WASHINGTON — The credit rating agencies knew as early as 2006 that top ratings assigned to mortgage-backed securities were flawed, but they failed to take action because of competitive pressures and fear of the impact on investment bank clients, a key lawmaker said Thursday.

Sen. Carl Levin, the chairman of the Senate Permanent Subcommittee on Investigations, told reporters that because they failed to reevaluate their ratings, Standard & Poor's Ratings Services, Moody's and Fitch Ratings underplayed the riskiness of thousands of toxic securities, a delay that later exacerbated the financial crisis, he said.

"Lenders like Washington Mutual dumped hundreds of billions of dollars of high-risk loans into the financial system like dumping poison into a river," Levin said. "Wall Street firms bottled them into securities and got the credit rating agencies to add a label that these were safe, low-risk investments."

Levin is scheduled to hold a hearing on the topic today, and released a report that included e-mails and documents from all three major credit rating agencies.

According to the report, the agencies suspected in 2004 that mortgage fraud, lax underwriting standards and an unsustainable rise in housing prices was undermining their credit rating models. By 2006, Standard & Poor's and Moody's revised rating models to incorporate risk more accurately, but both companies failed to apply those models to thousands of existing securities until the middle of 2007, when thousands were downgraded within a few days.

"If I had to pick the immediate trigger of the 2008 financial crisis, I would vote for the July 2007 mass downgrades of subprime RMBS's by the credit rating agencies," Levin said.

The downgrades "shocked the financial markets," caused the subprime secondary market to collapse and triggered the sale of assets that had lost high ratings, which hurt the balance sheets of financial firms worldwide.

Standard & Poor's and Moody's are expected to testify at the hearing today called to examine cases where the two largest U.S. ratings firms issued high ratings to securities that ultimately were downgraded. The Financial Crisis Inquiry Commission is also looking into the issue, and issued a subpoena against Moody's this week for its failure to turn over certain documents.

Financial regulatory reform would change regulators' authority to deal with credit rating firms.

Currently the Securities and Exchange Commission lacks securities-rating oversight. The regulatory reform bill from Senate Banking Committee Chairman Chris Dodd would eliminate the ban, Levin noted. The legislation would also authorize the SEC to take enforcement action against the credit rating agencies, and subject rating companies to lawsuits from investors misled by ratings.

Still, Levin said the bill could go further. He said that neither bill would stop ratings agencies from being paid by the companies they rate. "We got to find a way, or direct regulatory bodies to find a way, to end that inherent conflict of interest," Levin said. "We shouldn't be paying the referee."

Levin said that he will not introduce an amendment to strengthen language pertaining to credit rating agencies language in the Senate bill, but that he would support one.

The 550-page subcommittee report reveals internal rumblings within the credit ratings agencies that models were not sufficiently incorporating risk. E-mails gathered by the subcommittee similarly show resistance from investment banks to proposed changes to strengthen ratings criteria.

A February 2006 e-mail from a Citigroup Inc. banker to a Standard & Poor's analyst said that Citi would be "happy to comply" with S&P's new ratings criteria "if we pass," but that it would "ask for an exception if we fail."

The three major rating agencies' revenue doubled between 2004 and 2007, to $6 billion — largely because of fees for rating residential mortgage-backed securities, the report said.

The report includes data showing that over 90% of the 10,000 triple-A-rated subprime securities issued between 2004 and 2007 had been downgraded to junk status by this year.

That such risky securities could fall so fast represents an "astonishing indictment of the triple-A rating," Levin said.

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