Big Bank Downgrades Demonstrate Dodd-Frank Failure

July 2, 2012 by · Leave a Comment
Filed under: Financial Reform, Moodys 

In a recent editorial, the Wall Street Journal reacted to Moody’s downgrade of 15 banks, including some of the largest in the world (e.g., Bank of America, Citigroup, Goldman Sachs, J.P. Morgan Chase, Morgan Stanley, and others), as evidence of the folly of Dodd-Frank.

“Two years ago, President Obama and Congressional Democrats told Americans they had strengthened the banking system and revoked too-big-to-fail privileges from the financial giants.” The editors continue, “The law’s signature achievements are higher costs, reduced opportunities and weaker banks.”

They point out that Moody’s downgrades were rooted in banks’ inability to “generate earnings to offset the inevitable losses” because, ironically, they have “higher capital buffers and have more liquidity than they used to have.” This enhanced capital position helps taxpayers avoid the risk of a bailout, but limits banks’ ability to make money.

The Wall Street Journal argues that banks should be free to take on more risk—risk that the editors believe will generate greater earnings and overall economic growth. “The goal of financial reform should not be weak banks, but strong banks that are independent of the taxpayer.”

European Union Proposes New Sovereign Debt Rating Rules


We don’t want your opinion unless we ask for it.

More of the same. The problem is the rating agencies, not the profligate spending of the politicians. 

Credit-ratings companies should be banned from rating sovereign debt unless they have been contracted to do so by the country concerned, a European Union lawmaker said in a draft report on proposed EU rules. Leonardo Domenici, who is responsible for steering rules on credit-rating companies through the European Parliament, called for the measure to be added to last year’s proposals from the European Commission. Domenici also said either “an independent public European credit rating agency” or “an existing independent Union institution shall be entrusted, with the task of assessing the creditworthiness of Member States’ sovereign debt.” Domenici’s report will be voted on by other members of the parliament. The assembly, together with EU ministers, must agree on the final wording of the proposed law before it can be implemented.

-From Bloomberg News, “EU Parliament Report Targets Curbs on Sovereign-Debt Ratings” by Jim Brunsden, Feb. 17, 2012

Market Knows Best

I agree—how can the rating agencies’ evaluations be worthless and yet be the de-facto measurement for establishing bank capital measures?

 I agree—let’s have the ratings be allowable metrics for creditworthiness, but not the sole determinate of credit quality. They never were meant to be, or defined, that way. Politicians, regulators and investors had all better get to a common definition of what a rating tells us, before we all decide how they can be used.

Then, let’s allow market forces determine winners and losers.

Rating the Ratings Firms: An ‘I’ for ‘Ignore’Wall Street Journal, August 3, 2011

Academics Caution About Increased Rating Agency Competition

In the wake of the mortgage-backed securities debacle and other questionable business practices, regulators in the U.S. and particularly Europe are urging that the “big three” rating agencies face increased competition to drive better quality ratings. However, Bo Becker of Harvard Business School and Todd Milbourn from Washington University, warn that increased competition may not be a solution.

Analyzing Moody’s and Standard & Poor’s reaction to the rapid growth of the then-upstart Fitch in the early 1990s, the authors explain in Financial Times that, “The evidence we uncover appears unequivocally consistent with lower ratings quality as competition increased.” Specifically, as Fitch’s market share grew, the accuracy (measured as the correlation between ratings and bond yields) of a rating fell about one-third and the predictive power of default fell by two thirds.

The authors hypothesize that “…competition most likely weakens reputational incentives for providing quality in the rating industry, and thereby undermines quality. The reputational mechanism appears to work best at modest levels of competition.”

SEC Seeking Public Input To Rules Making

January 7, 2011 by · Leave a Comment
Filed under: Financial Reform, SEC 

The Securities and Exchange Commission (SEC) has announced an unusual open-door rulemaking procedure to facilitate the development of new credit rating agency regulations required by the recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act.

The public can provide preliminary comments over the next 18 months, and comments will be posted on the SEC website.

The new procedure goes beyond what is required by the Administrative Procedure Act that governs federal rulemakings, and SEC Chair Mary Shapiro promised greater public disclosure of meetings with SEC staff as well.

Ms. Shapiro also said commission staff would meet with as many interested parties as possible, seek out parties with different points of view, and solicit opinions from those who do not appear to be fully represented. Good news, and a potential for a balanced, market-based solution.

Rating Agencies Threat to U.S. Economy?

Joshua M. Brown, a money manager for high net worth clients, charitable foundations, corporations and retirement plans, complained recently in a blog post for The Christian Science Monitor that rating agencies are threatening the still-fragile asset-backed securities market.

Moody’s Investment Services, Standard & Poor’s and Fitch Ratings, in reaction to the recently-passed Dodd-Frank law that overhauled U.S. financial regulation, would not allow their ratings to appear in bond registration statements. As a result, they effectively shut down the market selling new bundles of auto and consumer loans. The Security and Exchange Commission has since stepped in to untangle the situation.

