Ratings Agencies Need Better Rules: Whistleblower

Ratings agencies need to adopt universal standards to prevent the kinds of abuses that helped fuel the collapse of the credit markets, an industry whistleblower told CNBC.

The agencies use arbitrary parameters and are under pressure to issue ratings favorable to the companies that hire them, Eric Kolchinsky, former managing director of Moody's Analytics, said in a live interview. The agencies were blamed by giving good ratings to securities that backed up subprime loans, the collapse of which triggered the financial crisis.

"There's just no incentives at the rating agencies still to say 'no' to a deal," Kolchinsky said. "That's the problem that we still have in the capital markets."

He said there needs to be recognition that agencies like Moody's and Standard & Poor's perform a "quasi-regulatory" function. (S&P is owned by McGraw Hill.)

From there, the companies need to follow uniform rules—Kolchinsky suggested generally accepted accounting principles, or GAAP—to level the playing field.

Kolchinsky left Moody's after warning the company that it continued to use faulty methodology to evaluate deals backed by leveraged loans even after he warned them about the practice. He is testifying on the issue to Congress next week.

"There's no perfect solution," he said. "What you can do is set standards so you can have liability so ratings agencies can defend themselves."

• Banks' Large-Loan Losses Triple: Regulators