All the Devils Are Here [73]
In retrospect, the surprise is not that the rating agencies would eventually be corrupted by their business model, but that it took so long to happen. For many years, whatever mistakes they made were the result of misguided analysis, not out-and-out cravenness. This was especially true of Moody’s, which had a reputation among bond issuers as a “hard-ass,” according to a former employee. The Moody’s culture, introverted and nerdy, was more akin to academia than Wall Street. Analysts would answer their phones after many rings, if at all. Moody’s analysts were standoffish toward the issuers who paid their salaries—a little like journalists during the heyday of newspapers, when they could thumb their noses at advertisers. Credit analysts at Moody’s didn’t worry about the revenue that might be lost if they refused to give an issuer the rating it sought. That was someone else’s problem. In the early 1990s, Moody’s actually refused to rate a then popular structured product, on the grounds that a rating might lead investors to expect more than they were likely to get.
This last anecdote was recounted in a 1994 article in Treasury and Risk Management magazine entitled “Why Everyone Hates Moody’s.” After polling ninety-nine corporate treasurers, the magazine concluded that “ingrained in Moody’s corporate culture is a conviction that too close a relationship with issuers is damaging to the integrity of the rating process.” Moody’s was actually proud of that characterization. A company executive responded by saying that the survey left out “our most important constituency . . . investors.”
What caused Moody’s to change were three things. The first was the inexorable rise of structured finance, and the concomitant rise of Moody’s structured products business. The second was the 2000 spin-off, which resulted in many Moody’s executives getting stock options and gave them a new appreciation for generating revenues and profits. And the final factor was the promotion of a former lawyer named Brian Clarkson within structured finance.
A Detroit native who had graduated from Ferris State University in Michigan and then practiced law at a tony New York firm, Clarkson joined Moody’s as an executive in 1991, without ever having worked as a credit analyst. One of his early tasks was to rate mortgage-backed securities issued by Guardian, the subprime mortgage originator founded by the Jedinaks in California. The bonds, needless to say, eventually blew up, but if there was a lesson in that, it was lost on Clarkson and his bosses. By 1995, he had become the co-head of the asset-backed finance group.
Clarkson went off like a bomb inside Moody’s. He developed a reputation for being nasty to those who couldn’t fight back and for never forgetting a slight. “At my level, any watercooler discussion of his management style included the words ‘fear and intimidation,’” a former Moody’s lawyer, Rich Michalek, later told the Senate Permanent Subcommittee on Investigations. Mark Froeba, another ex-Moody’s lawyer, told investigators that the company’s top executives “recognized in Brian the character of someone who could do uncomfortable things with ease, and they exploited his character to advance their agenda.” That agenda was using structured finance to boost revenues, market share, and—above all—Moody’s stock price.
Clarkson had no problem with this agenda. “We’re in a service business,” he once told the Wall Street Journal. “I don’t apologize for that.” But what exactly did that mean for a company that rated bonds? It wasn’t just a case of answering the phones on the first ring. Under Clarkson, former analysts say, it also meant caring about whether the issuers—meaning the small group of investment banks who mattered—were happy with the ratings they got.
Clarkson’s co-head of