United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE

USA CRISIS

Inflated Credit Ratings Case Study of Moodys and Standard & Poors
This chapter examines how inflated credit ratings contributed to the financial crisis by masking the true risk of many mortgage related securities. Using case studies involving Moodys Investors Service, Inc. (Moodys) and Standard & Poors Financial Services LLC 6 (S&P), the nations two largest credit rating agencies, the Subcommittee identified multiple problems responsible for the inaccurate ratings, including conflicts of interest that placed achieving market share and increased revenues ahead of ensuring accurate ratings. Between 2004 and 2007, Moodys and S&P issued credit ratings for tens of thousands of U.S. residential mortgage backed securities (RMBS) and collateralized debt obligations (CDO). Taking in increasing revenue from Wall Street firms, Moodys and S&P issued AAA and other investment grade credit ratings for the vast majority of those RMBS and CDO securities, deeming them safe investments even though many relied on high risk home loans. In late 2006, high risk mortgages began incurring delinquencies and defaults at an alarming rate. Despite signs of a deteriorating mortgage market, Moodys and S&P continued for six months to issue investment grade ratings for numerous RMBS and CDO securities. Then, in July 2007, as mortgage delinquencies intensified and RMBS and CDO securities began incurring losses, both companies abruptly reversed course and began downgrading at record numbers hundreds and then thousands of their RMBS and CDO ratings, some less than a year old. Investors like banks, pension funds, and insurance companies, who are by rule barred from owning low rated securities, were forced to sell off their downgraded RMBS and CDO holdings, because they had lost their investment grade status. RMBS and CDO securities held by financial firms lost much of their value, and new securitizations were unable to find investors.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS The subprime RMBS market initially froze and then collapsed, leaving investors and financial firms around the world holding unmarketable subprime RMBS securities that were plummeting in value. A few months later, the CDO market collapsed as well. Traditionally, investments holding AAA ratings have had a less than 1% probability of incurring defaults. But in 2007, the vast majority of RMBS and CDO securities with AAA ratings incurred substantial losses; some failed outright. Analysts have determined that over90% of the AAA ratings given to subprime RMBS securities originated in 2006 and 2007 were later downgraded by the credit rating agencies to junk status. In the case of Long Beach, 75 out of 75 AAA rated Long Beach securities issued in 2006, were later downgraded to junk status, defaulted, or withdrawn. Investors and financial institutions holding the AAA rated securities lost significant value. Those widespread losses led, in turn, to a loss of investor confidence in the value of the AAA rating, in the holdings of major U.S. financial institutions, and even in the viability of U.S. financial markets. Inaccurate AAA credit ratings introduced risk into the U.S. financial system and constituted a key cause of the financial crisis. In addition, the July mass downgrades, which were unprecedented in number and scope, precipitated the collapse of the RMBS and CDO secondary markets, and perhaps more than any other single event triggered the beginning of the financial crisis. S&P issues ratings using the AAA designation; Moodys equivalent rating is Aaa. For ease of reference, this Report will refer to both ratings as AAA. The Subcommittees investigation uncovered a host of factors responsible for the inaccurate credit ratings issued by Moodys and S&P. One significant cause was the inherent conflict of interest arising from the system used to pay for credit ratings. Credit rating agencies were paid by the Wall Street firms that sought their ratings and profited from the financial products being rated.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS Under this issuer pays model, the rating agencies were dependent upon those Wall Street firms to bring them business, and were vulnerable to threats that the firms would take their business elsewhere if they did not get the ratings they wanted. The rating agencies weakened their standards as each competed to provide the most favorable rating to win business and greater market share. The result was a race to the bottom. Additional factors responsible for the inaccurate ratings include rating models that failed to include relevant mortgage performance data; unclear and subjective criteria used to produce ratings; a failure to apply updated rating models to existing rated transactions; and a failure to provide adequate staffing to perform rating and surveillance services, despite record revenues. Compounding these problems were federal regulations that required the purchase of investment grade securities by banks and others, which created pressure on the credit rating agencies to issue investment grade ratings. While these federal regulations were intended to help investors stay away from unsafe securities, they had the opposite effect when the AAA ratings proved inaccurate. Evidence gathered by the Subcommittee shows that the credit rating agencies were aware of problems in the mortgage market, including an unsustainable rise in housing prices, the high risk nature of the loans being issued, lax lending standards, and rampant mortgage fraud. Instead of using this information to temper their ratings, the firms continued to issue a high volume of investment grade ratings for mortgage backed securities. If the credit rating agencies had issued ratings that accurately reflected the increasing risk in the RMBS and CDO markets and appropriately adjusted existing ratings in those markets, they might have discouraged investors from purchasing high risk RMBS and CDO securities, and slowed the pace of securitizations. It was not in the short term economic interest of either Moodys or S&P, however, to provide accurate credit ratings for high risk RMBS and CDO securities, because doing so would have hurt their own revenues. Instead, the credit rating agencies profits became increasingly reliant on the fees generated by issuing a large volume of structured finance ratings.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS In the end, Moodys and S&P provided AAA ratings to tens of thousands of high risk RMBS and CDO securities and then, when those products began to incur losses, issued mass downgrades thats hocked the financial markets, hammered the value of the mortgage related securities, and helped trigger the financial crisis.

