparency, and other deficiencies.
    As you are aware, SEC funding does not increase the Federal 
deficit, because its budget is fully offset by fees imposed on 
financial entities engaged in SEC-regulated securities 
transactions.
    Depriving the SEC of necessary funding as a supposed 
punishment for past failures is counterproductive and contrary 
to the needs of investors. Providing an appropriate level of 
accountability to investors requires that credit rating 
agencies be subject to liability to investors for poor 
performance and poorly managed conflicts.
    As you might expect, we were disappointed by the Committee 
on Financial Services' vote last week in support of House 
Resolution 1539. As you are aware, that bill would amend Dodd-
Frank to provide those NRSROs that directly contributed to the 
multitrillion global financial crisis a shield from 
accountability to investors.
    We note that a similar shield from liability is not 
provided under the Federal securities laws to any other 
financial gatekeepers.
    Colorado PERA and the council stand ready to work with this 
subcommittee, the SEC, and other interested parties to better 
ensure that the credit rating agencies post-Dodd-Frank will, to 
the extent possible, more effectively and efficiently serve the 
needs of investors and all participants in the U.S. financial 
system.
    That concludes my prepared remarks. I look forward to your 
questions. Thank you.
    [The prepared statement of Mr. Smith can be found on page 
129 of the appendix.]
    Chairman Neugebauer. I thank the panel.
    And we will start with questions. I will recognize myself 
first for 5 minutes.
    I want to put up a chart. I know it is hard to read, and so 
that chart is being passed out, and we will make sure the 
panelists get one as well.
    Basically, where I am going with this is that one of the 
things I feel like Dodd-Frank does is it makes the big get 
bigger and it is not--what we have heard is testimony here that 
even in the rating agency space--but also what I think Dodd-
Frank has also done and what is going on in the rating agency 
is they are kind of complicit in the fact that we are helping 
the big financial institutions actually stay bigger and 
actually giving many of those an unfair advantage.
    And so what you have here is a chart that basically shows 
the ratings of four banks, and so there is a kind of a before 
the uplift and after. And basically, what you see are two 
banks, SunTrust and TrustMark, that actually have a before 
uptick ratings of A3, and then we have Bank of America and 
Citigroup has a Baa2 rating, in using ratings of bank financial 
strength, C, and the two other banks, C-minus.
    But when you look at the upticks that they are getting, for 
example, Bank of America is getting a 5-point uptick. And so, 
it takes it up to Aa3 and Citigroup gets an uptick 4 to A1.
    And so the concern here is, and what I am hearing over and 
over again, is that we haven't cured this too-big-to-fail 
perception out there among the rating agencies, and that, in 
fact, the rating agencies today are giving these systemically 
important financial institutions advantage over other financial 
institutions that may, in fact, from a core standpoint be more, 
obviously, from your own ratings, maybe be a better financial 
risk on a standalone basis.
    So my question is, where are we in this process of removing 
this too-big-to-fail advantage for these large financial 
institutions?
    Mr. Sharma, I will start with you.
    Mr. Sharma. Thank you, Mr. Chairman. In the spirit of our 
objectives of transparency and clarity, we have recently also 
clarified how we are going to rate banks in the future.
    And we start with looking at the stand-alone credit risk 
assessment of a bank on a number of factors that include 
business position, risk exposure, funding, and liquidity.
    But then after we do the stand-alone credit risk 
assessment, we do look at what external support it may be 
provided by a holding company or by a parent institution or by 
government support. And in that context, we have created a very 
simple framework that looks at different governments based on 
their policies and regulations and history as to whether they 
are supportive or supportive-uncertain or interventionist.
    And then we look at different institutions as to how 
important they are for the economy, the size, the 
concentration, the interconnection across the different market 
participants. And based on that, we determine how much support 
we believe the government may provide to these institutions 
when there is a crisis or a situation.
    So in that context, we do believe, given the situation, we 
are recognizing the Dodd-Frank Act has a very clear aim to 
bring stability and raise the capital of the banks and the fact 
that the banks should not be provided any support.
    But our role is to provide the investor with a forward-
looking view. And in that context, our analysts have said, were 
a similar situation to exist, we think, based on the history, 
based on the size of the banks and the connectivity, that there 
may be attempts at changing the policies to support the banks 
in the future.
    Chairman Neugebauer. But based--attached to the handout 
there--based on a statement that was recently issued by your 
company, you questioned whether the too-big-to-fail issue has 
actually been settled.
    Mr. Sharma. Mr. Chairman, that is my co-panelist's company, 
Moody's, but we have also recently published research that 
highlights the fact that we recognize the Dodd-Frank Act and 
the aim of the Dodd-Frank Act to sort of take this too-big-to-
fail support away.
    But we recognize on some of the connectiveness, the high 
concentration of the large banks, the importance to the 
sovereigns, that in a similar situation, policymakers may end 
up looking at changes to the law to give support to the 
institution in the future.
    Chairman Neugebauer. And just for the record, the 
statement, though, that is up there is a statement from--
Moody's is--these are ratings from--the table is from Moody's, 
but the statement is from Standard & Poor's?
    Mr. Sharma. Yes, and that is what I said. We have recently 
published a similar--
    Chairman Neugebauer. Yes. Just quickly, Mr. Rowan, your 
response, because your company does the very same thing.
    Mr. Rowan. Yes, Mr. Chairman.
    Chairman Neugebauer. Won't you push your--yes, thank you.
    Mr. Rowan. Sorry about that. Mr. Chairman, as the head of 
the commercial group, I am completely removed from the rating 
analysis, rating committees and the formation of the 
methodologies, so I am not the person who can speak 
authoritatively on the question and point that you are asking.
    Chairman Neugebauer. At least let me ask you a question. Do 
you think it give financial institutions an unfair advantage 
that they get anywhere from two to four upticks for being 
considered a risky financial institution? Do you think that 
gives them an unfair advantage in the marketplace?
    Mr. Rowan. Mr. Chairman, as I said, I am not involved in 
the methodology, and I am aware that the methodology 
incorporates the--
    Chairman Neugebauer. I am not talking about methodology. I 
am talking about common sense here. Do you think it is an 
unfair advantage for an entity to get upticks just because the 
Federal Government has not sent a clear signal whether it will 
bail that entity out or not? Yes or no?
