Credit rating firms grilled on Capitol Hill

NEW YORK (CNNMoney.com) -- Lawmakers grilled credit rating agency executives Wednesday about their role in the subprime mortgage meltdown, particularly their cozy relationship with issuers of some of the securities that soured during this summer's crisis.

Testifying before the Senate Banking Committee, representatives from two of the largest ratings firms - Moody's (Charts) and Mc-Graw Hill's (Charts, Fortune 500) Standard & Poor's - conceded the companies had made mistakes but defended the integrity of their ratings process and promised improvement.

"We understand that certain things did not work and we are looking at root causes," said Vickie Tillman, executive vice president for credit market services at Standard and Poor's.

Credit rating agencies have shouldered blame for the subprime crisis that roiled financial markets.

Critics have claimed that the agencies were blinded by cozy relationships with debt issuers. Typically underwriters pay rating agencies to grade debt they are issuing.

"It seems as if agencies were playing both coach and referee in the debt rating game," Sen. Robert Menendez (D-N.J.) said during the hearing.

The agencies have maintained that they aren't unduly influenced by working closely with issuers of debt.

Michael Kanef, managing director of Moody's asset finance group, also faced lawmakers Wednesday. He said his firm was in discussions with issuers with an eye on reforms.

"We believe that these discussions help enhance overall market transparency and stability in that both issuers and investors have a better understanding of our analytical thinking and the ratings that result," Kanef said in prepared testimony.

Lawmakers are expected to call for stricter and broader oversight - especially when it comes to handling conflicts of interest.

Securities and Exchange Commission (SEC) Chairman Christopher Cox, who also testified Wednesday before the Senate committee, said the SEC would spend the next several months investigating the issue, but has yet "as yet formed no firm views" on the issue.

Under the Credit Rating Agency Reform Act of 2006, the SEC has the authority to inspect the big three debt rating firms - Moody's, S&P and Fitch - although it can't substitute its judgment for that of the agencies on specific ratings.

The SEC has already adopted rules that require rating firms to disclose conflicts of interest and, in some cases, prohibit them from rating securities because of conflicts.

Cox told lawmakers that the SEC has been looking into whether the firms should be required to disclose additional information about their performance, such as a credit rating downgrade that occurs long after the security being rated has lost substantial value.

The SEC chief said last year's legislation could provide some transparency to the industry by making it easier for competitors to enter the market.

Other possible remedies emerged at Wednesday's hearing. John Coffee, a law professor at Columbia University, suggested that the SEC publish real-time default rates, which would shine a light on the work of the rating agencies.

He also believed that rating agencies should sell subscriptions to their ratings information to free them of potential conflicts by taking payment from debt underwriters.

A House financial services subcommittee is scheduled to hold a similar hearing on the credit rating firms Thursday.