Record Ratings and Revenues

From 2004 to 2007, Moodys and S&P produced a record number of ratings and a record amount of revenues for rating structured finance products. A 2008 S&P submission to the SEC indicates, for example, that from 2004 to 2007,S&P issued more than 5,500 RMBS ratings and more than 835 mortgage related CDO ratings. According to a 2008 Moodys submission to the SEC, from 2004 to 2007, Moodys issued over 4,000 RMBS ratings and over 870 CDO ratings. Revenues increased dramatically over the same time period. The credit rating agencies charged substantial fees to rate a product. To obtain a rating during the height of the market, for example, S&P generally charged from $40,000 to $135,000 to rate tranches of an RMBS and from $30,000 to $750,000 to rate the tranches of a CDO. Surveillance fees generally ranged from $5,000 to $50,000 per year for mortgage backed securities. Over a five-year period, Moodys gross revenues from RMBS and CDO ratings more than tripled, going from over $61million in 2002, to over $260 million in 2006. S&Ps revenue also increased. S&Ps gross revenues for RMBS and mortgage related CDO ratings quadrupled, from over $64 million in 3/14/2008 compliance letter from S&P to SEC, SEC_OCIE_CRA_011218-59, at 20. Altogether, revenues from the three leading credit rating agencies more than doubled from nearly $3 billion in 2002 to over $6 billion in 2007.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS

Conflicts of Interest
Credit rating agencies are paid by the issuers seeking ratings for the products they sell. Issuers and the investment banks want high ratings, whether to help market their products or ensure they comply with federal regulations. Because credit rating agencies issue ratings to issuers and investment banks who bring them business, they are subject to an inherent conflict of interest that can create pressure on the credit rating agencies to issue favorable ratings to attract business. The issuers and investment banks engage in ratings shopping, choosing the credit rating agency that offers the highest ratings. Ratings shopping weakens rating standards as the rating agencies who provide the most favorable ratings win more business. In September 2007, Moodys CEO described the problem this way: What happened in 04 and 05 with respect to subordinated tranches is that our competition, Fitch and S&P, went nuts. Everything was investment grade. In 2003, the SEC reported that the potential conflicts of interest faced by credit rating agencies have increased in recent years, particularly given the expansion of large credit rating agencies into ancillary advisory and other businesses, and the continued rise in importance of rating agencies in the U.S. securities markets.