    Mr. Rowan. Mr. Chairman, I am not the right person who can 
give you a yes-or-no answer, but I can arrange to have the 
right people speak with you and your staff, if that would be 
helpful.
    Chairman Neugebauer. So you don't have an opinion on that?
    Mr. Rowan. As a representative of Moody's, sir, that is not 
my specific area of expertise. I wouldn't want to mislead you.
    Chairman Neugebauer. Okay.
    Ranking Member Capuano, for 5 minutes.
    Mr. Capuano. Thank you, Mr. Chairman.
    Mr. Sharma, just to clarify, under your understanding of 
current law, current law alone, you don't think we have made 
any changes? I know what you said is, based on what you think 
we might do, that is what you think. But based on current law, 
do you think that too-big-to-fail still exists?
    Mr. Sharma. The current law clearly states that, and it is 
very clear about that, that it--
    Mr. Capuano. Clearly states what?
    Mr. Sharma. That it will not provide any--
    Mr. Capuano. That we will not. So it does not provide. 
Therefore, your opinion is based on your opinion that we might 
act.
    As a matter of fact, obviously, I won't read the 
transcript, but I wrote it down, I think, pretty clearly, that 
your opinion is based on the fact that you think we maybe will 
attempt to change the policies, which means the current policy 
to support. So when your opinion is based on your fact that you 
think, in your professional opinion, which you are entitled to, 
that we would change our current policies to react to a new 
situation?
    Mr. Sharma. Yes, that is exactly what our analysts have 
said.
    Mr. Capuano. That is fair.
    Mr. Sharma. That is their future view of how things may 
happen.
    Mr. Capuano. That is a very fair statement. I just wanted 
to be clear about that. You don't think that we do it now. You 
think that we would react to it. And as long as it is a 
statement of your opinion of what we would have to do, we would 
have to change current law and our current activities in order 
to do this again--
    Mr. Sharma. Correct.
    Mr. Capuano. --which, of course, we could change law to do 
anything we wanted.
    Mr. Sharma. Sure.
    Mr. Capuano. That is the whole idea of why Congress exists, 
to change laws.
    I appreciate that, Mr. Sharma. I just want to make that 
clear. It is your opinion of what we might do in the future.
    And, Mr. Rowan, I know you are not the perfect person to 
answer this. It is my understanding that Moody's has officially 
said that they think that too-big-to-fail has been ended. Is 
that a fair reading of what--not yours; I am not asking for 
your opinion. I recognize you said you are not the guy here, 
but I would hope that you would know what Moody's has said as a 
general statement.
    Mr. Rowan. Mr. Congressman, I am not sure that is Moody's 
official statement. I can arrange to have the individuals who 
are responsible for that--
    Mr. Capuano. That is fair enough.
    Mr. Rowan. --but I can't answer your question.
    Mr. Capuano. I think that you should arrange to have them 
put their official documents on the record, because it is my 
understanding that Moody's has said so. I am not going to hold 
you to it, and maybe I am wrong. I guess I am rolling the dice 
here, but I have been led to believe that Moody's has said 
that, and, therefore, I would like Moody's to go on the record 
one way or the other what you think about too-big-to-fail, 
because I have been led to believe they do.
    Shifting to another thing, Mr. Kroll, I wanted to push a 
little bit. You had earlier said that you would agree with Mr. 
Gellert on everything, yet your comment on the First Amendment 
indicated that you may not agree, and I am not so sure.
    As I understand it, the reason that we had to change some 
of the laws to take away or to limit the First Amendment 
defense of the credit rating agencies, we put in ``knowingly or 
recklessly,'' which is now under the law, under the Dodd-Frank 
law, the new standard as to credit rating agencies.
    It has nothing to do with the First Amendment. The First 
Amendment is what has been used up until now to prevent them 
from having any liability whatsoever.
    Do you disagree with that, first of all, understanding?
    And, second of all, do you think that we should get rid of 
the new standard of extending liability to rating agencies 
under a ``knowingly or recklessly'' standard?
    Mr. Kroll. I am not sure what your question is.
    Mr. Capuano. The question is, you said that--I want to make 
sure I understood it. I am under the impression you said we 
should get rid of the First Amendment defense?
    Mr. Kroll. No. What I said was the rating agencies should 
be accountable like lawyers, like auditors--
    Mr. Capuano. I agree.
    Mr. Kroll. --like investment bankers--
    Mr. Capuano. But the courts--
    Mr. Kroll. --and not hide behind the First Amendment and 
not be accountable.
    Mr. Capuano. But the courts up until now have stated that 
the First Amendment protects them.
    Mr. Kroll. Yes.
    Mr. Capuano. So, therefore, the only way around it is to 
provide a different standard, and the different standard in 
Dodd-Frank is to say that they are now subject to a ``knowingly 
or recklessly'' standard, therefore opening the door. It does 
exactly what, I think, you suggest we should do.
    Mr. Kroll. I think it is doing surgery instead of with a 
laser, doing surgery with a meat cleaver. I believe that the 
attempt to rectify the behavior can be done very simply and 
create the same standard, the same standard for rating agencies 
as every other professional in the financial marketplaces. That 
would solve the problem.
    Mr. Capuano. I would suggest that you talk to your lawyers, 
because I am pretty sure it is the same standard, ``knowingly 
or recklessly,'' that applies to everybody else. And if your 
lawyers, or anyone else, have a suggestion of how we could have 
done it surgically to get rid of--
    Mr. Kroll. I am a lawyer.
    Mr. Capuano. And how could we have circumvented a 
longstanding series of court decisions that has said that they 
are protected by the First Amendment?
    Mr. Kroll. If you look at the recent ruling of the 2nd 
Circuit--
    Mr. Capuano. And I have.
    Mr. Kroll. --which was very favorable to the rating 
agencies, very favorable--
    Mr. Capuano. But not based on the ``knowingly or 
recklessly'' standard. It was a completely different approach, 
which I actually thought was a stupid approach.
    Mr. Kroll. Okay. If you are saying ``knowingly and 
recklessly,'' that is a separate issue. If you are talking 
about having an absolution from general behavior and liability, 
that is what I am focusing on. I think under reckless behavior, 
anybody could be found liable, if that could be proven.
    Mr. Capuano. I would be interested to hear what your 
standard would be, because ``knowingly or recklessly''--if you 
are a lawyer, you know this--has been a longstanding standard 
that has applied to virtually everybody. It is actually a 
relatively--it is a very common standard.
