Whatever the defensive spin and the persistent denial of the deepening conditions of adversity, problems yet to ripen mean that we are not yet even approaching what Winston Churchill termed the “end of the beginning.” …The agencies themselves are touting a menu of fixes, from Moody’s proposal to replace letter ratings with numbers – arguably no more than a switch from illiteracy to innumeracy – to massive downgrades of mortgage-backed securities with knock-on effects for other debt portfolios and the entire bond insurers speciality, to the blame-the-user invocation by Standard & Poor’s of more “investor education.”
But should the ratings agencies feel confident of dodging the bullets? Two lessons in history suggest not. First, the closely analogous model of the auditors’ participation in the securities marketplace has brought them to grief, with multi-billion dollar litigations threatening their very survival. Second, both plaintiffs’ lawyers and legislators, inspired by Sarbanes-Oxley, will pick on proximate targets. That’s where they will both fix the blame and aim their fire…
But let’s back up a little bit.
Let’s bring the auditors into the picture.
…Are the ratings agencies always the last to know, or just the last to acknowledge a problem? The agencies point out that they rely on facts presented by issuers, and that they are not responsible for conducting due diligence. In other words, if S&P and Moody’s are asked to rate a pool of mortgage loans, they don’t actually examine any of the individual mortgages within the pool. An S&P spokesperson tells us, “We are not auditors; we are not accounting firms.” So if all the information about the assets underlying these bonds comes from the person selling them, and the credit rating agency never verifies any of it, investors might ask, what exactly does the rating agency provide? An opinion…
But does it get any better for the investor if the audit firms are involved in the process?
No way, José !
I have criticized the audit firms for their “too little too late” response to their banking and financial serviccs clients’ accounting issues related to the subprime crisis. They’re all involved in all of them. So if the auditors are supposed to be certifying financial statements and giving assurances on companies that are issuing mortgages and later mortgage-backed securities and the ratings agencies are counting on those disclosures, without doing their own due diligence to ascertain that those ratings are justified, who is monitoring the authenticity, integrity, and financial viability of the ratings agencies’ business model?
The Big 4.
The three largest ratings agencies, S&P (part of McGraw-Hill), Moody’s, and Fitch (part of Fimalac, a French company) are all public companies that issue Big 4 certified financial statements. So the Big 4, that’s right – only four firms, are on all sides of the equation:
1) They audit the companies that create the mortgages like New Century, Countrywide, Northern Rock and American Home.
2) They audit the firms that create, market and invest in the collateralized mortgage obligations such as Bear Stearns and Citibank and Merrill Lynch.
3) They audit the ratings agencies that put the seal of approval on the credit risk insurers and the securities for sale to the investor public.
4) They audit the monoline credit risk insurance providers MBIA (PwC) and AMBAC (KPMG).
And the ratings agencies rate the credit risk insurers.
From AMBAC’s web page:
Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose affiliates provide financial guarantees and financial services to clients in both the public and private sectors around the world. Ambac’s principal operating subsidiary, Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned AAA ratings from Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services and a Aa rating from Fitch, Inc. Moody’s has placed Ambac’s AAA on review for possible downgrade. Standard & Poor’s has placed Ambac’s AAA rating on “negative outlook.” Fitch has placed Ambac’s Aa rating on “rating watch negative.”
The auditor for Moody’s has been PwC for a long time .
The auditor for Fimalac, owner of Fitch, has been PwC for a long time .
The auditor for McGraw-Hill, owner of S&P, has been E&Y for a long time .
All recent opinions for all three are clean.
Dontcha think that the audit firms should have had some kind of insight into how the pieces did or didn’t fit together? Or did they just take the enormous amounts of money and run?