WASHINGTON — The chairman and CEO of Moody's Corp. said Friday that he didn't know that his company continued to give investment-grade ratings to complex financial instruments backed by shaky subprime mortgages even after it downgraded billions of dollars worth of such deals in the summer of 2007.
His admission came during a daylong hearing by the Senate permanent subcommittee on investigations, which is looking into the origins of the nation's worst financial crisis since the Great Depression.
Moody's chief Ray McDaniel, under questioning, said that he didn't think his company had continued to rate complex deals backed by U.S. mortgages after it and competitor Standard & Poor's jolted the markets in July 2007 with massive downgrades of earlier deals.
"I apologize, I do not recall that," McDaniel said.
The panel's chairman, Sen. Carl Levin, D-Mich., then presented him with documentation that both Moody's and S&P gave investment-grade ratings to a Citigroup deal in December 2007, worth almost $400 million, backed by shaky subprime loans that by then clearly were toxic.
The point Levin was making — and made repeatedly — is that credit-rating agencies did whatever was needed to get lucrative fees, some as high as $1.4 million, for rating complex deals.
Later, McDaniel stressed that preserving market share "is not as important as ratings quality."
While other Wall Street executives have expressed contrition when they appeared before Congress, McDaniel and former S&P president Kathleen Corbet were unapologetic on Friday.
Throughout the day in earlier testimony and in e-mails released by Levin, however, former Moody's and S&P officials told how they were pushed out or quit in frustration because managers badgered them to "massage" complex deals until they could land the business.
A McClatchy investigation in October documented how top managers from the structured finance division, which rated the complex deals, were moved into the top executive suites at Moody's and effectively took over the company.
McDaniel and Corbet said they were unaware that their analysts felt pressured to sacrifice the quality of investment-grade ratings to maintain market share and earn the huge accompanying fees.
Investment-grade ratings gave investors the illusion of safe bets, allowing big Wall Street firms such as Goldman Sachs to peddle the securities across the globe. Moody's and its chief competitors were key players in the prelude to a near meltdown of global finance in September 2008.
Called to appear before the panel, Richard Michalek, a former Moody's vice president and senior credit officer, described the ratings process for deals that could bring more than $1 million in fees as a "must say yes" atmosphere.
Levin read e-mail after e-mail from inside the ratings agencies about deals that never should have been rated, much less received investment-grade ratings.
"These e-mails are just devastating to the kind of culture that is going on here," he said.
Most striking was testimony from Eric Kolchinsky, a Moody's managing director who in 2007 was in charge of the division that rated the complex deals called collateralized debt obligations. CDOs are securities backed by pools of U.S. mortgages that have been packaged together into bonds and sold to investors.
Kolchinsky recounted how in the first two quarters of 2007, his group generated more than $200 million in revenue for Moody's by giving complex deals investment-grade ratings — which told investors that they were safe bets. In the late summer of 2007, however, Kolchinsky was informed by superiors that bonds issued a year earlier were about to be severely downgraded.
That should have required a new methodology for ratings on deals that were still pending, but when he tried to do that, he was told not to. It amounted to securities fraud, in his opinion.
"My manager declined to do anything about the potential fraud, so I raised the issue to a more senior manager," he testified. He said that the complaint resulted in a change to methodology. "I believe this action saved Moody's from committing securities fraud. Because of the culture, I knew what I did would possibly jeopardize my role at Moody's."
He was right. Less than two months after challenging the integrity of the ratings, Kolchinsky was removed from his post and given a lower-paying job elsewhere in the company with far less responsibility. He eventually left.
Under questioning from Levin, Kolchinsky acknowledged that he and his staff rated the complex Goldman Sachs deal that this month became the subject of fraud charges brought against Goldman by the Securities and Exchange Commission.
The SEC alleges that Goldman failed to disclose to investors that hedge fund mogul John Paulson helped pick the mortgages in the deal with an eye toward betting that they'd fail. Kolchinsky said this information was never shared with Moody's.
"I did not know and... I am fairly certain my staff did not know either," Kolchinsky said.
Asked by Levin whether that would have affected the rating the deal received, Kolchinsky said yes.