    The First Amendment defense--I thought it was a very unique 
defense brought before the courts many years ago. It is 
surprising that the courts upheld it. And I would be interested 
to pursue with you or your lawyers at a later time any other 
way to do it, because I am not stuck on ``knowingly or 
recklessly'' here. I just couldn't find one any other way.
    Mr. Kroll. It is really simple. There are standards that 
bankers, auditors, lawyers, and other people in the financial 
process system are susceptible to and they are liable for.
    There should be--the rating agencies wield enormous power. 
We see it every day. They are deciding on which countries 
should be upgraded or downgraded, including our own country. 
They are doing all sorts of things, and they are doing it in 
effect, without any legal responsibility.
    Mr. Capuano. They have responsibility now. And ``knowingly 
or recklessly'' is the standard that is applied to virtually 
everybody else. And if there is another standard, I would like 
to know what it is.
    Mr. Kroll. If you want me to keep going on this, I will.
    Mr. Capuano. Just tell me what standard it should be.
    Mr. Kroll. I just told you. The standard should be the 
level of liability that every other professional has in the 
securities process.
    Mr. Capuano. As a lawyer, you know that is not a legal 
answer. That is a generic answer. What is the standard that 
other people have? And the answer for me is that it is 
``knowingly or recklessly.''
    Mr. Kroll. Staying with this point, for example, if you 
have an investment banker or an auditor or a lawyer who acts 
negligently, they are going to be liable, if you can prove that 
is the case.
    Mr. Capuano. Under the ``knowingly or recklessly'' 
standard?
    Mr. Kroll. If that is the case with a rating agency, good 
luck.
    Mr. Capuano. That is the new standard. I do wish you good 
luck. Thank you.
    Chairman Neugebauer. I thank the gentleman.
    Now the vice chairman, Mr. Fitzpatrick.
    Mr. Fitzpatrick. Thank you, Mr. Chairman.
    I want to thank all the witnesses for their testimony. This 
is very helpful.
    Mr. Rowan, the question I have for you relates to--in the 
written testimony of Mr. Gellert, he has proposed an initiative 
that would apply to all NRSROs that would require them to file 
an attestation on a quarterly basis, essentially reconfirming 
the ratings and opinions previously issued.
    He is doing that. I guess he believes it would provide 
confidence to the public that the rating agencies are standing 
by the ratings and their opinions.
    Is Moody's prepared to file quarterly attestations? And 
would Moody's stand by the ratings on an ongoing basis going 
forward?
    Mr. Rowan. Congressman, Moody's on a regular basis reviews 
and maintains its credit opinions. Our willingness or capacity 
to sign an attestation on a quarterly basis is something that I 
can't answer for you today. But I do know that we regularly 
review and monitor our ratings on all of the instruments that 
we have ratings on.
    Mr. Fitzpatrick. Mr. Rowan, how long have you been with 
Moody's?
    Mr. Rowan. For about 15 years.
    Mr. Fitzpatrick. Fifteen years. So certainly, you remember 
6 or 7 years, ago Enron and WorldCom went bankrupt. Moody's had 
rated both of those entities as investment grade 5 days before 
their filings for bankruptcy.
    Had Moody's been standing by its ratings and filing 
quarterly updates, investors would have had better information 
about what was coming down the pike, would they have not?
    Mr. Rowan. I believe that Moody's had continuously reviewed 
and monitored those ratings, and that as information becomes 
available, it is incorporated into the rating. And those 
ratings and the issues surrounding those events are fairly well 
documented, Congressman. I don't know whether or not a 
quarterly attestation would have changed those ratings.
    Mr. Fitzpatrick. Mr. Gellert?
    Mr. Gellert. Thank you, Congressman.
    Rapid Ratings had Enron as a below investment grade credit 
in the mid 1990s. Re-rating things on a quarterly basis gives 
an accurate perspective of the credit quality as it changes. 
Companies do not maintain one single credit quality--or 
securities don't maintain one single credit quality for decades 
at a time.
    And one of the fundamental tenets of the traditional 
ratings process from the big three is the concept of rating 
through the cycle. Rating through the cycle is essentially 
putting a rating on a security and having it be good for some 
period of time that is undefined and indefinite.
    The concept is that it is fine until we say otherwise. And 
the problem is, that has been proven to be incorrect over and 
over again.
    Mr. Kroll. Congressman, my former company ran Enron in 
bankruptcy for 4 years, and we studied every single fraudulent 
act in that company, going back historically because of all the 
legal liabilities.
    James has a good idea. What we are doing with structured 
products is something Moody's and Standard & Poor's failed to 
do, which was a key part of this crisis. They stopped doing 
something called surveillance in the structured products area.
    What does that mean? It means for years--for years--when we 
thought they were watching the ship, they weren't. They were 
not conducting surveillance.
    Now James' idea is worth thinking about, because it forces 
you to do that. We have committed to investors that we are 
going to provide surveillance every month, whether we get paid 
for it or not, through the life of the bond.
    I think rating agencies need to be held accountable and put 
on the record. That is a very interesting way to do it.
    Chairman Neugebauer. I thank the gentleman.
    Mr. Carney, you are recognized for 5 minutes.
    Mr. Carney. Thank you, Mr. Chairman.
    I really just have two basic questions.
    And one goes to something, Mr. Sharma, that you said in 
your remarks, referring to look-back reviews. And looking 
through your testimony, that is part of the action you have 
taken to ensure integrity and independence.
    Could you tell me a little bit about what that means in 
that context? And then I would like to ask it in another 
context as well.
    Mr. Sharma. Congressman, as part of our number of actions 
that we had announced in early 2008 to make changes in the 
business, to improve our governance and checks and balances, 
including our analytical independence, one of the things we 
looked at was looking at people who would leave our 
organization to go to an issuer, and to then examine all the 
ratings that they may have been involved with, but when they 
were at our organization and conducting the ratings for an 
issuer with whom--
    Mr. Carney. So it is a look-back at personnel and where 
they move and--
    Mr. Sharma. And the ratings that they had performed.
    Mr. Carney. Right, right, right.
    Mr. Sharma. And now, that has become a part of the 
regulation. And we had adopted that, and we had announced that 
we would adopt that in 2008.
    Mr. Carney. So if you go the next section, ``Actions taken 
to strengthen analytics,'' it doesn't use the term ``look-back 
reviews.'' But do you do look-back reviews?
