By Karey Wutkowski and Rachelle Younglai

"The story of the credit rating agencies is a story of colossal failure," Rep. Henry Waxman, chairman of the House of Representatives Oversight and Government Reform Committee, said at a hearing.

Moody's Corp, McGraw-Hill Cos Inc's Standard & Poor's, and Fimalac SA's Fitch Ratings have been blamed for failing to flag problems with mortgage securities that have spread through the financial system.

"The rating agencies broke this bond of trust, and federal regulators ignored the warning signs and did nothing to protect the public," said Waxman, a California Democrat. "The result is that our entire financial system is now at risk."

Rep. Tom Davis, the top Republican on the committee, said the credit rating firms' triple-A credit ratings are meant to insulate investors against nasty shocks. "Many are asking how and why ... they got it so wrong," said the Virginia congressman.

The rating agencies themselves acknowledged some responsibility. "We did not ... anticipate the magnitude and speed of the deterioration in mortgage quality or the suddenness of the transition to restrictive lending," Moody's Chief Executive Raymond McDaniel said in prepared remarks.

"We see missed opportunities, as we imagine every participant in the mortgage origination, securitization and investment process does," McDaniel said.

Fitch Ratings Chief Executive Stephen Joynt said Fitch did not foresee the magnitude of decline in the U.S. housing market or dramatic shift in borrower behavior.

S&P President Deven Sharma said it is now clear a number of assumptions used in preparing ratings on mortgage-backed securities issued between 2005 and mid-2007 did not work.

U.S. and European regulators are crafting rules to rein in credit raters, and have already proposed a series of reforms, such as forcing raters to disclose more information about their underlying assumptions used to rate products.

Since the subprime mortgage market collapsed, credit raters have come up with some of their own solutions.

S&P is implementing more safeguards against potential conflicts of interest by establishing an office of the ombudsman and is increasing the amount of information it publishes about the stress tests for ratings.

Fitch's Joynt said that to win back investor confidence, ratings must be more predictive and must tell the market about what might happen, instead of what happened yesterday.

(Editing by John Wallace)