Mass Downgrades
The credit ratings assigned to RMBS and CDO securities are designed to last the lifetime of the securities. Because circumstances can change, however, credit rating agencies conduct ongoing surveillance of each rated financial product to evaluate the rating and determine whether it should be upgraded or downgraded. Prior to the financial crisis, the numbers of downgrades and upgrades for structured finance ratings were substantially lower.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS From 2004 through the first half of 2007, Moodys and S&P provided AAA ratings to a majority of the RMBS and CDO securities issued in the United States, sometimes providing AAA ratings to as much as 95% of a securitization. Beginning in July 2007, however, Moodys and S&P issued hundreds and then thousands of downgrades of RMBS and CDO ratings, the first mass downgrades in U.S. history. By 2010, analysts had determined that over 90% of the AAA ratings issued to RMBS securities originated in 2006 and 2007 had been downgraded to junk status. 1/2003 Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities Markets, prepared by the SEC, at 40. The report continued: Concerns had been expressed that a rating agency might be tempted to give a more favorable rating to a large issue because of the large fee, and to encourage the issuer to submit future large issues to the rating agency. Id. at 40 n.109. Then, in July 2007, both S&P and Moodys initiated the first of several mass downgrades that shocked the financial markets. On July 10, S&P placed on credit watch the ratings of 612 subprime RMBS with an original value of $7.35 billion. Later that day, Moodys downgraded 399 subprime RMBS with an original value of $5.2 billion. Two days later, S&P downgraded 498 of the ratings it had placed on credit watch. In October 2007, Moodys began downgrading CDOs on a daily basis, downgrading more than 270 CDO securities with an original value of $10 billion. In December 2007,Moodys downgraded another $14 billion in CDOs, and placed another $105 billion on credit watch. Moodys calculated that, overall in 2007, 8725 ratings f rom 2116 deals were downgraded and 1954 ratings from 732 deals were upgraded, which means that it downgraded over four times more ratings than it upgraded. On January 30, 2008, S&P either downgraded or placed on credit watch over 8,200 ratings of subprime RMBS and CDO securities, representing issuance amounts of approximately $270.1 billion and $263.9 billion, respectively. These downgrades created significant turmoil in the securitization markets, as investors were required by regulations to sell off assets that had lost their investment grade status, holdings at financial firms plummeted in value, and new securitizations were unable to find investors.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS As a result, the subprime RMBS and CDO secondary markets slowed and then collapsed, and financial firms around the world were left holding billions of dollars in suddenly unmarketable RMBS and CDO securities. Neither Moodys nor S&P produced any meaningful contemporaneous documentation explaining their decisions to issue mass downgrades in July 2007, disclosing how the mass downgrades by the two companies happened to occur two days apart, or analyzing the possible impact of their actions on the financial markets. When Moodys CEO, Raymond McDaniel, was asked about the July downgrades, he indicated that he could not recall any aspect of the decision-making process. He told the Subcommittee that he was merely informed that the downgrades would occur, but was not personally involved in the decision. The July downgrades were not the first to take place during 2007. The letter reports that, altogether in the first six months of 2007, S&P downgraded 739 RMBS and 25 CDOs. These downgrades, however, took place on multiple days over a six-month period. Prior to July, Moodys had downgraded approximately 480 RMBS during the first six months of 2007 (this figure was calculated by the Subcommittee based on information from Moodys Structured Finance: Changes & Confirmations reports for that time period). See 3/19/2007 Subprime Mortgages: Primer on Current Lending and Foreclosure Issues, report prepared by the Congressional Research Service, Report No. RL33930; 5/2008 The Subprime Lending Crisis: Causes and Effects of the Mortgage Meltdown, report prepared by CCH, at 13. Subcommittee interview of Ray McDaniel (4/6/2010). At S&P, no emails were produced that explained the decision-making process, but a few indicated that, prior to the mass downgrades, the RMBS Group was required to make a presentation to the chief executive of its parent company about how we rated the deals and are preparing to deal with the fallout (downgrades). Although neither Moodys nor S&P produced documentation on its internal decision-making process related to the mass downgrades, one bank, UBS, produced an email in connection with