    You talk about creating an independent model validation 
group, which in some ways could be validating models that were 
used. Did you look back at some of the structured products that 
you had rated that fell apart, rated AAA and they turned out to 
be less than that, let us just say?
    Mr. Sharma. Congressman, like many other participants, we 
have also reflected on and learned from many lessons of this. 
But just as a context also, clearly, there were many lessons we 
learned out of the U.S. residential mortgage-backed securities.
    Mr. Carney. What would you mention as the most important of 
those lessons?
    Mr. Sharma. Part of it was sort of looking at our analytics 
and making sure some of our ratings are completely comparable, 
looking at the stress scenarios that we apply to them, and 
enhancing surveillance. We have always conducted surveillance, 
and we have enhanced them. We have strengthened our 
surveillance programs.
    Mr. Carney. When you say ``surveillance,'' what do you 
mean?
    Mr. Sharma. It is when the rating is--once it is new--
rating is issued on new issuance, then we continue to monitor 
it. We get monthly reports on the servicers. We review it. We 
look at it. What we have now done is we have gone one level 
below. We are looking at the underlying collateral, etc., that 
makes up a structured security.
    So we have really expanded and enhanced our surveillance. 
But the surveillance program was always in place, that we would 
look at this on a quarterly basis--
    Mr. Carney. So you discovered through the surveillance 
process that you had rated securities that didn't perform at 
AAA securities?
    Mr. Sharma. We learned why the ratings sort of behaved the 
way they did, what were some of the things to learn and 
observe. Another aspect was information quality. We have now--
not only have we done that, we are looking at the rating of 
different information that we receive based on the credibility 
of the source of the information. And so, we have started to 
apply that framework against it and it is also being introduced 
as part of the regulation.
    Mr. Carney. So changing gears a little bit as my time runs 
out, what does it mean to you--and I will ask the others as 
well--to stand behind your rating?
    Mr. Sharma. First of all, we are accountable. We are 
accountable to the regulators to make sure that what we do 
follows our process, policies, regulations as appropriate.
    Secondly, we are accountable through market scrutiny. And 
at the end of the day, it is our credibility and our reputation 
of our ratings. And the fact of the matter is, there are 
independent reports--for example, IMF recently came out and 
looked at the sovereign credit ratings and our performance in 
those sovereign ratings, and how it has performed over time.
    Mr. Carney. So Mr. Rowan, yourself--
    I apologize for interrupting, but my time is running out.
    How about Moody's?
    Mr. Rowan. Mr. Congressman, the concept of credibility that 
Mr. Sharma just mentioned is an integral part of the business 
of a rating agency. And putting the brand and franchise behind 
the rating is important, and the users of ratings look to 
Moody's longstanding track record of credibility and 
consistency of performance of our ratings in many areas outside 
of residential mortgage-backed securities.
    Mr. Carney. So we had a big discussion earlier, and you 
were all here, about 939G in the liability section. What is 
your view of that provision?
    Mr. Rowan. Congressman, I am not a lawyer.
    Mr. Carney. Okay. So we will go Mr. Sharma, then, if you 
can't answer.
    Mr. Sharma. Congressman, do you mean 436G or--
    Mr. Carney. Section 939G, as I understand it, is the 
section that imposes the provision for a stricter liability 
standard.
    Mr. Sharma. Oh. Sorry. Yes.
    As I mentioned, we are accountable, and we recognize that 
Dodd-Frank Act changes the pleading standard, which is actually 
unique to rating agencies, unlike any other market 
participants, that the pleading standard has now been changed 
on us.
    But otherwise, we are sued. We are sued. And cases have 
been filed on us and on other laws that are on the books.
    Mr. Carney. So does anybody--Mr. Smith, I think I heard you 
articulate a different view of that?
    Mr. Smith. We believe that in our review of the credit 
rating agency line in case law, the ranking member is correct 
that the standard that has been imposed by Dodd-Frank is 
exactly the standard that is imposed on every other participant 
in the financial markets--certainly, the lawyers, the 
accountants--a knowing and reckless standard.
    It is not a negligence standard. It is a knowing and 
reckless standard, and it is one that makes them realize that 
what they have done is wrong or that they were so reckless in 
their disregard for whether it was wrong that they should be 
held accountable for it.
    I think that is the correct standard, and it is a standard 
that applies across-the-board.
    Mr. Carney. Thank you, Mr. Smith.
    And I thank the Chair for the extra time.
    Chairman Neugebauer. I thank the gentleman.
    And now the chairman of the Capital Markets Subcommittee, 
the gentleman from New Jersey, Mr. Garrett.
    Mr. Garrett. I thank you. And I thank the panel.
    So the panel probably heard the earlier panel, some of the 
questions with regard to the larger issue that is affecting 
this country right now, and that is the debt limit. And so, 
there are certain questions there.
    I will start with Mr. Sharma. Could you comment on the 
evaluation of the potential for a downgrade on the President's 
position or his solution to the problem as whether we will 
still get a downgrade?
    Mr. Sharma. Congressman, the way our sovereign analysts 
look at it is they look at five variables to sort of assess the 
creditworthiness of this commercial debt of a sovereign. They 
look at the fiscal aspect. They look at the monetary. They look 
at the economic strength of the country, as well as look at the 
liquidity and funding, and then, of course, the political 
institutions that formulate the policy and--
    Mr. Garrett. And so one of those five--I only have so much 
time. I realize the five-point analysis, and one of those 
points of the analysis is what structural changes that the 
Congress is going to pass. So were you able to look at what the 
President has presented and be able to give an evaluation on 
that, whether that is sufficient?
    Mr. Sharma. What we have said is our analysts have said 
that there has to be a credible plan to reduce the debt burden, 
as well as reduce the deficit levels.
    Mr. Garrett. I understand. So I serve on the Budget 
Committee, and there is now that infamous statement from CBO 
where they said, ``We do not evaluate speeches.''
    Is there something that you were able to evaluate with 
regard to the Administration as to whether their plan is 
credible? Do they have a plan that you are able to look at?
    Mr. Sharma. Congressman, there have been a number of plans 
that have been announced by the Administration--
    Mr. Garrett. Have you been able to look at them?
    Mr. Sharma. --and we think some of the plans to reduce debt 
levels could bring the U.S. debt burden, as well as the deficit 
levels, in the range of a threshold for a AAA rating. And so we 
have analyzed it, but we are waiting to see what the final 
proposal is for a sovereign analyst to really analyze it more 
thoroughly and then to opine on it.
