[Congressional Record (Bound Edition), Volume 159 (2013), Part 9]
[Senate]
[Pages 12359-12360]
[From the U.S. Government Publishing Office, www.gpo.gov]




                         CREDIT RATING AGENCIES

  Mr. FRANKEN. Mr. President, I rise today to discuss a problem I have 
spoken about many times over the past 3 years, beginning with debate on 
the Dodd-Frank Wall Street reform bill. That bill, which Congress 
passed in July 2010, contained a provision I authored with my 
Republican colleague Senator Roger Wicker of Mississippi. Our provision 
gave the Securities and Exchange Commission the authority to issue 
rules to address the conflicts of interest inherent in the credit 
rating industry--conflicts of interest which contributed mightily to 
our recent financial collapse and which have continued to plague that 
industry through today.
  I am speaking about this issue again because even though the 
conflicts continue to put our economy at risk, the SEC still has not 
proposed meaningful reforms. The SEC has studied the issue, the 
Financial Crisis Inquiry Commission has studied the issue, and the 
Permanent Subcommittee on Investigations has studied the issue. Now it 
is time to move forward and take action on the issue.
  Let me start off by briefly reminding everyone what this conflict of 
interest is about and why it is important. In the years leading up to 
2008 financial collapse the credit rating agencies were enjoying 
massive profits and booming business. There is nothing inherently wrong 
with massive profits and booming business, but there was one 
fundamental problem: Booming business was coming at the expense of 
accurate credit ratings, which is supposed to be the entire reason for 
the existence of the credit rating agencies.
  Credit rating agencies were and still are paid to issue ratings 
directly by the big Wall Street banks issuing the paper and requesting 
the ratings. If a rating agency--let's say Moody's--does not provide 
the triple-A rating the bank wants, the bank can then just take its 
business over to Fitch or S&P. That is called ratings shopping, and it 
continues to this day. The opportunity for ratings shopping creates an 
incentive for the credit raters to give out those triple-A ratings even 
when they are not warranted, and that is exactly what happened with the 
subprime mortgage-backed securities that played such a crucial role in 
the financial crisis--and it happened over and over. It became 
ingrained in the culture of the industry.
  The Permanent Subcommittee on Investigations, chaired by Senator 
Levin, took a close look at the big three rating agencies, examined 
millions of pages of documents, and released an extensive report 
detailing the internal communications at Moody's, S&P, and Fitch. Among 
the many troubling e-mails, there is one in particular from an S&P 
official that sums up the prevailing attitude quite nicely: ``Let's 
hope we are all wealthy and retired by the time this house of cards 
falters.''
  With all the risky bets in the financial sector--and bets on those 
bets--our financial sector indeed became a house of cards. But without 
the conduct of the credit raters, the house of cards would have been 
just one card tall.
  Two years after that e-mail was written, that house of cards did not 
just falter, it collapsed. Because that house of cards had grown 
several stories high, when it collapsed it brought down the entire 
American economy with it. The financial meltdown cost Americans $3.4 
trillion in retirement savings. It triggered the worst crisis since the 
Great Depression with its massive business failures and mass 
foreclosures and job losses and the explosion of our national debt.
  The crisis profoundly affected the everyday lives of millions of 
Americans in so many negative ways, including in Minnesota. People lost 
their homes, their jobs, their retirement savings, and their health 
insurance.
  I have previously shared on the floor the story of my constituent 
Dave Berg from Eden Prairie, MN. He testified at a field hearing I had 
in May of 2010 and told his story about having to start over--finding a 
new job and rebuilding his retirement savings--at 57 years of age. His 
reflections on his experience in the recession mirror those of millions 
of other Americans.
  He said:

       The downturn of the economy, caused in part by the abuses 
     on Wall Street, led to the loss of my retirement security. 
     Reforming the way Wall Street operates is important to me 
     personally, because I have a lot of saving yet to do--and I 
     simply cannot afford another Wall Street meltdown. I need to 
     have confidence in the markets--and I need to know there is 
     accountability to those who caused a financial crisis.

