Vows of Change at Moody’s, but the Flaws Remain the Same

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by Jesse Eisinger, ProPublica, April 13, 2011, 4:28 p.m.March 30, 2011

In the aftermath of the financial crisis, nobody has gone to prison and there haven’t been any serious structural changes in the financial system. But at least everyone involved feels bad about it and has vowed to change, right?

For Moody’s Investors Service, those pledges are empty, Bill Harrington says.

Mr. Harrington was an analyst in the structured finance group at Moody’s for more than a decade, much of it spent rating collateralized debt obligations. He worked at Moody’s until the middle of last year, although he left the C.D.O. group in 2006. In his job, he had a window on the biggest debacle in the history of credit ratings. Companies like his allowed banks to pass off hundreds of billions worth of paper onto investors by waving their magic wands and deeming the securities investment-worthy.

Since then, the government has tried to change the ratings agencies. The Dodd-Frank financial reform law has some bold measures, like making the ratings firms liable for their judgments. Unfortunately, the rules are in danger of not being enforced because of budget constraints and resistance from the agencies.

But the biggest problems at Moody’s may have been cultural. The dominant ethos during the boom, instilled by Brian M. Clarkson, the former president and chief operating officer, was that customer service was Job 1. And the customers were the bankers.

The ability for bankers to run the show has long been an obvious flaw in the ratings system for structured products. Investment banks create the securities and benefit when they receive generous ratings. Banks pay the agencies that supply the ratings. Yet the agencies are somehow supposed to hold the line with the people who are responsible for their paychecks.

To Moody’s credit, Mr. Clarkson is now gone. To Moody’s discredit, however, his philosophy is largely still in place, at least according to Mr. Harrington.

To the last day Mr. Harrington was there, he says, bankers remained hard-charging and aggressive advocates for their deals, sometimes to the point of abusing the analysts.

Wall Street ain’t beanbag, so that’s not surprising. The troubling aspect is that the Moody’s bosses acted like disinterested brokers between two sides in disputes with analysts, instead of standing up for the analysts and defending their independence. “That was the standard operating procedure that got worse and worse. We didn’t get the benefit of the doubt,” Mr. Harrington said.

When I asked Moody’s about Mr. Harrington’s experiences, a spokesman wrote in an e-mail: “We take strong exception to your characterization of Moody’s culture. We have always had an unwavering culture of integrity, analytical independence and objectivity and that culture has only grown stronger since the financial crisis.” He pointed to numerous efforts at Moody’s to improve the ratings process and to bolster Moody’s procedures.

In the spring of 2009, Mr. Harrington was working on a deal and a banker was persistently calling him. He returned the first call, but had other work that day and didn’t return the next two calls right away. “I thought caller ID served a purpose,” he said wryly.

Soon after, his boss alerted him to a call he’d received from Michael Kanef, the head of compliance. Mr. Kanef wanted to know why Mr. Harrington hadn’t returned the banker’s call. Mr. Harrington was shocked. Why was the head of compliance getting involved? But he got the apparent message: Analysts are to lean over backward for the bankers. That had been Mr. Clarkson’s philosophy, and now it was his successors’.

“The culture persists — and it’s being enforced by compliance department,” Mr. Harrington said.

So who is Mr. Kanef? Before he was the head of regulatory affairs and compliance, he was in charge of ratings on residential mortgage-backed securities. Did such an executive deserve a promotion?

And then there is Raymond W. McDaniel, the chief executive throughout the housing boom, the bust and the entire financial crisis. He remains at the helm. And he had to swallow the bitter pill of more than $9 million in compensation last year. Indeed, most of Moody’s top management has been in place through the crisis.

Moody’s didn’t make Mr. Kanef or Mr. McDaniel available for comment.

So if Moody’s doesn’t think the executives who ran the company were responsible for its collapse in reputation and contribution to the multitrillion-dollar financial crisis, who do they think is to blame? The analysts, Mr. Harrington says. The hard-working, low-level minions with little decision-making power.

Mr. McDaniel has conceded that sometimes “we drink the Kool-Aid.”

But that hardly makes the analysts to blame.

“If some analysts drank the Kool-Aid, it was only because management mixed and stirred it up and threatened that analysts wouldn’t get to heaven on the spaceship unless he or she drank it,” Mr. Harrington said.

Moody’s has recognized it has a disaster on its hands — a public relations disaster. Clients — the investors who use ratings — have been losing faith in the agencies. Mr. Harrington said that Moody’s executives marched analysts into meetings to explain how they were going to tell their clients about how much Moody’s had grown and learned from its mistakes. It was as if they were in “Communist re-education camp,” he said.

At one of these meetings, an analyst asked if they could be given training in how to deal with banker abuse, Mr. Harrington recalls. The suggestion was immediately shot down by the executive running the meeting.

Moody’s says that its retraining efforts are part of its continuing efforts to reach out to investors to improve its ratings.

When Moody’s executives make public presentations, as when Mr. McDaniel testified in front of the Financial Crisis Inquiry Commission, the overarching theme is that the agency’s problem was limited to the housing-related structured finance. Few people saw how fast and deep the housing market would crash. How could the ratings agencies?

A few weeks ago, Alan Greenspan penned an instantly notorious line: “With notably rare exceptions,” he wrote, unfettered financial markets have worked well. Moody’s persists in believing that with notably rare exceptions, so too have credit ratings.

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