updated 6/5/2008 2:22:35 PM ET 2008-06-05T18:22:35

New York Attorney General Andrew Cuomo announced an agreement with Wall Street’s three major credit-rating agencies Thursday that would overhaul how they evaluate investments backed by risky mortgage debt.

Cuomo, flanked at a news conference in New York City by executives from Moody’s Investors Service, Fitch Ratings, and Standard & Poor’s, said the new guidelines will have “a dramatic effect on the industry.” An investigation was launched in February to determine how mortgage-backed securities, home loans that are pooled together and sold as investments, carried high ratings yet still collapsed during the subprime crisis.

The deal applies only to riskier, non-prime loans in the U.S., and is designed to end what the industry calls “ratings shopping” that pits credit-rating agencies against one another. The $5 billion rating agency industry has been accused of issuing favorable ratings to secure business with leading Wall Street investment banks.

Investment banks looking to issue mortgage-backed bonds previously went to all three agencies for a review, but banks would only use, and pay for, the most optimistic rating. The agencies will now get paid up front regardless if they are hired to assign a rating, a move expected to avoid any conflict of interest.

“The economic benefits for the ratings agency was to see the transaction close,” Cuomo said. “If the investment bank didn’t like where the process was going, they would just go to another rating agency. The rating agencies will now undertake new standards.”

The overhaul is reminiscent of former Attorney General Eliot Spitzer’s settlement six years ago with investment banks over how they conduct stock research. The banks were accused of pressuring analysts to put out favorable reviews of stocks to help maintain and attract investment banking business.

The three ratings agencies also signed a letter of agreement to continue working with Cuomo to pursue further reforms for the mortgage industry. The attorney general said his probe into the entire mortgage industry, including loan originators and big banks, is continuing.

“We continue to believe that the more our customers, investors and other market participants know about how we do our work, the better,” said Deven Sharma, president of Standard & Poor’s. “We continue to work with the attorney general and policymakers to support effective operations of the world’s capital markets.”

The reform package also forced rating agencies to require investment banks provide for review more detailed data packaged loans before a rating can be issued. The standards in which they review these pools must also be posted on their Web sites.

Cuomo said all three agencies have favored such rules for some time, but none of them wanted to act alone. The changes will be implemented within the next six months.

Putting more restrictions on the rating agencies, criticized for not sounding the alarm soon enough over risky mortgage investments, is just one step Cuomo sees in reforming the housing industry. While agencies were motivated to churn out favorable ratings to collect fees, big Wall Street firms were at the same time pressuring loan originators to sell more mortgages.

“We’ve had an ongoing investigation on the entire housing system almost from the first day I walked in the door,” said Cuomo, who previously served as secretary of the Department of Housing and Urban Development under President Clinton. “Today we’re talking about the secondary market when the loans are securitized, and depending on how much you securitize it controls the flow through the housing pipeline.”

Cuomo’s office worked on the reforms alongside the Securities and Exchange Commission. The regulator will vote on its own set of reforms on June 11.

“The Attorney General’s actions, as well as the comprehensive new rules for all nationally registered credit rating agencies that the commission will consider next week, are motivated by our mutual desire to promote ratings with integrity and curb the questionable practices that contributed to the credit market turmoil,” SEC Chairman Christopher Cox said in a statement.

The agency is considering new rules to limit conflicts of interest in the credit-rating industry and to require the rating firms to disclose detailed information on the mortgage assets underpinning the securities they rate.

Shares of McGraw-Hill Cos., which owns S&P, rose 84 cents to $44.69 in early afternoon trading. Moody’s Corp. rose $1.79, or 4.5 percent, to $41.42. Fitch is owned by France’s Fimalac SA.

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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