5/13/2010 Rating Agencies Shared Data, and Wall…

Reprints

This copy is for your personal, noncommercial use only. You can order presentation-
ready copies for distribution to your colleagues, clients or customers here or use the
"Reprints" tool that appears next to any article. Visit www.nytreprints.com for samples
and additional information. Order a reprint of this article now.

April 23, 2010

Rating Agency Data Aided Wall Street in

Deals
By GRETCHEN MORGENSON and LOUISE STORY
One of the mysteries of the financial crisis is how mortgage investments that turned out to be so
bad earned credit ratings that made them look so good.

One answer is that Wall Street was given access to the formulas behind those magic ratings —
and hired away some of the very people who had devised them.

In essence, banks started with the answers and worked backward, reverse-engineering top-
flight ratings for investments that were, in some cases, riskier than ratings suggested, according
to former agency employees.

The major credit rating agencies, Moody’s, Standard & Poor’s and Fitch, drew renewed criticism
on Friday on Capitol Hill for failing to warn of the dangers posed by complex investments like
the one that has drawn Goldman Sachs into a legal whirlwind.

But while the agencies have come under fire before, the extent to which they collaborated with
Wall Street banks has drawn less notice.

The rating agencies made public computer models that were used to devise ratings to make the
process less secretive. That way, banks and others issuing bonds — companies and states, for
instance — wouldn’t be surprised by a weak rating that could make it harder to sell the bonds or
that would require them to offer a higher interest rate.

But by routinely sharing their models, the agencies in effect gave bankers the tools to tinker
with their complicated mortgage deals until the models produced the desired ratings.

“There’s a bit of a Catch-22 here, to be fair to the ratings agencies,” said Dan Rosen, a member
of Fitch’s academic advisory board and the chief of R2 Financial Technologies in Toronto. “They
have to explain how they do things, but that sometimes allowed people to game it.”

There were other ways that the models used to rate mortgage investments like the

nytimes.com/2010/04/…/24rating.html… 1/4
5/13/2010 Rating Agencies Shared Data, and Wall…
controversial Goldman deal, Abacus 2007-AC1, were flawed. Like many in the financial
community, the agencies had assumed that home prices were unlikely to decline. They also
assumed that complex investments linked to home loans drawn from around the nation were
diversified, and thus safer.

Both of those assumptions were wrong, and investors the world over lost many billions of
dollars. In that Abacus investment, for instance, 84 percent of the underlying bonds were
downgraded within six months.

But for Goldman and other banks, a road map to the right ratings wasn’t enough. Analysts from
the agencies were hired to help construct the deals.

In 2005, for instance, Goldman hired Shin Yukawa, a ratings expert at Fitch, who later worked
with the bank’s mortgage unit to devise the Abacus investments.

Mr. Yukawa was prominent in the field. In February 2005, as Goldman was putting together
some of the first of what would be 25 Abacus investments, he was on a panel moderated by
Jonathan M. Egol, a Goldman worker, at a conference in Phoenix.

The next month, Mr. Yukawa joined Goldman, where Mr. Egol was masterminding the Abacus
deals. Neither was named in the Securities and Exchange Commission’s lawsuit, nor have the
rating agencies been accused of wrongdoing related to Abacus.

At Goldman, Mr. Yukawa helped create Abacus 2007-AC1, according to Goldman documents.
The safest part of that earned an AAA rating. He worked on other Abacus deals.

Mr. Yukawa, who now works at PartnerRe Asset Management, a money management firm in
Greenwich, Conn., did not return requests for comment.

Goldman has said it will fight the accusations from the S.E.C., which claims Goldman built the
Abacus investment to fall apart so a hedge fund manager, John A. Paulson, could bet against it.
And in response to this article, Goldman said it did not improperly influence the ratings process.

Chris Atkins, a spokesman for Standard & Poor’s, noted that the agency was not named in the
S.E.C.’s complaint. “S.& P. has a long tradition of analytical excellence and integrity,” Mr. Atkins
said. “We have also learned some important lessons from the recent crisis and have made a
number of significant enhancements to increase the transparency, governance and quality of
our ratings.”

David Weinfurter, a spokesman for Fitch, said via e-mail that rating agencies had once been
criticized as opaque, and that Fitch responded by making its models public. He stressed that

nytimes.com/2010/04/…/24rating.html… 2/4
5/13/2010 Rating Agencies Shared Data, and Wall…
ratings were ultimately assigned by a committee, not the models.

Officials at Moody’s did not respond to requests for comment.

The role of the rating agencies in the crisis came under sharp scrutiny Friday from the Senate’s
Permanent Subcommittee on Investigations. Members grilled representatives from Moody’s
and Standard & Poor’s about how they rated risky securities. The changes to financial
regulation being debated in Washington would put the agencies under increased supervision by
the S.E.C.

Carl M. Levin, the Michigan Democrat who heads the Senate panel, said in a statement: “A
conveyor belt of high-risk securities, backed by toxic mortgages, got AAA ratings that turned
out not to be worth the paper they were printed on.”

As part of its inquiry, the panel made public 581 pages of e-mail messages and other documents
suggesting that executives and analysts at rating agencies embraced new business from Wall
Street, even though they recognized they couldn’t properly analyze all of the banks’ products.

The documents also showed that in late 2006, some workers at the agencies were growing
worried that their assessments and the models were flawed. They were particularly concerned
about models rating collateralized debt obligations like Abacus.

According to former employees, the agencies received information about loans from banks and
then fed that data into their models. That opened the door for Wall Street to massage some
ratings.

For example, a top concern of investors was that mortgage deals be underpinned by a variety of
loans. Few wanted investments backed by loans from only one part of the country or handled
by one mortgage servicer.

But some bankers would simply list a different servicer, even though the bonds were serviced
by the same institution, and thus produce a better rating, former agency employees said.
Others relabeled parts of collateralized debt obligations in two ways so they would not be
recognized by the computer models as being the same, these people said.

Banks were also able to get more favorable ratings by adding a small amount of commercial real
estate loans to a mix of home loans, thus making the entire pool appear safer.

Sometimes agency employees caught and corrected such entries. Checking them all was
difficult, however.

“If you dug into it, if you had the time, you would see errors that magically favored the banker,”
nytimes.com/2010/04/…/24rating.html… 3/4
5/13/2010 Rating Agencies Shared Data, and Wall…
said one former ratings executive, who like other former employees, asked not to be identified,
given the controversy surrounding the industry. “If they had the time, they would fix it, but we
were so overwhelmed.”

nytimes.com/2010/04/…/24rating.html… 4/4