  It is hard to overestimate the extent to which the credit rating 
agencies contributed to the financial crisis in which millions like 
Dave Berg lost their jobs, their homes, and far too many Minnesotans 
had their hopes for the future dashed.
  These Americans are not necessarily seeking retribution from Wall 
Street. They just need to be assured it will not happen again. They 
know there is a problem and the problem needs to be fixed.
  We do not need further proof of that, but we get it in the February 
complaint filed by Department of Justice against S&P in which DOJ 
alleges--as it stated when it filed the complaint--that the credit 
rating agency ``falsely represented that its ratings were objective, 
independent, and uninfluenced by S&P's relationships with investment 
banks when, in actuality, S&P's desire for increased revenue and market 
share led it to favor the interest of these banks over investors.''
  The complaint highlights the patently problematic way the credit 
rating agencies habitually did business. One e-mail obtained in that 
investigation from a high-level S&P official reads:

       We are meeting with your group this week to discuss 
     adjusting criteria for rating CDO's of real estate assets . . 
     . because of the ongoing threat of losing deals.

  CDOs--collateralized debt obligations--are one of those derivatives, 
or bets, that added stories to the house of cards. This official had 
apparently become so comfortable with the culture of conflicts of 
interest that he appeared to have no reservations about putting it in 
writing.
  In fact, a while ago, S&P asked the judge in the case to throw out 
the Justice Department lawsuit against them by pointing to a previous 
decision made by a U.S. district court judge in an earlier securities 
fraud case against them. That earlier suit against the S&P had been 
filed by shareholders who said they had bought their shares believing 
that S&P's ratings were independent and objective--as the S&P had long 
declared. But the judge in the earlier case dismissed the shareholders' 
suit, finding that the S&P's statements that their ratings were 
independent and objective were ``mere puffery.'' In other words, no one 
could take S&P's statements about their ratings objectivity and 
independence seriously. It was just puffery and advertising that no one 
could believe.
  Very recently, S&P tried to use--in the Department of Justice's case 
against them in their filing--the earlier ``puffery'' ruling to try to 
get the Justice Department suit thrown out against them. So S&P's legal 
argument was that no one could reasonably think that they had a 
reputation for producing independent and credible ratings.
  Thankfully, earlier this month, the judge in the DOJ suit ruled that 
the DOJ suit could go forward and said last week he found S&P's puffery 
defense to be ``deeply and unavoidably troubling.''
  S&P's rationale should strike us all as deeply and unavoidably 
troubling because their legal defense--this is S&P's legal defense--
said no one could possibly rely on their ratings. But their job is to 
provide independent, objective, and accurate ratings. Millions of 
Americans lost their jobs because S&P didn't do its job. S&P didn't do 
their one job. They have one job and that is to provide accurate 
ratings.

[[Page 12360]]