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS a court case indicating that Moodys was meeting with a series of investment banks to discuss the upcoming downgrades. In an email dated July 5, 2007, five days before the mass downgrades began, a UBS banker sent an email to a colleague about a meeting with Moodys: I just got off the phone with David Oman . Apparently theyre meeting w/ Moodys to discuss impacts of ABS subprime downgrades, etc. Has he been in contact with the[UBS] Desk? It sounds like Moodys is trying to figure out when to start downgrading and how much damage theyre going to cause theyre meeting with various investment banks. It is unclear how much notice Moodys or S&P provided to investment banks regarding their planned actions. One senior executive at S&P, Ian Bell, the head of European structured finance ratings, provided his own views in a post-mortem analysis a few days after the initial downgrades. He expressed frustration and concern that S&P had mishandled its public explanation of the mass downgrades, writing: One aspect of our handling of the subprime that really concerns me is what I see as our arrogance in our messaging. Maybe it is because I am away from the center of the action and so have more of an outsiders point of view. I listened to the telecon TWICE. That guy [who asked a question about the timing of the mass downgrades] was not a jerk. He asked an entirely legitimate question that we should have anticipated. He then got upset when we totally fluffed our answer. We did sound like the Nixon White House. Instead of dismissing people like him or assuming some dark motive on their part, we should ask ourselves how we could have so mishandled the answer to such an obvious question. I have thought for awhile now that if this company suffers from an Arthur Andersen event, we will not be brought down by a lack of ethics as I have never seen an organization more ethical, nor will it be by greed as this plays so little rolein our motivations; it will be arrogance. In August 2007, Eric Kolchinsky, a managing director of Moodys CDO analysts, sent an urgent email to his superiors about the pressures to rate still more new CDOs in the midst of the mass downgrades:

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS Each of our current deals is in crisis mode. This is compounded by the fact that we have introduced new criteria for ABS CDOs. Our changes are a response to the fact that we are already putting deals closed in the spring on watch for downgrade. This is unacceptable and we cannot rate the new deals in the same away [sic] we have done before....Bankers are under enormous pressure to turn their warehouses into CDO notes. Both Moodys and S&P continued to rate new CDO securities despite their companies accelerating downgrades.

Ratings Deficiencies
The Subcommittees investigation uncovered a host of factors responsible for the inaccurate credit ratings assigned by Moodys and S&P to RMBS and CDO securities. Those factors include the drive for market share, pressure from investment banks to inflate ratings, inaccurate rating models, and inadequate rating and surveillance resources. In addition, federal regulations that limited certain financial institutions to the purchase of investment grade financial instruments encouraged investment banks and investors to pursue and credit rating agencies to provide those top ratings. All these factors played out against the backdrop of an ongoing conflict of interest that arose from how the credit rating agencies earned their income. For more details about these three examples, see Fact Sheet for Three Examples of Failed AAA Ratings, prepared by the Subcommittee based on information from S&P and Moodys websites. See Percent of the Original AAA Universe Currently Rated Below Investment Grade, chart prepared by the Subcommittee using data from Black Rock Solutions, Hearing Exhibit 4/23-1i. See also 3/2008 Understanding the Securitization of Subprime Mortgage Credit, report prepared by Federal Reserve Bank of New York staff, no. 318,at 58 and table 31 (92 percent of 1st-lien subprime deals originated in 2006 as well as 91.8 percent of 2nd-liendeals originated in 2006 have been downgraded.). See also Regulatory Use of Credit Ratings: How it Impacts the Behavior of Market Constituents, University of Westminster - School of Law International Finance Review(2/2009), at 65-104 (citations omitted) (As of February 2008, Moodys had downgraded at least one tranche of 94.2% of the subprime RMBS issues it rated in 2006, including 100% of the 2006

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS RMBS backed by second-lien loans, and 76.9% of the issues rated in 2007. In its rating transition report, S&P wrote that it had downgraded44.3% of the subprime tranches it rated between the first quarter of 2005 and the third quarter of 2007.) Credit rating agencies had issued ratings that accurately exposed the increasing risk in the RMBS and CDO markets, they may have discouraged investors from purchasing those securities, slowed the pace of securitizations, and as a result reduced their own profits. It was not in the short term economic self-interest of either Moodys or S&P to provide accurate credit risk ratings for high risk RMBS and CDO securities.