    Mr. Garrett. So the story is--at least one of the stories 
out there is, with regard to the Reid plan, that it would be a 
better plan to ensure that we would not get a downgrade 
according to some of the rating agencies. Is that story true, 
that it is one that would aid better or is one that is 
satisfactory?
    And I say that partially with regard to your own analysis 
of July 14th that says what we really need to have here in 
order to avoid a downgrade is a $4 trillion structural change. 
As far as I know, the Reid plan does not reach that level. So 
would that be satisfactory?
    Mr. Sharma. Congressman, I think we were misquoted. We do 
not comment on any specific plan or the political choices or 
policy choices being made. We are just commenting on what is 
the level of debt burden, what is the level of deficit that 
must meet the threshold to retain its AAA.
    Mr. Garrett. Okay.
    Mr. Sharma. And since there was a $4 trillion number put 
forward by a number of Congressmen, as well as by the 
Administration, our analyst was just commenting on those 
proposals, that that would bring the threshold within the range 
of what a AAA-rated sovereign debt would require.
    Mr. Garrett. So watching my time, first, is something under 
that then potential still be able to maintain a AAA rating?
    Mr. Sharma. Congressman, I would leave that to our analysts 
to determine that. And it is a decision that is made by the 
ratings committee and by our sovereign analyst. We have 
criteria on sovereigns that we have published. We have 
thresholds that are out in the public domain.
    Mr. Garrett. I know the original plans, the so-called grand 
plan was in the $4 trillion size. The Reid plan is 
substantially under that, $1.5 trillion or so under that. So 
you have not made any other pronouncements since the July 14th 
letter analysis saying that whereas $4 trillion would be 
satisfactory, we have seen these other potential plans out 
there, and they would or not--you have not produced any other 
documents in that regard. Is that correct?
    Mr. Sharma. No, Congressman, we have not. We are waiting 
for the plans to come.
    Mr. Garrett. Does Moody's want to chime in on this?
    Mr. Rowan. Congressman, I am not a rating analyst. But 
Moody's has placed the rating for the U.S. Government under 
review for possible downgrade--
    Mr. Garrett. Yes.
    Mr. Rowan. --looking at two dimensions: one, the short-term 
risk of a disruption; and two, the longer-term issue of the 
level of debt in relation to the overall economy.
    Mr. Garrett. Right. And I know you are not the analyst 
there, so do the plans that we have seen either from the White 
House, which are--I haven't seen anything on paper--or from 
Reid, which is more specific, which come under the $4 trillion 
level, do they satisfy those criteria?
    Mr. Rowan. To my knowledge, Moody's has not published 
anything in regard to specific policy issues or the specific 
parameters that the rating committee will consider for the 
review action.
    Mr. Garrett. Okay.
    Mr. Kroll, do you want to chime in?
    Mr. Kroll. I don't think rating agencies have the 
wherewithal, the intellectual range, the experience to be doing 
ratings on--
    Mr. Garrett. Sovereigns?
    Mr. Kroll. --100 countries around the world. I question 
whether this is the job of a private sector entity to be 
looking at the United States Government or, frankly, any other 
government and reaching decisions on their levels of 
creditworthiness.
    And what we have seen throughout history is a constant 
activity of being a day late and a dollar short and running 
around in front of the parade.
    So is this new news? What makes these organizations--we are 
not qualified to do this. We are too small. But I question 
conceptually whether private enterprise should be in this 
business for pay.
    Mr. Garrett. I thank you.
    I think my time is up.
    Chairman Neugebauer. I thank the gentleman.
    And now the gentleman from Texas, Mr. Canseco, for 5 
minutes.
    Mr. Canseco. Thank you, Mr. Chairman.
    Mr. Sharma, do you believe that the amount of debt held by 
the United States poses a systemic risk to our economy?
    Mr. Sharma. Our sovereign analysts in the publication have 
highlighted that the debt burdens and the growth rate of the 
debt burdens is something that does need to be addressed for us 
to continue to assess the creditworthiness of the sovereign 
commercial debt at AAA levels.
    Mr. Canseco. In the political discourse that we are seeing 
today, do you think that it is the job of a credit agency to 
get involved in trying to make a decision one way or the other 
on a political basis? Do you think that is interference on the 
part of the credit rating agencies to be stepping in at this 
stage and making an assessment?
    Mr. Sharma. Congressman, sovereign debt is a large asset 
class that many investors around the world invest in. And our 
role is to really provide an independent view and a future 
forward-looking view for the investors as to what the risk 
levels are for those assets that they invest in.
    And that is what we are doing today. We are really for the 
benefit of investors giving them a perspective and a point of 
view that says what do we believe, whether the risks are rising 
for any sovereign, whether it is here or Europe or anywhere 
else. We are doing the same that we do in any other part of the 
world, that we are speaking to the risk that the investors 
invest in.
    And this is a large asset class that investors invest in, 
and they are the ones who determine what to pay for those 
risks.
    Mr. Canseco. Do you honestly believe that the United States 
could default on its debt?
    Mr. Sharma. Our analysts don't believe they would. And by 
the way, changing a rating doesn't mean it would default. AAA, 
all it means is that it is a low probability, a very low 
probability of a default. That is all it means. And if you 
change a rating, it means that the risk levels have gone up. It 
doesn't mean it is going to default. If you believe that, they 
would change it to a default status.
    Mr. Canseco. Thank you.
    Mr. Gellert, is there information to which Moody's and S&P 
have access that your firm cannot access?
    Mr. Gellert. A significant amount, actually. And in 
addition, there is a lot of information that they have that 
even NRSROs like Kroll Bond Ratings can't access. I think it is 
17(g)(5) that is the rule that created last year, or in late 
2009, an ability for--in structured products for data that is 
being used by a paid-for rating to be shared and accessed by 
another NRSRO for an unsolicited rating.
    As a non-NRSRO, we don't have access to any of that. As an 
NRSRO, what Mr. Kroll would not necessarily have is access to 
things like the underlying data that goes into a collateralized 
loan obligation (CLO) security. CLOs are very, very closed. 
They are not covered in the asset-backed securities that are 
really covered under 17(g)(5). And in fact, the SEC doesn't 
have purview over the loans themselves, the underlying 
collateral for those types of securities.
