Obama’s Bank Tax Draws Fire
Senator Judd Gregg, (R-NH) who is working with Senator Jack Reed (D-RI) on regulation of derivatives and credit rating agencies, criticized President Obama’s proposals to tax and curb Wall Street’s activities, calling the bank tax a political response to losing the Massachusetts Senate seat.
“I think it’s confused the issue considerably, because he’s basically fanned the fires of populism and in a lot of instances, populism doesn’t give you either good regulatory activity or strong markets,” Mr. Gregg said. “It undermines both, in many instances.”
But industry representatives and Democratic Congressional aides have countered, saying that the president’s new proposals have dialed up the energy and volume of the lobbying on regulatory reform, a sure sign that things are moving along. One thing is for sure: vengeance makes bad tax policy.
Chairman Frank Pledges Fix on NRSRO Language
NRSRO — the shorthand for credit rating agencies registered with the SEC — is currently in dispute, specifically with regards to the second letter. Until recently, the acronym stood for Nationally Recognized Statistical Rating Organization. But the Wall Street Reform and Consumer Protection Act, HR 4173, officially changed the second word from Recognized to Registered every place it appears in the Securities Act and Exchange Act.
Opponents of the change argue that it puts thousands of contracts in default and upsets many federal and state regulations.
Advocates, who include Chairman Barney Frank, support the change because they believe it prompts investors to employ a degree of judgment and not rely solely on ratings agencies.
Acknowledging that a considerable number of states and private institutions have the old language in their statues, Frank is meeting with various state and agencies to find a legislative fix.
Portugal’s Finance Minister Blames Ratings Agencies
Fernando Teixeira dos Santos, Portugal’s finance minister was critical of the international credit rating agencies for damaging his country’s economy. He is saying that the risk assessments being made are mistaken.
The Financial Times reports him saying, “Many of the problems we face are related to errors in risk evaluation that have been made, in part, by the rating agencies… We cannot be subject to the commercial strategies [of rating agencies] whose objective may be to increase their market share.”
He went on to say that it was “paradoxical” that the rating agencies (and others in the banking and business communities) had appealed to governments to support economies at the height of the global crisis. Now, however, these same players are insisting that states rapidly consolidate their deficits.
Three credit rating agencies have recently warned that Portugal’s sovereign debt faces downgrading if it should fail to take steps to lower its budget deficit. That deficit is now at a record 9.3 per cent of gross domestic product in 2009. In contrast, the U.S. 2009 deficit is projected to be 12.4%. of GDP.
Portugal’s long-term debt rating currently ranges from Aa2 at Moody’s to A+ at Standard & Poor’s. Spain and Greece’s credit ratings have also been threatened by their respective deficits forced by the worldwide economic conditions.
Federal Judge Dismisses Suit Against Moody’s and Standard & Poor’s
U.S. District Judge Lewis Kaplan dismissed claims against Moody’s Corp and Standard & Poor’s in litigation over nearly $100 billion of Lehman Brothers Holdings Inc. mortgage-backed securities.
Investors had accused the agencies of having misled them by disregarding ratings guidelines and having a conflict of interest. They claimed that the agencies had rated mortgage-backed securities that they had helped to create and structure.
Reuter’s news service quotes Joshua Rubins of Satterlee Stephens Burke & Burke LLP, the law firm representing Moody’s, “The judge has obviously agreed with the arguments that we made that the ratings agencies have never been held to be potential defendants under these provisions and it was a distortion of the statute to try to bring claims against the ratings agencies.”
The judge’s rationale is not yet available. A written ruling is expected.
Ratings Agencies Announce Higher Than Expected Profits
Credit rating agencies Standard & Poor’s and Moody’s are widely criticized for assigning high ratings to investments, particularly mortgage-backed securities, that later proved to be of poor quality. They are widely blamed for disserving investors.
Despite the damage done to their reputations, as the economy recovers, the credit rating agencies’ fortunes are reversing. Bond sales surged 41% to $1.2 trillion in 2009 as companies rushed to take advantage of loosening credit markets. As a result, the demand for ratings has also significantly increased so the ratings agencies have delivered solid operating results.
Moody’s fourth quarter income was reported at $101.9 million, 42 cents a share, which came in ahead of expectations. Similarly Standard & Poors’ owner, McGraw-Hill, reported earnings of 51 cents a share — far ahead of the 40 cents per share that was expected. Contributing to the profit surge was that revenue in their credit markets services group grew by 19%.
Ratings Agencies Relied On Bad Information from Freddie Mac and Fannie Mae
Peter Wallison, a Treasury Official in the Reagan administration, wrote in The Wall Street Journal that Edward Pinto, former Fannie Mae credit manager, discovered that both Fannie Mae and Freddy Mac routinely exaggerated the quality of its mortgages. Mr. Pinto explains that Alt A and subprime mortgages were routinely rated as “prime” to make mortgage credit more readily available to lower income levels.