Investment Banks Pressure

At the same time Moodys and S&P were pressuring their RMBS and CDO analysts toincrease market share and revenues, the investment banks responsible for bringing RMBS and CDO business to the firms were pressuring those same analysts to ease rating standards. Former Moodys and S&P analysts and managers interviewed by the Subcommittee described, for example, how investment bankers pressured them to get their deals done quickly, increase the size of the tranches that received AAA ratings, and reduce the credit enhancements protecting the AAA tranches from loss. They also pressed the CRA analysts and managers to ignore a host of factors that could be seen as increasing credit risk. Sometimes described as ratings shopping, the analysts described how some investment bankers threatened to take their business to another credit rating agency if they did not get the favorable treatment they wanted. The evidence collected by the Subcommittee indicates that the pressure exerted by investment banks frequently impacted the ratings process, enabling the banks to obtain more favorable treatment than they otherwise would have received. The type of blatant pressure exerted by some investment bankers is captured in a 2006email in which a UBS banker warned an S&P senior manager not to use a new, more conservative rating model for CDOs.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS He wrote: Heard you guys are revising your residential mbs [mortgage backed security] rating methodology getting very punitive on silent seconds. Heard your ratings could be 5notches back of [Moodys] equivalent. Gonna kill your residential biz. May forceus to do moodyfitch only cdos! When asked by his colleague about the change in the model, an S&P senior manager, ThomasWarrack, noted that the new model took a more conservative approach that would result inraising our credit support requirements going forward, but Mr. Warrack was also quick toadd: We certainly did [not] intend to do anything to bump us off a significant amount of deals. In another instance in May 2007, an S&P analyst reported to her colleagues about attempting to apply a default stress test to a CDO transaction proposed by Lehman Brothers. She wrote: They claim that their competitor investment banks are currently doing loads of deals that are static in the US and where no such stress is applied. Wed initially calculated some way of coming up with the stresses, by assuming the lowest rated assets default first . They claim that once they have priced the whole thing, it is possible that the spreads would change . We suggested that it was up to them to build up some cushion at the time they price, but they say this will always make their structures uneconomic and is basically unmanageable => I understand that to mean they would not take us on their deals. Her supervisor responded in part: I would recommend we do something. Unless we have too many deals in US where this could hurt. On still another occasion in 2004, several S&P employees discussed the pressure to make their ratings profitable rather than just accurate, especially when their competitor employed lower rating standards: We just lost a huge Mizuho RMBS deal to Moodys due to a huge difference in the required credit support level. Its a deal that six analysts worked through Golden Week so it especially hurts. What we found from the arranger was that our support level was at least 10% higher than Moodys. Losing one or even several deals due to criteria issues, but this is so significant that it could have an impact in the

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS future deals. Theres no way we can get back on this one but we need to address this now in preparation for the future deals. Other emails illustrate the difficulty of upgrading the ratings models, because of the potential disruption to securitizations in the process of being rated. Some investment banks applied various types of pressure to maintain the status quo, despite the fact that the newer models were considered more accurate. In a February 2006 email to an S&P analyst, for example, an investment banker from Citigroup wrote: I am VERY concerned about this E3 [new CDO rating model]. If our current structure, which we have been marketing to investors doesnt work under the new assumptions, this will not be good. Happy to comply, if we pass, but will ask for an exception if we fail. In another instance from May 2005, an investment banker from Nomura in the middle of finalizing a securitization raised concerns that S&P was not only failing to provide the desired rating, but that a new model could make the situation worse. He wrote: My desire is to keep S&P on all of my deals. I would rather not drop S&P from the upcoming deal, particularly if it ends up being for only a single deal until the new model is in place. Can you please review the approval process on this deal? Initially hesitant, S&P analysts ultimately decided to recommend approval of the deal in linewith the bankers proposal. The same pressure was applied to Moodys analysts. In an April 2007 email, for example, a SunTrust Bank employee told Moodys: SunTrust is disconcerted by the dramatic increase in Moodys loss coverage levels given initial indications. Our entire team is extremely concerned. ... Each of the other agencies reduced their initial levels, and the material divergence between Moodys levels and the other agencies seems unreasonable and unwarranted given our superior collateral and minimal tail risk.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS On another occasion in March 2007, a Moodys analyst emailed a colleague about problems she was having with someone at Deutsche Bank after Moodys suggested adjustmentsto the deal: [The Deutsche Bank investment banker] is pushing back dearly saying that the dealhas been marketed already and that we came back too late with this discovery . She claims its hard for them to change the structure at this point.