    So there is a whole world of information that none of us 
have access to that really would open up the space to 
competition, as well as providing the investor community 
information that they directly could use, if that information 
was available to them.
    Mr. Canseco. Thank you.
    Mr. Kroll, would your answer be the same or different?
    Mr. Kroll. As an NRSRO, which is one of the reasons we 
became an NRSRO, we do have access to most of the information. 
So, for example, we have just in the last 30 days rated 3, and 
in 2 weeks it will be 5, commercial mortgage-backed deals. We 
are privy to the same information that the oligopoly gets, if 
they are on those deals.
    Mr. Canseco. Okay.
    Mr. Gellert, were you disappointed or pleased with the 
provisions of Dodd-Frank related to credit rating agencies?
    Mr. Gellert. I think by and large, I was disappointed with 
them. I think the idea behind Dodd-Frank, in my understanding, 
was to, vis-a-vis rating agencies, was to create transparency, 
create accountability, increase competition.
    In fact, I think what happened was a lot of punitive, 
directed initiatives towards the big three with unintended 
consequences that hurt the variety of us who would consider 
being NRSROs or even those firms that are NRSROs.
    Ultimately, innovation and competition in this space is 
what is going to evolve it, and I don't think Dodd-Frank as a 
whole really helps contribute to that mission.
    Mr. Canseco. As a non-NRSRO player in an entrenched field, 
what is the biggest challenge your firm faces?
    Mr. Gellert. I think there is still a certain amount of or 
a decent number of institutional investors that are paying 
attention to the NRSROs before they will pay attention to a 
non-NRSRO, in part because of the infrastructure in the 
regulatory environment that continues, although it may be 
evolving, but continues to support them.
    For us, we don't mind the hard work. We are in this for the 
long term and we are in this to grow our business. And doing 
the hard work and explaining our ratings to a variety of 
potential and current users is very much a part of what we do, 
but we are trying.
    This example of the quarterly ratings affirmation, we 
believe even as a non-NRSRO, we are leading the field in best 
practices in certain areas and will continue to try to do that. 
So we are prepared to compete, but obviously it becomes harder 
with certain folks, given the entrenchment.
    Mr. Canseco. Thank you.
    I see that I am out of time, Mr. Chairman, so thanks very 
much.
    Chairman Neugebauer. In consultation with the ranking 
member, we are going to provide members another round of 
questions. And so, I will start that.
    Mr. Sharma, in the last 6 or 7 months, have you had 
conversations with Secretary Geithner about the ratings of U.S. 
sovereign debt?
    Mr. Sharma. Mr. Chairman, like we do for all entities that 
issue debt, we meet with the management, in this case the 
Treasury is the management for us, and so our sovereign teams 
have had ongoing dialogue. And we do this with not only with 
the sovereign governments around the world. We do that with 
companies. We meet them regularly and sometimes hourly when 
they have new updates to information.
    So our sovereign team has been meeting and discussing and 
dialoguing with the Treasury, as well as other parts of the 
Administration and some Members of Congress to just better 
understand what the situation is, what policies are being 
formulated, how credible would those plans be in that to be put 
into place. So they have been having a regular ongoing dialogue 
in the spirit of getting better understanding.
    Chairman Neugebauer. So let me re-state my question. Have 
you and Secretary Geithner had a conversation about the rating 
of U.S. sovereign debt?
    Mr. Sharma. No, Mr. Chairman. I have not had any direct 
conversation with Secretary Geithner.
    Chairman Neugebauer. Yes, and so what about--I know this 
sovereign debt thing is not just a U.S. issue right now, but it 
is a global issue, particularly in the European Union and the 
European Central Bank. Have those entities been having ongoing 
dialogue on how you might be rating their debt in the same 
respect?
    Mr. Sharma. Congressman, first of all, our sovereign 
analysts meet with the central banks, with finance ministries, 
Treasuries and other policymakers around the world on a regular 
basis. We rate about 126 countries, and we have over 100 
analysts in sovereign. So they are really meeting with all the 
people around the world all the time.
    And from time to time, yes, I do in my role meet with 
central banks as well as finance ministry and Treasuries around 
the world to just exchange views, but not on their ratings per 
se.
    Chairman Neugebauer. And so, here is the question. What 
about countries that can monetize their own debt, like the 
United States and some other countries? Would a country that 
can print money get a higher credit rating than a country that 
doesn't have that ability available to it?
    Mr. Sharma. Yes. In our criteria, we explicitly say that 
countries that can have their own currency, and in this case 
U.S. is a global reserve currency, so it does get a lift. I am 
not exactly sure how much lift, but yes, they do get a lift.
    Chairman Neugebauer. Yes. It would be interesting, I think, 
for me at least and maybe some of my Members to know what the 
lift is for countries that can print money.
    Mr. Sharma. Sure. I think we may have published it, and we 
will make efforts to get it to you.
    Chairman Neugebauer. Another question here is when you are 
looking at the potential--what a rating is is the potential or 
what you think the risk of default is. What percentage of a 
country's government expenditures attributed to interest would 
begin to cause you to enhance the potential for default?
    In other words, some countries, their interest is 5 
percent, 10 percent. Some countries are 25 percent interest. At 
some point in time, it is squeezing out the amount of 
government expenditures and forcing either additional taxes 
or--but would the interest carry be a factor that you would--
    Mr. Sharma. It is. And cost of debt servicing is an 
important factor, as is the total debt level, as is the 
deficit, as is the economic growth prospects, because they all 
influence the trajectory of the growth of the debt levels for 
the country.
    So clearly, we have thresholds for each rating category 
against many indicators that we look at. At this point in time, 
I don't know explicitly what that threshold is for a AAA for 
the debt servicing, but we can look at our published documents 
to see if it is in there and then can send it to you.
    Chairman Neugebauer. Last point, in a country that the debt 
levels are increasing, in other words, the interest carry is 
increasing at a faster level than the GDP, the growth in the 
economy, what is the pathway for that country?
    Mr. Sharma. It all is a function of that, plus it is a 
function of--the total debt level is a function of the debt 
deficit. It is a function of the economic growth, and then, of 
course, of what steps are going to be taken to address all 
these things. So you can change the trajectory by using a 
number of other variables.
    And then, as you mentioned, the dollar as a global reserve 
currency also brings some benefits also to the 
creditworthiness.