They didn't do their one job. They have no other job.
  I am glad the Department of Justice is pursuing this case, but DOJ's 
action is not enough. It is backward-looking and addresses past harms. 
My concern is that the conduct continues to this day.
  The ACTING PRESIDENT pro tempore. The Senator's time has expired.
  Mr. FRANKEN. Mr. President, I ask unanimous consent for 5 more 
minutes.
  The ACTING PRESIDENT pro tempore. Without objection, it is so 
ordered.
  Mr. FRANKEN. Mr. President, I am glad the DOJ is going forward in 
pursuing this case, but as I said it is not enough. It is backward-
looking and addresses past harms. My concern is that the conduct 
continues to this day. The credit raters are still influenced by the 
relationships with the banks because that is who pays them. It is a 
clear conflict of interest, and we need to prioritize actions that will 
prevent another meltdown in the future.
  The Dodd-Frank provision I wrote with Senator Wicker, if implemented 
in full, would root out the conflicts of interest from the issuer pays 
model. The amendment we offered and the Senate passed directed the SEC, 
Securities and Exchange Commission, to create an independent self-
regulatory organization that would select which agency--one with the 
adequate capacity and expertise--would provide the initial credit 
rating of each structured financial product.
  The assignments would not be based just on the agency's capacity and 
expertise but also, after time, on its track record. Our approach would 
incentivize and reward excellence. The current pay-for-play model--with 
its inherent conflict of interest--would be replaced by a pay-for 
performance model. This improved market finally allows smaller rating 
agencies to break the Big Three's oligopoly.
  The oligopoly is clear. The SEC estimates that as of December 31, 
2011, approximately 91 percent of the credit ratings for structured 
finance products were issued by the three largest credit rating 
agencies--Fitch, Moody's, and S&P--each of which was implicated in the 
PSI investigation. The other five agencies doing structured finance 
make up the remaining 9 percent.
  The current oligopoly does not incentivize accuracy. However, if we 
move to a system based on merit, the smaller credit rating agencies 
would be better able to participate and serve as a check against 
inflated ratings, thereby helping to prevent another meltdown.
  In our proposed model, the independent board would be comprised 
mainly of investor types--managers of university endowments and pension 
funds--who have the greatest stake in the reliability of credit 
ratings, as well as representatives from the credit rating agencies, 
the banking industries, and academics who have studied this issue.
  Our amendment passed the Senate with a large majority, including 11 
Republican votes. This is not a progressive or conservative idea, it is 
a commonsense idea.
  The final version of Dodd-Frank modified the amendment and, to be 
frank, put more decisionmaking authority in the hands of the SEC as to 
how to respond to the problem of conflicts of interest in the credit 
rating agency industry. The final version directed the SEC to study the 
proposals that Senator Wicker and I made, along with other 
alternatives, and then decide how to act.
  The SEC released its study in December. The study acknowledged the 
conflicts of interest in the credit rating industry and reviewed our 
proposal and many of the alternatives. They laid out the pros and cons 
of each proposal without reaching a definitive conclusion on which 
route to pursue.
  The study also proposed holding a roundtable discussion to further 
examine reform opportunities. This SEC convened this roundtable on May 
14, and both Senator Wicker and I had the opportunity to present 
opening remarks. Bloomberg News had a good article on the roundtable on 
March 14, including several key quotes that I am going to use in my 
remarks. The roundtable provided a rigorous examination of our proposal 
and of the alternatives.
  One executive who was from a smaller rating agency endorsed the 
concept of a rotating assignment system to help break up the current 
oligopoly. Jules Kroll, the CEO of Kroll Bonding Credit Agency, said of 
the Big Three: ``They're selling themselves out, just as they did 
before.''
  The Big Three were also represented at the roundtable. An S&P 
representative argued against meaningful reform by suggesting that ``a 
government assignment system could create uncertainty, could slow down 
markets, and disrupt capital flows at a time when we could least afford 
it.'' He didn't mention puffery. Unsurprisingly, I disagree with his 
characterization and would indeed suggest that what we can least afford 
is to maintain the status quo.
  An alternative proposal, the continuation of the 17g-5 proposal, was 
met with more than a little skepticism. The 17g-5 Program seeks to 
encourage unpaid, unsolicited ratings by requiring the sharing of data 
on which ratings are based. The theory is, unsolicited ratings will 
keep paid ratings honest. Joseph Petro of Morningstar Credit Ratings 
said using the unsolicited rating program ``is not the best use of 
resources as we're trying to build out our ratings platform.'' SEC 
Commissioner Troy Paredes made a strong point when he noted that 
negative, unsolicited ratings by a firm ``may not be the best way to 
get business in an issuer-pays setting.'' By the time the report was 
written, the 17g-5 Program had produced only one or two ratings.
  I have said all along that I believe the proposal of Senator Wicker 
and myself is a good one and the right one, and I continue to believe 
that more and more as I have thought about it and looked at it in the 
years now since we originally wrote the legislation. But I have also 
said I am open to any other meaningful proposals, and I will support 
any proposal the SEC recommends that addresses the conflicts of 
interest in a meaningful way. But the Roundtable made very clear once 
again that reform is necessary and that the status quo is inadequate to 
protect American investors, workers, and homeowners in the years ahead.
  Dealbreaker.com, a satirical blog that covers Wall Street, ran a post 
on the day of the SEC Roundtable with this title: ``The SEC Will Keep 
Talking About Credit Rating Agencies Until Everyone Stops Paying 
Attention.'' That is one approach Wall Street regulators can choose to 
take and it would be completely unacceptable. To do that would be to 
fail the American people. Senator Wicker and I have worked with the SEC 
continuously over the past 3 years, and I will continue to pursue this 
issue until the SEC fulfills its directive to address the conflicts of 
interest in the credit rating industry. I am obligated to my 
constituents and to the American public to make sure that satirical 
headline does not become reality.
  I look forward to working with the SEC on the next steps toward a 
proposed rule on credit rating reform.
  I yield the floor, and I note the presence of both of my esteemed 
colleagues from Hawaii, including the one presiding, and Senator 
Hirono, who is about, I believe, to ask for the floor.
  The ACTING PRESIDENT pro tempore. The Senator from Hawaii.

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