Congress Commissions Ratings Study
As a compromise between the House wanting to abolish the mention of credit ratings in the Federal register, and the Senate, who tried to become MORE involved in the ratings process, Dodd-Frank (DONK) commissioned a study. The regulators have a year to study and report back to Congress about their use of NRSRO ratings.
We support Chairman Frank’s efforts to strike the reference and official use of ratings. Ratings can’t be corrupt and useless, AND be the source of regulatory measurement.
The study should model its answer on the NAIC solution to PMBS:
- Ignore the rating
- Find a reliable third party to price the assets
- Publish the results.
The NAIC has already solved the rating problem, and it works. Let’s just copy that.
Agencies Issue Advance Notice of Proposed Rulemaking… – Board of Governors of the Federal Reserve System, August 10, 2010
The Effects of Reform
Filed under: Bond Regulation, SEC, The Rating Agencies
So, after protecting ratings as a First Amendment opinion, Congress changed the 2300-page regulatory reform bill and exposed the raters to legal liability if the ratings don’t reflect an ultimate change in the price of the bonds, or a default (crank up the class action lawsuit machine…).
What does this mean? Can a bond holder sue an NRSRO if the market value of a bond declines after a downgrade?
It means that this chills the value of a rating, if it exposes the rater to monetary liability. It seems there is a loophole, however.
If the rating was not part of the submitted OS or documents submitted to the SEC, the rating would be legally exempted, since it was not officially part of the submitted deal documents.
This is a stupid, populist nod to the worst of Congressional impulses. AT BEST, it will raise the cost of credit, and make it less available. AT WORST, it will put lawyers in charge of credit allocation.
What’s next, broker/ dealer stock buy and sell ratings? Will realtors be subject to legal liability if a house depreciates after you buy it? Will Las Vegas odds makers be subject to legal action if the odds are wrong and you don’t win?
The only good news is municipal bonds would be exempt because they do not have to register with the SEC.
Bond Sale? Don’t Quote Us, Request Credit Firms – WSJ.com, July 21, 2010
Ratings Agencies Take the Stand
Tune in to C-SPAN 2 to see the ratings agencies testify to the Financial Crisis Inquiry Commission.
Buffett wouldn’t voluntarily testify; he had to be subpoenaed.
With this many witnesses, expect lots of written/read testimony, some Congressional grandstanding and little discovery.
Here is the lineup (no pun intended):
Session 1: The Ratings Process
Eric Kolchinsky, Former Team Managing Director, U.S. Derivatives, Moody’s Investors Service
Jey Siegel, Former Team Managing Director, Moody’s Investors Service
Nicholas S. Weill, Group Managing Director, Moody’s Investors Service
Gary Witt, Former Team Managing Director, U.S. Derivatives, Moody’s Investors Service
Session 2: Credit Ratings and the Financial Crisis
Warren E. Buffett, Chairman and Chief Executive Officer, Berkshire Hathaway
(Mr. Buffett has elected to provide written testimony)
Raymond W. McDaniel, Chairman and Chief Executive Officer, Moody’s Corporation
Session 3: The Credit Rating Agency Business Model
Brian M. Clarkson, Former President and Chief Operating Officer, Moody’s Investors Service
Mark Froeba, Former Senior Vice President, U.S. Derivatives, Moody’s Investors Service
A History of Credit Ratings
Filed under: Bond Regulation, The Rating Agencies, The Ratings System
Dennis Berman gets it right in today’s WSJ. We have institutionalized the use of credit ratings and mandated their use in regulation to the degree that it has been allowed to replace individual due diligence. It is convenient for individuals, fiduciaries and politicians to pile on the ratings agencies and attribute all sub optimal economic outcomes to the “incompetent” ratings agencies. Everybody has a scapegoat, and the power of the Federal government is bearing down hard on the NRSROs.
Berman makes a good case for knowing the history of ratings before we try and implement a solution.
We should also know what ratings measure. There is a huge gap between what a rating measures and what the general public (and Congress) thinks it measures. There is also a huge problem in using a single obligor ratings system in a multiple obligor security sector.
We have two choices:
More government involvement (the Al Franken Plan): Otherwise known as the “how is that working out so far” solution…
Or
The logical conclusion: De-certify the NRSRO designation, remove the references to ratings from the Federal statutes, and let caveat emptor rule.
If you don’t know what the credit “worthiness” of a bond of an asset is, don’t buy it. If you have an investment manager or a fiduciary representing your interests, it is their responsibility to understand underlying credit. This will let the market establish the usefulness of Credit Ratings Agencies and the concerns of ratings shopping without government involvement or any additional regulation.
