The Securities and Exchange Commission is taking written comments on its regulation of bond rating agencies, and one of the submissions was from a former Moody’s senior analyst with something to get off his chest. As noted by one reporter who read the testimony, “the comment is a scathing indictment of Moody's processes, conflicts of interests, and management” and will make the former employee “a star witness at any future litigation or hearings on this topic.”
The analyst rated mortgage backed securities during the housing bubble, with those issuing the securities paying the rating agencies to provide ratings. That is the way bond ratings now work. The conflict of interest is that those issuing the securities might not hire agencies willing to warn investors by issuing low ratings. “Moody's analysts whose conclusions prevent Moody's clients from getting what they want,” according to the former analyst’s comment, “are viewed as ‘impeding deals’ and, thus, harming Moody's business. These analysts are often transferred, disciplined, ‘harassed,’ or fired.” The submission confirms what many if not most people suspected.
According to the analyst, “Moody's ratings often do not reflect its analysts' private conclusions. Instead, rating committees privately conclude that certain securities deserve certain ratings–but then vote with management to give the securities the higher ratings that issuer clients want.” The reporter, Henry Blodget, is a former securities analyst banned from the industry for a similar reason – his official research reports on the internet stocks he was paid to follow in the 1990s dot.com bubble were at odds with what he actually believed. Because the companies he was analyzing would only give business to those investment banks that reported on them favorably, and because the investment banks wanted to dump soon to be worthless stocks on gullible investors.
“Moody's defense of its conduct during the housing bubble is laughable,” according to the ex-analyst’s comments. “The company knew full well what it was doing and what might happen. And it took deliberate steps to protect itself in the event the housing market crashed.”
In 2005, Moody’s acquired an internet-based economic data and forecasting firm, Economy.com, that had been started by two former consultants at the WEFA economic consulting group. The principals of that group had seen the same obvious trend that I and others had – housing prices had soared far beyond normal relationships to household income, to levels impossible if buyers were being held to the same underwriting standards as in the past, and the result (as in the Northeast in the late 1980s housing bubble) would be a crash. The confessing former Moody’s bond rater had know the principals of the economics firm, and was told by one of them “for some period of time after being acquired, Moody’s management had unleashed an onslaught of criticism of his forecasts…in his view, some of the criticism by management felt like personal attacks.”
Bond raters are among a host of “truth telling” professions – including appraisers, actuaries, accountants, etc. – whose opinions are supposed to be fair and objective. One by one, each of these professions and many others have been exposed as untrustworthy. For example, actuaries with opinions funded by public employee unions reported again and again for 15 years that deals to enrich public employee pensions would cost noting, while those funded by politicians found that contributions to the pension plans could be cut to reduce taxes. Instead, taxes are soaring and/or public services are being gutted across the country, to pay for the lies.
Leaving aside the effect of this on business and government, where is an honest person to work? Following my Don Quixote run against the state legislature in 2004 and my decision to exit the public sector, the bond rating agencies were among the organizations I considered applying to for a job. Given the type of bonds they rare, I figured they could have used my background in public finance, regional economics and/or real estate – or so I thought at the time. I might have very well ended up with the economist subject to “personal attacks,” or the senior bond analyst now coming clean, as my boss.
People reading what I have written in recent years might consider me a cynic. But cynicism has been beaten into me by an objective observation of events. As late at 2005, even after the discrediting of the accountants and stock analysts during the 1990s stock market bubble, and despite knowing the appraisers and actuaries could no longer be trusted, I had no idea the bond raters were also rotten to the core. I could have found myself in an environment where “everything that Moody's management did sent the message that an analyst's job was to rubber stamp ratings that issuers' wanted. The only force pulling in the opposite direction–toward integrity–was an analyst's self-respect.” I probably would have ended up getting fired.
Now this sort of thing isn’t new, I am well aware, but in this era of approaching institutional collapse – with less and less self-respect and integrity – it is pervasive. Perhaps institutions have a shelf life, as the idealism of those who founded them is replaced by the lower motivation of those who just work there, and eventually by the exploitation of those who merely seek to pillage them for their own benefit and ambition. Many of our institutions, it seems, have reached their sell-by dates in the era of Generation Greed.
My conclusion is that those with the ability, inclination or resources to start their own, brand new, uncorrupted business or non-profit organization would probably be well placed to do so. For those who do not, I advise trying to work for organizations where the founders, or at least those who worked directly with the founders, are still in charge (which is my current situation, fortunately). And don’t expect to make a lot of money, but some things are more important. Because as I wrote a while back “nobody’s gonna tell you to tell the truth>”
Of course nobody is founding any governments in the United States, and we are a long way from 1776. Which is why I believe we may end up with a much more painful restructuring, in business and the economy and government, than just about anyone now benefitting from current arrangements is prepared to contemplate.