Spooky Economy

   Knowledge Dispels Fear

Eric Kolchinsky was an analyst with Moody's Analytics [2], a financial company that rates the quality of financial products.

Kolchinsky received national attention when he appeared before a Congressional panel [2][14] and testified that Moody's Investor Service, a prominent financial rating company, had given a higher priority to preserving their market share than to the accuracy of the ratings they gave. [4][5][6]

Rating services, such as Moody's, are relied on worldwide to determine the level of risk that is present in investment products to be sold. After the appropriate research is done by the rating agency, the product receives a special code that helps the buyer decide whether the product is right for them. Some of the products go into retirement accounts and pension plans. [19]

In his testimony, Kolchinsky said that the bankers who create the products could have gone to Moody's competitors if Moody's did not provide provide a favorable rating for it. [9]

Kolchinsky explained that while ordinary accountants must follow a set of industry-standard rules, rating agencies currently do not have similar standards. Since the are only being paid to give an opinion, it is basically unregulated [citation]. The possibility exists that a competitor agency may provide a more favorable rating and the rating company's employees didn't want to be held responsible for losing a customer. There was no up side for the employee to give a bad rating. [1@3:20] Employees felt intimidated and feared losing their jobs if customers were lost [6][7].

Before going public, Kolchinsky provided his manager a 14-page memo describing his concerns. [12] He says he believes that it was this that ultimately resulted in his losing his job. [1]


It was an unspoken understanding that loss of market share would cuase a manager to lose his or her job.[4]
I believed that to assign new ratings based on assumptions which I knew to be wrong would constitute securities fraud.[5]
They knew that the ratings were incorrect. They had knowledge of it, and yet they still went forward and issued the rating.[2@0:00]
They broke the law when they assigned ratings in January of '09 to... this CLO squared because they knew that the ratings underlying that structured note were wrong... yet they still, with that knowledge, rated it a high rating.[2@0:52]
Despite the massive manifest errors in the ratings assigned to structured finance securities and the market implosion we were witnessing, it appeared to me that my manager was more concerned about losing a few points of market share than about violating the law.[3@53:45][4]

In response to Kolchinsky's memo, Moody's responded say that their internal review found that his assertions were unsupported. [1@1:01]

Personal Concerns

Kolchinsky testified that he was demoted in 2007 as a result of his bringing his concerns to his employer. [5]

In 2009, he raised "nearly identical situtation" in a 14-page memo. He was effectively suspended from his job then. “They asked me to come down to their office and... they gave me an ultimatum. Either I speak with [their] attorney now or I'm suspended... I wanted an attorney present when I spoke with their litigator and I didn't have a chance [to have an attorney present] so I just walked out.” [1@0:21][2@1:23] He wanted to have his own attorney present. “I was suspicious of their motives” [2@1:50

Proposed Solutions

  • Reform of the rating agency system [1@2:53]
  • A regulatory agency which would impose minimum standards on all rating agencies. [1@3:01][6]
  • A way must be made to give an analyst an incentive to say “no” to a deal. [1@3:20]

Must-see Resources

  1. Video: Kolchinsky Suggests FASB-Style Body for Ratings Agencies [October 2, 2009]
    URL: http://www.youtube.com/watch?v=Ay2ML-FCv9E
  2. Video: Moody's Whistleblower Speaks [October 2, 2009]
    URL: http://www.cnbc.com/id/15840232/?video=1282619042&play=1
  3. Video: 2008 Financial Crisis and Credit Rating Agencies, Panel [April 23, 2010]
    URL: http://www.c-spanarchives.org/program/293156-1 (beginning at 48:36)
  4. Document: Statement of Eric Kolchinsky... [April 23, 2010]
    URL: http://hsgac.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=bd65f802-961c-4727-b176-72ece145baef
  5. Document: Moody's Valued Share More Than Law, Kolchinsky Says
    URL: http://www.businessweek.com/news/2010-04-23/moody-s-valued-cdo-market-share-more-than-law-kolchinsky-says.html
  6. Document: Moody's analysts: We were bullied into giving rosy ratings to risky products
    URL: http://www.nydailynews.com/money/2010/06/02/2010-06-02_moodys_analysts_we_were_bullied_into_giving_rosy_ratings_to_risky_products.html
  7. Document: Moody's played a rating game
    URL: http://www.newsobserver.com/2009/10/18/166034/moodys-played-a-ratings-game.html#storylink=misearch
  8. Document: Staff Said Fired For Doing Their Jobs Properly
    URL: http://news.hereisthecity.com/news/business_news/10719.cntns
  9. Document: How the Ratings Agencies Lost the Will to Say 'No'
    URL: http://www.dailyfinance.com/story/investing/how-the-ratings-agencies-lost-the-will-to-say-no/19452836/
  10. Document: The stage was set for a financial crisis when bond-rating agencies went public
    URL: http://www.pressofatlanticcity.com/opinion/commentary/article_7ed51cda-23c4-5305-baee-fcd7fbee09d6.html
  11. Document: Ex-Moody's Analyst to Testify On Industry Conflicts of Interest
    URL: http://online.wsj.com/article/SB125375108331535851.html
  12. Document: [Memo from supervisor from Kolchinsky reporting issues, 14 pages]
    URL: http://online.wsj.com/public/resources/documents/KolchinskyMemo924.pdf
  13. Document: Congress drops the ball on ratings agency reform
    URL: http://curiouscapitalist.blogs.time.com/2010/04/23/congress-drops-the-ball-on-ratings-agency-reform/
  14. Document: Statement and Testimony by Eric Kolchinsky Before the Financial Crisis Inquire Commission
    URL: http://www.fcic.gov/hearings/pdfs/2010-0602-Kolchinsky.pdf
  15. Site: Eric Kolchinsky – LinkedIn Page
    URL: http://www.linkedin.com/in/erickolchinsky
  16. Document: Kolchinsky Hired by State Regulators After Criticizing Moody's
    URL: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIt_7p6HP41I
  17. Document: Nothing has changed
    URL: http://www.huffingtonpost.com/2009/09/23/eric-kolchinsky-moodys-wh_n_295789.html
  18. Document: At SEC, the system can be deaf to whistleblowing
    URL: http://www.washingtonpost.com/wp-dyn/content/article/2010/01/20/AR2010012005125.html?hpid=topnews
  19. Document: Wikipedia: Credit rating agency
    URL: https://secure.wikimedia.org/wikipedia/en/wiki/Ratings_agency

Added December 3, 2009 Posted February 12, 2010 Revised (n/a)

This is my opinion. It's a work in progress. I hope it's helpful.

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