One of the big reasons that real estate is where it’s at now is because subprime mortgage-backed securities got such fabulous ratings from credit-rating firms when, in fact, greater scrutiny was in order.
State Attorney General Andrew Cuomo on Thursday announced a deal with the nation’s major credit-rating agencies aimed at ensuring such scrutiny. The reforms would require greater disclosure and would change how the agencies are paid by the investment banks that seek their ratings.
Moody’s Investors Service, Standard & Poor’s and Fitch Ratings agreed to five reforms expected to be implemented over the next six months:
- Fee Reforms: Credit-rating agencies are typically compensated only if they are selected to rate mortgage-backed securities by an investment bank. The agencies will now establish a fee-for-service structure, where they will be compensated regardless of whether the investment bank ultimately selects them to rate a security.
- Disclosure Reforms: The agencies will disclose information about all securitizations submitted for their initial review. This will enable investors to determine whether issuers sought, but subsequently decided not to use, ratings from a credit rating agency.
- Loan Originator Review. The agencies will establish criteria for reviewing individual mortgage lenders (known as originators), as well as the lender’s origination processes. The agencies will review and evaluate these loan originators and disclose their originator evaluations on their Web sites.
- Due Diligence Reforms: The agencies will develop criteria for the due diligence information that is collected by investment banks on the mortgages comprising a mortgage-backed security. The agencies will receive loan level results of due diligence and review those results prior to issuing ratings. The credit rating agencies will also disclose their due diligence criteria on their websites.
- Credit Agency Independence: The agencies will perform an annual review of their mortgage-backed securities businesses to identify practices that could compromise their independent ratings. The agencies will remediate any practices that they find could compromise independence.
- Representations and Warranties: The agencies will require a series of representations and warranties from investment banks and other financially responsible parties about the loans underlying the securities.