Special Treatment
Documents obtained by the Subcommittee indicate that investment bankers who complained about rating methodologies, criteria, or decisions were often able to obtain exceptions or other favorable treatment. In many instances, the decisions made by the credit rating agencies appeared to cross over from the healthy give and take involved in complex analysis to concessions made to prevent the loss of business. While the former facilitates efficient transactions, the second distorts the market and hurts investors. In a February 2007 email directed to Moodys, for example, a Chase investment banker complained that a transaction would receive a significantly lower rating than the same product was slated to receive from another rating agency: Theres going to be a three notch difference when we print the deal if it goes out as is. I'm already having agita about the investor calls Im going to get. Upon conferring with a colleague, the Moodys manager informed the banker that Moodys was able to make some changes after all: I spoke to Osmin earlier and confirmed that Jason is looking into some adjustments to his [Moodys] methodology that should be a benefit toyou folks. In another instance, a difference of opinion arose between Moodys and UBS over how to rate a UBS transaction known as Lancer II.

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS One senior Moodys analyst wrote to her colleagues that, given the time line for closing the deal, they should side with the investment bank: I agree that what the [Moodys rating] committee was asking is reasonable, but given the other modeling related issues and the time line for closing, I propose we let them go with the CDS Cp criteria for this deal. S&P made similar concessions while rating three deals for Bear Stearns in 2006. Analyst wrote: Bear Stearns is currently closing three deals this month which have 40 year mortgages (negam) . There was some discrepancy in that they were giving some more credit to recoveries than we would like to see. It was agreed that for the deals this month we were OK and they would address this issue for deals going forward. While the rating process involved some level of subjective discretion, these electronic communications make it clear that in many cases, close calls were made in favor of the customer. An exception made one time often turned into further exceptions down the road. In August 2006, for example, an investment banker from Morgan Stanley tried to leverage past exceptions into a new one, couching his request in the context of prior deals: When you went from [model] 2.4 to 3.0, there was a period of time where you would rate on either model. I am asking for a similar dual option window for a short period. I do not think this is unreasonable.A frustrated S&P manager resisted, saying: You want this to be a commodity relationship and this is EXACTLY what you get. But even in the midst of his defense, the same S&P manager reminded the banker how often he had granted exceptions in other transactions: How many times have I accommodated you on tight deals? Neer, Hill, Yoo, Garzia, Nager, May, Miteva,Benson, Erdman all think I am helpful, no?

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United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Senator Carl Levin Chairman THE RATING AGENCIES ROLE IN THE USA CRISIS Some rating analysts who granted exceptions to firm policies, and then tried to limit those exceptions in future deals, found it difficult to do. In June 2007, for example, a Moodys analyst agreed to an exception, while warning that no exceptions would be made in future transactions: This is an issue we feel strongly about and it is a published Moodys criteria. We are making an exception for this deal only. Going forward this has to be effective date level. I would urge you to let your colleagues k no was well since we will not be in a position to give in on this issue in future deals. A similar scenario played out at S&P. A Goldman Sachs banker strongly objected to a rating decision on a CDO called Abacus 200612: I would add that this scenario is very different from an optional redemption as you point out below since the optional redemption is at Goldmans option and a stated maturity is not. We therefore cannot settle for the most conservative alternative as I believe you are suggesting.The S&P director pushed back, saying that what Goldman wanted was a significant departure from our current criteria, but then suggested an exception could be made if it were limited to the CDO at hand and did not apply to future transactions:As you point out, it is a conservative position for S&P to take, but it is one weve taken with all Dealers. Since time is of the essence, this may be another issue that we table for2006-12[the CDO under consideration], but would have to be addressed in future trades. But a Moodys analyst showed how difficult it was to allow an exception once and demand different conduct in the future: I am worried that we are not able to give these complicated deals the attention they really deserve, and that they [Credit Suisse] are taking advantage of the light review and the growing sense of precedent. As for the precedential effects, we had indicated that some of the fixes we agreed to in Qians deal were for this deal only. When I asked Roland if they had given further thought to a more robust approach, he said (unsurprisingly) that they had no success and could we please accept the same [stopgap] measure for this deal. ---------------------------------------------------- END ----------------------------------------------------------

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