Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1020 - 1039)

TUESDAY 13 NOVEMBER 2007

MR PAUL TAYLOR, MR CHARLES PRESCOTT, MR MICHEL MADELAIN, MR FRÉDÉRIC DREVON, MR IAN BELL AND MR BARRY HANCOCK

  Q1020  Mr Simon: I know it is possible.

  Mr Madelain: And we can disagree sometimes on things that are very important—the cut off point between investment grade and non-investment grade, for example, or special situations where we may take a view and other raters may take a very different view.

  Q1021  Mr Simon: We have been hanging this around the Northern Rock situation. Give us an example in the Northern Rock situation of such a nuanced disagreement and the positive impact that it had?

  Mr Madelain: At the moment, I understand—

  Q1022  Mr Simon: No, no, I am talking about the run up to the run on this bank, which none of you sussed out in advance. To be fair, nobody else noticed it either and it is obviously not your fault—I am not saying it is your fault—but give us an example of how this might have worked in this particular instance where you rated it in some nuanced different way and thereby sent a subtle signal to the market?

  Mr Madelain: We had a higher rating for Northern Rock than Fitch and S&P. We had a double issue rating on Northern Rock, and the reason we had a higher rating was because in our rating methodology we do assign a higher weight to systemic support to bank ratings.

  Q1023  Mr Simon: But that does not really make any difference, does it? It is a different methodology, everybody knows that, everybody knows what the methodology is, so unless you are actually going to be making decisions in a different way, unless you are going to be forming views differently—

  Mr Madelain: We formed a view, which was that effectively we are rating the bank higher.

  Q1024  Mr Simon: That is because you always rate those higher banks higher than they do, and everybody knows that, so what is anybody learning from this?

  Mr Hancock: It comes back to the users of ratings value a variety of opinions. In this case Moody's took a different slant on the likelihood of state intervention in the case of Northern Rock. These are opinions, there is no right or wrong, and clearly our users value having a variety of opinions.

  Q1025  Mr Simon: Very briefly, Mr Bell, two hypotheticals. If one of the three of you did not exist, would it be a big problem for the market? Secondly, if none of you existed, would it throw the markets into crisis?

  Mr Bell: If one of us did not exist, it would narrow and reduce the number of opinions that investors can turn to.

  Q1026  Mr Simon: That is called a truism.

  Mr Bell: Yes.

  Q1027  Mr Simon: If one of you did not exist, there would be one fewer of you than there are now. I understand that. I would like a little bit of interpretation, which is what you do for a living after all.

  Mr Bell: I think the more educated, informed opinions there are, the more—

  Q1028  Mr Simon: So it would be better if there were ten of you?

  Mr Bell: Absolutely.

  Q1029  Mr Simon: Good.

  Mr Bell: If none of us existed, it depends which markets you are looking at, but in markets which are structured finance, which are global markets with fairly complex instruments, it is difficult to see how such markets could meaningfully exist without a series of independent opinions that looked directly at the transactions.

  Q1030  Mr Simon: Why cannot we just have a computer model? Everybody knows what these criteria are. Why can we not just have a programme and everybody runs it through at their desk?

  Mr Madelain: They are available today.

  Q1031  Mr Simon: Why do we need you then? Why do we need to pay you to do that?

  Mr Bell: Because the thing about computer models is they are very inflexible and, therefore, they are subject to gaming. There are a lot of very highly paid people in banks whose job it is to try to figure out a better mouse trap, and if you have an inflexible model with no human element to actually see how the model is being gamed, you will get yourself into a lot of trouble fairly quickly.

  Q1032  Mr Simon: I am sorry if I am going on a little bit, but when I ask, "How come you all agree or you do not quite agree?", nobody says, "We disagree because we have added a little bit of human element into this, because we made a slightly different judgment." The only reason you disagree is, "Oh, we have got a slightly different criteria"?

  Mr Madelain: It is not. It is human judgment. That is exactly what it is.

  Q1033  Mr Simon: You could write that into your model?

  Mr Madelain: No, it is not a model, it is actually a view we form over time for bank ratings. We assign a higher element.

  Q1034  Mr Simon: In all cases; in every instance?

  Mr Madelain: No.

  Q1035  Mr Simon: "In these cases we assign this rating"—that is not a warm, human, touchy judgment. You could write it as an algorithm.

  Mr Madelain: Well, eventually you can, but how you came to that conclusion is exactly the image, and that is what you differentiate as.

  Q1036  Mr Simon: That is another truism. These are all human judgments because the algorithms are written by humans.

  Mr Bell: Let me give you an example outside of Northern Rock which I think is useful. Both Moody's and us rate structured finance transactions in emerging markets, including Russia. They are not, you will be glad to know, rated triple-A. However, we have formed quite different views about the nature of the risk of sovereign interference in Russia on various asset classes and Moody's view of their analysts based in Russia, knowing the market and knowing the Government, about what is more likely, an interference with a mortgage transaction or an interference with a consumer loan transaction, is the exact opposite of ours. We have our view; they have their view. As a result we rate those transactions differently and we explain why we rate them differently. That is a classic example of the human subjective element based on our staff in Russia and their understanding of what is happening. Moody's staff in Russia have a different understanding. I am not saying I believe ours is better because I am S&P, but I think it is of value to investors to be able to see those different ratings, to understand why they are differently assigned, to understand the subjective element behind them and then, as an investor, to make their own view as to whether they feel Moody's is right or whether we are right.

  Q1037  Chairman: You mentioned about value to investors to see the different ratings. Would you take it then that some investors can mistake a good credit rating for a green light to invest?

  Mr Bell: My experience of investors over the 20 years that I have been in the structured financial market is that the spectrum of investors in structured finance is huge. At one end it is composed of extremely sophisticated funds that have their own—

  Q1038  Chairman: My question is a very simple one, Mr Bell: do you think that some investors can mistake a group credit rating for a green light to invest?

  Mr Bell: I think some investors may well have done that, yes.

  Q1039  Chairman: You would all agree on that?

  Mr Bell: Yes.


 
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