Because of this misrepresentation, the ratings agencies believed that losses from the securities backed by these mortgages would be “within the historical range for the number of high-risk loans known to be outstanding.” Instead the number of high-risk loans was much larger than anyone knew. When the default rates and losses exploded, Mr. Wallison explains, the subterfuge was exposed, leaving those holding the assets — and the ratings agencies — wondering what happened.
Therefore, the fault for the collapse, Mr. Wallison maintains, was not Wall Street’s or the ratings agencies’, but the misreporting that distorted the perception of everyone who bought and sold securities backed by these mortgages. This misreporting, he believes, was in response to government affordable housing rules. “Fannie Mae and Freddie Mac are inexorably intertwined in the market collapse. It is essential that any examination of the crisis begin with a review of Congress’s use of Fannie Mae and Freddie Mac. We won’t hold our breath.”
S&P President Pushes to Drop Ratings Requirements
Deven Sharma, President of Standard & Poors, has argued for the repeal of regulations that require banks, public pensions, money market funds, and other regulated investors to hold debt evaluated by Nationally Recognized Statistical Rating Organizations (NRSROs). Standard & Poors is one of ten NRSROs, and these regulations originated in legislation following the Great Depression and have existed essentially unchanged for nearly 80 years.
The intent in the ‘30s was to prevent banks from risking their capital in highly speculative investments. The Federal Deposit Insurance Corporation (FDIC) was formed at the same time, and the regulation was, in part, intended to avoid exposing the FDIC to extraordinary risk.
Mr. Sharma speculates that, “rating mandates may have prompted some investors to use ratings in ways they were never intended.” Investors, he suggests, are confused, as they believe that NRSRO ratings are a “government seal of approval” and a short cut for evaluating an investment risk profile. Instead, Mr. Sharma maintains, the ratings should be use as only one of many tools that investors can use to analyze risk. “Hear, hear. Let’s have investors do their own due diligence.”
Instead of requiring regulated investors to hold NRSRO-rated instruments, Mr Sharma believes that the market should determine whether their assessments are used. “Our most important audience will remain the marketplace. If our ratings are valuable, people will use them. If not, market participants should not be forced to use them.”
The SEC Speaks Out
Well , we got our answer from the SEC. today.
Chairman Mary Shapiro answered the Journal in a letter to the editor. It seems that the SEC doesn’t want the NRSROs to be the end-all for credit measurements. They are “seeking to reduce an undue reliance on the ratings” and that money managers do their own independent credit quality analysis. The NRSRO rating should just be a baseline measurement, a minimum level, or as she describes, a floor.
Shouldn’t the SEC stay out of this?
If you invest in anything, you should bear the risk. If there is fraud or mismanagement, the SEC. licensing and regulatory surveillance functions will find it. EC opinion on NRSRO credit evaluations puts them, and the U.S. back in the endorsement business.
We will end up back in the same money market crisis again. We need to get out of the taxpayers-backstopping-investors cycle. If you invest in a money market fund, you should earn the money market rate. Its up to you to decide if you want to take the risk
On her second point, I applaud Chairman Shapiro for clarifying the “floating NAV” proposal, and their investigation of its utility.
SEC is On the Job With Ratings and NAV Proposal – WSJ.com, February 4, 2010
Proposals Pending to Eliminate Ratings’ First Amendment Protection
The free speech provisions of the First Amendment currently protect rating agency opinions. Although in the past the agencies have been sued for ratings given to investments that did not meet stated objectives, the agencies have never been found liable. This is because the burden of proof is the same as for libel. The plaintiff must demonstrate malice. Suggested legislation, proposed rule changes by the SEC and pending court cases are challenging this protection.
By law, financial statements and disclosures must be factually accurate and complete. However, credit ratings have been exempt from this legal standard since 1981 by the SEC. Proponents of revoking this exception argue that the rating agencies should be held to the same standard and that liability will lead to more accurate ratings.
Opponents have four primary objections: First, the nature of the rating agency’s work is purely speculative and there will always be factors that are impossible to anticipate and will impact investment performance. Second, a rating is an opinion. A person has always been free to accept a rating or reject it. A prudent investor should use a rating as only one of several measures of risk.
Third, removing the protection would lead to extensive litigation that would place an undue burden on the ratings agencies. And finally, future ratings would be designed to avoid legal action and would likely be so indeterminate to pass legal review that they would be virtually useless.
A Good Idea
Representative Paul Kanjorski D-PA has proposed that the federal rule be dropped that requires credit ratings to determine what an asset is worth, and therefore determine capitalization. Representative Kanjorski’s intent is to distance the Federal Government from a de facto endorsement of ratings agencies’ work. In its own right, this is a worthy goal.
But dropping this rule, which dates from the Great Depression would have a far greater consequence. The unanswered question is: What will replace NRSRO ratings.
Although a good move, this rule change is still nibbling around the edges of the reform that’s needed at the ratings agencies. Until the business model is changed so securities issuers are no longer paying for their own ratings, the value of those ratings will be forever suspect.