    Chairman Neugebauer. Would you say this is a fair 
assumption that the comments you made recently about U.S. debt 
was not whether we were going to default or not, but whether we 
were going to actually address the massive deficits that this 
country is running?
    Mr. Sharma. Mr. Chairman, that is it exactly. The more 
important issue is really the long-term growth rate of the debt 
as it is driven by the debt burden, as well as the deficit. 
That is the more important issue at hand. And to your point, 
that is the more important issue.
    Chairman Neugebauer. I thank you. My time has expired.
    Ranking Member Capuano?
    Mr. Capuano. Thanks, Mr. Chairman.
    Mr. Chairman, I just want to point out that I have the 
Bloomberg News report on the 2nd Circuit opinion. It deals with 
underwriters. Apparently, Moody's and Standard & Poor's and 
others were sued as underwriters.
    I can't imagine why they would sue you as underwriters. No 
one, other than probably this plaintiff, would have considered 
you to be underwriters. You are in the business of making 
thoughtful, professional opinions, not underwriting.
    I guess the plaintiffs made no other legal claim. So I am 
glad you won the case because I wouldn't want to get into this 
mess. But that has nothing to do with other cases that may 
come.
    Mr. Smith, I wanted to pursue another area. And I am not 
sure whether Colorado PERA is considered in the class as a muni 
type of bond. Are you in that category?
    Mr. Smith. As far as an issuer?
    Mr. Capuano. Yes.
    Mr. Smith. No, sir.
    Mr. Capuano. No, so you don't get tax-exempt status?
    Mr. Smith. No, we do not issue bonds. We are a pension fund 
that acquires assets, pays benefits, but we are not a part of 
the State. We are an arm of the State, but we are not a part of 
the State for purposes of issuing debt.
    Mr. Capuano. Okay. I appreciate that. I wanted to ask 
because I want to find--look, guys, I have been chasing the 
credit rating agencies for years, before this problem.
    And it really had to do with because I am a former mayor, 
and I was kind of giving you a little bit of taste of what I 
got from my 9 years as mayor. I didn't like it.
    As Mr. Carney said earlier, when you guys came in the door, 
I had to jump through hoops that were ridiculous to get ratings 
that were below what I deserved.
    And then, when I got here, I realized that I did get 
ratings below what I deserved, because my risk of default, 
which is really the only basis for which I thought anybody 
worked, was significantly in a different standard.
    Dodd-Frank was supposed to address some of these things, 
and I guess I would like to pursue as to whether it has.
    In the last couple of years--I have the numbers before me, 
but they are up until 2008; I have not updated them--but prior 
to 2008, the historic ratings of all rating categories, all of 
them, AAA down to noninvestment grade, munis by Moody's 
standards were 97 percent times less likely to default than 
corporate bonds, yet were rated lower. By S&P's standard, they 
were 45 times less likely to default, yet rated lower.
    Have you changed your ways? Are you now rating municipal 
and other governmental agencies as if they were corporations, 
again, based on one thing and only one thing, which is the risk 
of default?
    Mr. Sharma?
    Mr. Sharma. We have always had one scale, a consistent 
scale, that we have tried to adopt across all our asset 
classes. And, as a result, you will see we have been--our 
municipal ratings are generally higher than the corporates, of 
course, and other types of institutions, financial 
institutions.
    And we have now even made vigorous attempts to really make 
our ratings very comparable, whether it is munis or corporates 
or whether it is financial institutions, whether it is in the 
United States or it is in Europe.
    So we are striving toward getting comparability of our 
ratings across all asset classes, across all geographies.
    Mr. Capuano. So, the reason I ask, because in 2008--again, 
not updated, but I know it has changed a little bit, but my 
guess is--let me ask a basic question, are you aware that munis 
have defaulted at any higher rate than corporate bonds?
    Mr. Sharma. I don't have that data exactly, but, as I 
mentioned, we are aiming to get comparability of our ratings 
across all asset classes and geographies.
    Mr. Capuano. That would mean, basically, that you would now 
start rating what was once rated in 2008 as maybe a BA or BB, 
up to a AAA. They had approximately the same default rate as a 
AAA corporate bond.
    And I would argue that since default rates are really the 
only thing that matters in the final analysis, because, again, 
am I wrong to think that the only thing that matters is the 
likelihood of getting repaid?
    And if that is the only thing that matters, you should, 
based on historic data, absent individual items, that munis 
should be rated--BBA munis should be rated AAA. So are you 
telling me you have addressed that issue and that now that all 
munis are addressed comparable to corporates?
    Mr. Sharma. We are working toward it. We are recalibrating. 
We have, in fact, recalibrated our criteria across many areas, 
including structured finance, sovereigns, governments, and we 
have been also recalibrating our criteria on municipals, with 
the aim and objective to sort of have comparability of ratings 
and across all our sectors, across all asset classes and 
geographies, but this is forward-looking--
    Mr. Capuano. Mr. Rowan, has Moody's made some progress on 
this as well?
    Mr. Rowan. Yes, Mr. Congressman, I am aware that since 
2008, Moody's has recalibrated, formally recalibrated, all of 
the U.S. public finance ratings to move them on to a scale that 
is comparable to corporate ratings, financial institutions--
    Mr. Capuano. Based on historic default rates?
    Mr. Rowan. There was a research piece and a lot of analysis 
around that recalibration that I can make sure is provided to 
you and your staff.
    Mr. Capuano. My staff will be in touch with both of you to 
try to catch up on some of the data.
    Mr. Gellert, do you do governmental issues? I don't know 
whether you do or not.
    Mr. Gellert. We do not. But I would point out, and I am not 
sure the data that you are referring to, but I will point out, 
of course, a lot of the municipal issuants were insured, so you 
definitely have a skewing of default stats and statistics and 
ratings--
    Mr. Capuano. Actually, these are based on noninsured.
    Mr. Gellert. Okay, fine.
    Mr. Capuano. And that was my basic argument, that I 
believed then that munis were being chased into insurance that 
they didn't need.
    Mr. Gellert. I was just clarifying.
    Mr. Capuano. Mr. Kroll, do you do munis?
    Mr. Kroll. Yes.
    Mr. Capuano. Do you--
    Mr. Kroll. We are releasing a--
    Mr. Capuano. Oh, your microphone, please.