We have to know the history of ratings, NRSROs and the mis-application of a ratings system architecture to a modern structured finance asset class. The Franken solution will raise the cost of capital and make it less available. The elimination of the NRSROs will let investors be responsible for their own decisions.
The Credit Raters: How We Got Here – Wall Street Journal, May 25, 2010
LeMieux Responds to Franken
The Al Franken amendment added more government involvement in the NRSRO space, and added a layer to getting a rating on a securitized asset. This will make credit more expensive and less available.
Thankfully there is SA 3774, the LeMieux amendment that passed in the Senate, which strips the references of ratings from the federal register. This mirrors the language in the House/Barney Frank Financial Reg. Reform bill, but should become effective now.
Completely removing reference like the House version helps, but then regulators shouldn’t hold financial institutions hostage to a discredited rating.
It is logically inconsistent for the ratings to be useless and the foundation of regulatory credit analysis.
[$$] The Credit Raters Brawl – WSJ.com, May 14, 2010
Franken’s Progress?
The Franken amendment put the SEC in charge of assigning who rates what deal.
Is this progress?
Let’s use the system we have in place.
After all of the trouble and doubt we have been through, let’s have the investor be responsible for his investment decision. If the NRSROs are so corrupt, and the ratings so valueless, they will be out of business without government involvement.
This will guarantee a slowdown in credit creation and make it more expensive in the middle of a recession.
If we are trying to prevent “ratings shopping,” this isn’t the way to do it.
Is there any problem that can be solved without government intervention? ANY?
Senate Passes Plan Aimed at Eliminating Credit Rating Conflicts – Bloomberg, May 13, 2010
Trouble for NRSROs
Filed under: Bond Regulation, The Rating Agencies, The Ratings System
Senate grandstanding by Levin aside, this does not help the NRSROs’ case.
The headline oversimplifies the story, but the truth is some NRSRO employees saw the conflict and worried about it, while some charged full steam ahead. This is ultimately a management problem. There are inherent potential conflicts of interest in a seller pays ratings model.
Everyone knows this. This horse has already left the barn.
It is impossible to legislate all capital market behavior. Regulation should be observational. We need to set up rules of conduct, keep a level playing field and referee the game, not become part of the game. It is bad public policy when government picks winners and losers.
This still does not address the completely under-reported part of the entire ratings debate: Doesn’t the buyer bear some responsibility for his own action? If you relied on the rating and didn’t do your own due diligence, who is to blame?
Lots of investors didn’t buy these complicated investments, despite the high yield and AAA rating.
Senate panel: Ratings agencies rolled over for Wall Street – McClatchy Newspapers, April 22, 2010
FHLB Seattle Sues Wall Street
FHLB Seattle, forced by regulators to write down millions in downgraded MBS last year , has effectively sued all of Wall Street for selling them $4 Billion in inappropriately underwritten MBS. This action accuses the Street of intentionally selling MBS that was underwritten with lax standards, didn’t have proper documentation or supported by documentation that was “untrue.”
This is a huge new front in the ongoing war between investors and the street for responsibility. Did the Street knowingly sell toxic securities? Did the ratings agencies turn a blind eye to the shortcomings of the new issues to generate fees, or were they “gamed” by Wall Street? Do investors bear all of the responsibility for their decisions? Is it cavet emptor all the time? What if you bought securities under false pretenses?
FHLB Seattle is a formidable and serious litigant. The risk of the responsibility for “bad” loans being put back to the underwriter just went higher.
[$$]Mortgage Suit Targets the Street – WSJ.com, February 16, 2010
Back to the Drawing Board…Why?
The SEC. seems to be going back to the same old regulatory structure. Last year, money market funds showed stress, and the US government prevented the funds from breaking the buck.
In the future, don’t we want investors to bear the cost of their own decisions? Do we want the government to remove moral hazard? If you invest, isn’t there any “caveat emptor”?
The Journal takes the SEC to task. Is this what the SEC really meant to do?
[$$] The SEC v. Investors – Wall Street Journal, February 3, 2010
Good News for Life Insurers
The insurance industry regulators have prevailed. The rule change is in effect and billions in capital has not been squandered. This common sense approach to capital measurements takes into account the economic value of a bond and its cost basis.
When determining the value of anything, isn’t what you paid for it important?
For example: If I paid $70 for a $100 face value bond, and I received $90 at maturity, is that good or bad? One correct answer is “it depends on what you were expecting….”
But the FACT that you received $20 more than you paid for it should count for something.
[$$] For Insurers, a $5 Billion Benefit – Wall Street Journal, January 15, 2010
