Moody and S&P to Address Ratings Role in Mortgage Market

Scheduled to speak today and tomorrow on Capital Hill, executives of Moody’s Investors Service, owned by Moody Corp, and McGraw-Hill Cos.’ Standard & Poor will be addressing publicly for the first time their decision to downgrade hundreds of mortgage-bond ratings over the summer, a move some feel came a little too late and helped exacerbate the credit markets' woes since.  
 
Additionally, Moody's, in attempt to assuage critics, is suggesting a host of industry overhauls it says would help prevent what happened this past summer. The effort is an attempt to ward off more extensive, and expensive, federal regulations while restoring ratings firms' reputation among investors who worry the ratings for complex structured mortgage products may not be as reliable as they thought.  
 
Rating firms play an integral role in the mortgage market. Homeowners borrow from mortgage bankers, which often resell the loans to Wall Street firms. The loans get bundled and repackaged as part of securities that are evaluated by the rating firms and then sold. The rating firms help investors understand the risk of these bonds defaulting by putting a rating, such as a stellar triple-A, on the bonds.  
 
Some of those ratings have come into question as the firms have downgraded hundreds of previously highly rated securities, contributing to the turmoil in credit markets as investors dumped downgraded securities and refused to step in and buy securities on the market.  
 
"We're very nervous right now," says Richard Metcalf, director of corporate affairs for the Laborers' International Union of North America, which advises pension funds. "We'll be much less likely to invest in these types of products if we're not assured we're getting an honest and independent rating."  
 
Some have questioned if the rating firms are independent from the Wall Street firms that issue bonds and pay for their ratings. Mr. Metcalf says he wants rating firms to disclose more about their business practices, much like accounting firms did with the 2002 Sarbanes-Oxley law.  
 
Moody's is focusing on changes that could improve the data it relies on to rate bonds in the hard-hit sub-prime mortgage area. Moody's and other rating firms sometimes relied on what turned out to be bad data on the creditworthiness of borrowers and the value of the homes they bought.  
 
Among the firm's suggestions: requiring more reporting on loan performance and including auditors who would review the accuracy of loan information such as appraised home values and borrowers' credit history. Moody's suggests a third party, a mortgage trustee, for example, could audit loans by contacting borrowers to confirm their income, loan terms and whether the house is their primary residence.  
 
"We have to restore the confidence in what we do," says Brian Clarkson, president of Moody's rating business. Moody's says it would potentially give higher ratings to mortgage bonds that abide by its recommendations.  
 
The problems with the ratings started when the default rates on some sub-prime bonds started coming in much higher than projected. If investors lose confidence in ratings, markets for new issues can dry up, hurting revenue at both the ratings firms and at Wall Street firms. If worries persist, ratings could be viewed as less valuable, and issuers may become less willing to pay firms to rate their bonds.  
 
The Senate Banking Committee today and a House financial services subcommittee tomorrow will ask if rating firms need more rules. Securities and Exchange Commission Chairman Christopher Cox is slated to testify today. The committee's chairman, Christopher Dodd, wrote to Mr. Cox on Monday, suggesting topics could include whether the agency should consider revoking firms' designation to rate certain securities in cases w