    Mr. Kroll. We are releasing--yes, we do munis. We are just 
starting. We will release a study in September, taking the 200 
most liquid muni issues. Many involve States. Some involve 
cities. And we are looking at the actual financials, so we will 
not be using dated information, and sometimes a year, year and 
a half dated, to come up with our ratings of those. So stay 
tuned for September.
    Mr. Capuano. I am looking forward to it.
    Thank you all very much. I appreciate it.
    Chairman Neugebauer. I thank the gentleman.
    And, now, the vice chairman, Mr. Fitzpatrick.
    Mr. Fitzpatrick. Mr. Sharma, I want to follow up on the 
line of questions of the chairman earlier.
    In a letter sent to this subcommittee dated June the 13th, 
Secretary Geithner acknowledged that he, along with Deputy 
Secretary Wolin, OMB Director Lew, and a representative of the 
Vice President's office, met with S&P personnel on April 13th, 
an actual meeting.
    Are you aware of what was discussed at that meeting?
    Mr. Sharma. Congressman, no, I am not. I know our team, as 
mentioned, regularly meets with them as part of the process on 
trying to get a better understanding, and they met with the 
Treasury. I wasn't even aware that they met with the members 
that you just said, but I know they had a meeting. They met 
with them.
    I am not privy to people they meet, once they are in the 
ratings process.
    Mr. Fitzpatrick. According to documents obtained by this 
committee, 2 days after that meeting, on April 15th, David 
Beers reached out to Under Secretary Goldstein to let Treasury 
know the rating committee's outcome.
    Do you know what was discussed on that call?
    Mr. Sharma. No, Congressman, I don't. Normally, the process 
would be once the ratings committee makes a decision, we write 
up the decision. We also inform the issuer of the rating 
action, if there is a change or if there is an affirmation. And 
if there is any publication that we are going to do, we do 
share it with them also.
    Mr. Fitzpatrick. So you would have informed the issuer 
before the public would find out what the--
    Mr. Sharma. We let them know that we would be taking a 
rating action, yes.
    Mr. Fitzpatrick. Shortly after that call, Mary Miller of 
Treasury reached out to David Beers of S&P for a draft press 
release on the outlook change. This was 3 days before the 
actual press release occurred.
    What would be the purpose of sharing a draft press release 
with the issuer?
    Mr. Sharma. It is to give the issuer a chance. If there are 
any factual errors or anything else in the press release, then 
there is an opportunity to correct that, so that we want to 
give the public a completely error-free information. And so, 
that is the opportunity for them.
    Mr. Fitzpatrick. And that is standard practice?
    Mr. Sharma. That is standard operating procedure, yes.
    Mr. Fitzpatrick. Do you know whether or not the Department 
made any substantive changes to the press release?
    Mr. Sharma. Congressman, I don't know that.
    Mr. Fitzpatrick. The next day, which was 2 days before the 
actual press release, another Treasury official reached out to 
John Chambers and asked if there is a communications director 
that Treasury's press people can connect with. And it appears 
that a call actually did take place.
    Do you know what happened on that call, what might have 
been discussed?
    Mr. Sharma. I don't know specifically, but generally, there 
is--they may have wanted to coordinate as to when we will be 
releasing our information so they can plan their own releases 
of information that they may have intended to do so.
    And that is a normal process that even a corporation that 
we rate, where if we are going to announce a rating action, 
which they believe is material, then they may want to 
coordinate with their own communications group as to what they 
may want to say to the public along the timelines of when we 
will say.
    Mr. Fitzpatrick. But you don't know what occurred on the 
telephone call?
    Mr. Sharma. No, I don't.
    Mr. Fitzpatrick. And you don't know whether or not Treasury 
asked for any substantive changes to the draft press release in 
the days before it was issued?
    Mr. Sharma. As I said, the purpose of sharing the draft 
release is only if there is a factual error. Once a rating 
committee decision is made, we proceed along those lines.
    Mr. Fitzpatrick. And you believe that is an appropriate 
process?
    Mr. Sharma. We believe that is an appropriate process, 
because it allows elimination of any errors that may occur by 
mistake or by any other reason. But once the rating action is 
done, we follow the process, and we follow it very rigorously 
within our organization.
    Mr. Fitzpatrick. Mr. Chairman, I would just ask that the 
Secretary's letter dated June 13th and the attachments be made 
a part of the hearing record.
    Chairman Neugebauer. Without objection, it is so ordered.
    Mr. Capuano. Mr. Chairman, if the gentleman would yield for 
a minute?
    Mr. Fitzpatrick. Yes.
    Mr. Capuano. Thank you.
    Mr. Sharma, again, I want to be clear. As I said, as a 
former mayor, I got phone calls from your agency before you 
came out with a rating. It is common throughout everything you 
do. Is that a fair statement?
    Mr. Sharma. Just to be--
    Mr. Capuano. Every rating you do, you give the individual 
being rated an opportunity to correct factual disagreements?
    Mr. Sharma. Yes.
    Mr. Capuano. Mr. Rowan, does your company do the same 
thing?
    Mr. Rowan. Our company has the same policy, Congressman, 
for the same purpose, to ensure that there isn't a material 
misstatement of fact or inadvertent disclosure.
    Mr. Capuano. I know you do, because Moody's called me, too.
    Mr. Gellert, again, you are a little different, in that you 
don't do public stuff, but do you do something similar?
    Mr. Gellert. We have absolutely no contact with issuers at 
all.
    Mr. Capuano. Because you don't make public statements of 
any kind, then?
    Mr. Gellert. That is correct.
    Mr. Capuano. That is what I thought.
    Mr. Kroll, on your public aspects?
    Mr. Kroll. On the issuer-paid side of our business, because 
we also have a subscription business--
    Mr. Capuano. Yes.
    Mr. Kroll. --on the issuer-paid, which has done our first 
five transactions, we do the same thing. But it is only about 
correcting any factual error that we may have.
    Mr. Capuano. So it is a standard practice in the industry?
    Mr. Kroll. Correct.
    Mr. Capuano. Thank you.
    Chairman Neugebauer. I want to thank this panel. This has 
been a very good hearing. And we appreciate your time and your 
thoughtful testimony.
    The Chair notes that some members may have additional 
questions for this panel which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for members to submit written questions to these 
witnesses and to place their responses in the record.
    If there is no further business, this hearing is adjourned.
    [Whereupon, at 1:02 p.m., the hearing was adjourned.]

























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