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More States Join Ohio Rating Agency Probe

Half a dozen states are working together to investigate rating agencies, banks and other players that benefited from the onetime boom in subprime mortgages that has since turned into a meltdown, Ohio Attorney General Marc Dann told Reuters.

Cooperating with Ohio, states including Massachusetts, Illinois and New York, as well as the District of Columbia, are gathering data to determine if agencies are independent enough
from Wall Street banks that issue mortgage bonds and other securities, he said.

Dann also stressed that the investigation focuses on all the firms that participated in the booming market for mortgage securities: mortgage brokers, appraisers, wholesale and retail
lenders, investment banks, law firms and accounting firms.

"Everybody knows they don't get paid until the transaction gets a triple-A rating," said Dann, who has been looking into rating agencies since July.

"The system clearly is broken, and the poster child for that breakdown is the securitization of fraudulently obtained mortgages now known as subprime bonds," Dann said in a brief interview Friday. "Something has to be done about it."

A spokesman for Massachusetts Secretary of the Commonwealth William Galvin confirmed the office is looking into subprime market issues.

New York Attorney General spokesman Jeffrey Lerner declined to comment on the credit agencies probe. "We have not commented on the ongoing investigation."

Officials from the other states were not immediately available.

Incentives for Ratings Agencies?

Dann in recent months has been among the most vocal critics of the mortgage securities industry. He argues that agencies such as the Moody's Investors Service unit of Moody's
and Standard & Poor's, part of McGraw-Hill, had an incentive to work with underwriters and
ultimately grant high ratings to securities packaged by Wall Street banks.

Those ratings in several cases were downgraded after subprime loans went sour, leading to losses in related securities. The rating cuts sparked a wider panic in debt markets that has triggered losses for investors and a credit crunch more broadly.

Thousands of Ohio homeowners now face default and state pension funds suffered losses on mortgage bonds that were supposed to be as safe as Treasuries, Dann said.

On Wednesday, the Securities and Exchange Commission said it had begun a probe into the role of rating agencies in the mortgage market. The review, an SEC official told a Congressional hearing, looks at advisory services provided by agencies to underwriters and to lenders, the potential for conflicts of interest, disclosures and the performance of credit ratings after issuance.

Moody's said it is cooperating with the various probes.

"In light of developments in the market we've received and anticipate receiving various government inquiries and we will assist with each of these inquiries," Moody's spokesman Tony
Mirenda said. S&P officials were not immediately available for comment.

Dann declined to comment on the specifics of his probe. He did say the state plans to hire an outside legal counsel over the next few weeks and has beefed up staff assigned to handle
the expanding probe.

Looking ahead, Dann said he expects these actions will lead to industry reforms, including greater transparency surrounding the relationship between banks and agencies. He also hopes the industry can create a different evaluation process for bonds that prevent conflicts of interest.

"We're going to work as hard as we can for consumers and pensioners, to hold accountable all those who created such a perverted version of our capital markets," Dann said.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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