Nonetheless, Mr. Brown accuses the agencies of cowardly and infantile behavior. He challenges that because the Federal Government would no longer shield the agencies from exposure to liability for their ratings “…they [the rating agencies] are taking their marbles and going home.

This is a cheap ad hominem attack by Mr. Brown. Unlimited liability would equal a rating premium equal to the par amount of the bonds. The rating agencies acted rationally.

Moody’s Bank Expectations

November 17, 2010 by · Leave a Comment
Filed under: Financial Reform, The Rating Agencies 

Moody’s Corporation, one of the beleaguered credit rating agencies, posted unexpected gains. In a statement, Moody’s reports that net income had climbed to $121 million, or 51 cents a share, from $109.3 million, or 46 cents, a year earlier.

The increase was driven by vibrant U.S. ratings services. Revenue grew 5.9 percent and was up 19% from the year-earlier period.

These gains were achieved while Moody’s was warning about their future vitality if the then-pending U.S. financial-regulation overhaul would pass and eliminate credit-rating companies’ shield from lawsuits.

Since passage of the Dodd-Frank bill, Moody’s has maintained its full year target earnings per share of $1.75 to $1.85; however, operating expenses and compliance costs related to regulatory changes are expected to increase.

SEC Steps In To Untangle Conflicting Regulation

November 10, 2010 by · Leave a Comment
Filed under: Financial Reform, SEC, The Rating Agencies 

The Securities and Exchange Commission (SEC) was needed recently to unravel an impossible situation that resulted from the newly passed financial reform act.

The new law creates legal liability for the evaluations that the ratings agencies assign to new bond issues. As a result, the ratings agencies refused to allow clients to use their ratings in documents needed to register new bond products. However the issuers are required by the SEC to include these ratings in their registration documents.

Bond issuers found themselves in an unworkable position and, in this case, the market selling new bundles of auto and consumer loans came to a full stop.

To circumvent the problem, the SEC announced that for the next six months ratings would not be required to register new bond products.

In a prepared statement Meredith Cross, director of the SEC’s corporate finance division said, “This action will provide issuers, rating agencies and other market participants with a transition period in order to implement changes to comply with the new statutory requirement while still conducting registered ABS (asset-backed securities) offerings.”

The confusion caused concern among the investment community. The Washington Post quotes Jeffery Elswick of Frost Investment Advisors as saying, “It’s still kind of murky…I’ve been involved in the asset-backed markets for 18 years, and I don’t understand [the legislation] at this point. If I don’t understand it, a lot of people don’t.”

Financial Reform Act Includes New Rules for Ratings Agencies

November 5, 2010 by · Leave a Comment
Filed under: Financial Reform, SEC, The Rating Agencies 

The Dodd-Frank Wall Street Reform and Consumer Protection Act has passed into law. It immediately subjects ratings agencies to greater liability and limits their protection under the First Amendment that they had historically used to defend themselves from investors angry about highly rated securities that later turned sour.  Specifically, rating agencies can now be sued if the plaintiff can prove that an agency “recklessly” neglected to review key information when creating a rating.

The Securities and Exchange Commission (SEC) was also directed to find a way to alleviate the risk of conflict of interest at rating agencies who are paid by the issuers whose debt they rate. If after two years the SEC does not find a solution, they are required to implement the Franken amendment and to create a board that assigns a rating agency to a debt issuer. The issuer would still be free to hire their own rating agency in addition to the one it was assigned; however, the rating provided by the assigned agency must be made available to investors.

Eventually, federal regulators will be required to remove all credit rating references from their rules to reduce reliance on the credit rating agencies. Congress will hold hearings in 12 months to review this action.

Credit Unions Join Rating Agencies in Criticism of Financial Reform Bill

October 27, 2010 by · Leave a Comment
Filed under: Financial Reform, The Rating Agencies 

The U.S. House of Representatives Democrats approved a plan to place a new financial consumer watchdog within the Federal Reserve.

The independent unit would have substantial budget, staffing and rule-making power, and would consolidate consumer-related duties now dispersed across several agencies, including overseeing mortgages, credit cards and other consumer financial products.

House Democrats also said they will support putting new limits on debit card transaction charges, known as interchange fees, with some changes to a proposal that was originally offered by Senator Richard Durbin (D-IL.)

Mr. Durbin said the changes would exempt prepaid and debit cards used in distribution of government benefits. He said the agreement would allow the Fed in some cases to adjust fee rates on cards for fraud prevention costs.

The National Association of Federal Credit Unions (NAFCU) said it was “greatly disappointed” by the agreement on Durbin’s proposal, predicting it would raise consumer costs and place credit unions at a disadvantage versus large card issuers.

The NAFCU joins the three major credit ratings agencies in criticizing the final financial regulatory reform bill.

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