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Conflict supposition

~~~~”McDaniel this month defended the credit raters’ issuer-pay model at an SEC roundtable in Washington, saying that investors can pressure ratings companies just as easily as underwriters….”*~~~~

This will become the central argument in defense of the “issuer pay” model for credit ratings agencies….

The SEC receives information from credit rating agencies as part of its Form NRSRO filings (Exhibit 10, page 6) that details the top 10 sources of revenue for each NRSRO… it would be useful for the public discussion of the reform of credit ratings to know, on an aggregate basis, what type of clients pay the bulk of fees to raters…

I think we will find that that a small handful of underwriters pay the vast majority of fees to raters and exert a disproportionate influence… 

From the SEC 2008 special examination on credit rating agency practices on “conflicts of interest” (page 31)

~~~~ “As the Commission noted in its recent release, some observers have indicated that while conflicts of interest due to the “issuer pays” model exist with respect to all asset classes that receive ratings, the conflicts created from the “issuer pays” model in rating structured finance products, particularly RMBS and related-CDOs, may be exacerbated for a number of reasons. First, the arranger is often the primary designer of the deal and as such, has more flexibility to adjust the deal structure to obtain a desired credit rating as compared to arrangers of non-structured asset classes. As well, arrangers that underwrite RMBS and CDO offerings have substantial influence over the choice of rating agencies hired to rate the deals.

Second, there is a high concentration in the firms conducting the underwriting function. Based on data provided by the three rating agencies examined, the Staff reviewed a sample of 642 deals.

While 22 different arrangers underwrote subprime RMBS deals, 12 arrangers accounted for 80% of the deals, in both number and dollar volume. Similarly, for 368 CDOs of RMBS deals, although 26 different arrangers underwrote the CDOs, 11 arrangers accounted for 92% of the deals and 80% of the dollar volume. In addition, 12 of the largest 13 RMBS underwriters were also the 12 largest CDO underwriters, further concentrating the underwriting function, as well as the sources of the rating agencies’ revenue stream.“~~~~

The math is not hard to do… Moody’s discloses it’s revenues in it’s public filings… the question for Mr. McDaniel is, of course, what investors can exert comparable pressure on raters as underwriters? 

And the question for lawmakers is “are these underwriters, who exerted “substantial influence over the choice of rating agencies hired to rate the deals (otherwise known as “rating shopping”) the same ones who packaged and distributed trillions of dollars of toxic assets and now beggar us for bailouts?”

The path to understanding is straight… let’s take it and see where it leads…

* from Bloomberg

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