‘Ratings Shopping’ Lives as Congress Debates a Fix – Wall Street Journal, May 24, 2010

The ratings don’t measure credit quality, they measure “distance” to first dollar loss. The House bill tried to eliminate all reference to credit ratings from the federal register. The Senate version is not as comprehensive, but the amendment process is not over.

Moody’s Declines 8.1% After Disclosing ‘Wells Notice’ From SEC – Bloomberg, May 10, 2010

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 – Wall Street Journal, February 4, 2010

There are dozens of proposals being floated that are all meant to arrive at this independence without fundamentally changing the business model that has rating agencies being paid by the securities’ issuers. Possibly the most startling is a proposal to hold all ratings agencies jointly liable whenever any of them violate securities law—an effort to have them all police each other. It isn’t difficult to foresee the chaos—and litigation—that would quickly ensue.

Until you reverse the flow of money, until money flows from investors to the agencies — until the crowd or an independent third party pays the referees instead of the players — there can be no real confidence that this conflict of interest has been extinguished..

• The bill removes all references to credit ratings in federal statutes under the jurisdiction of the Committee on Financial Services. The bill directs the agencies to devise a standard of creditworthiness to serve as a substitute for ratings in rules and regulations.”

Read it all here - ratings are discussed on pages 1034-1078.

I’m not sure upgrading all muni bonds during a recession is the best idea. We will have to see what the Senate version looks like.

Stay tuned…

[$$] Issuers Looking Closely at Rating Provision, The Bond Buyer, December 14, 2009

If Glass-Steagall had remained in place… if banks needed to keep loan standards high… if investment bankers hadn’t been able to bundle and sell off the toxic loans written from the commercial side of the house… if these mega banks hadn’t grown so large they couldn’t collapse without taking down the entire economy… the recession might never have happened. The 2005-2006-2007 boom might never have happened.

That is a lot of “ifs,” but the call for reinstatement of Glass-Steagall is coming from some unusual corners. Citigroup’s former CEO, John Reed, was instrumental in getting Glass-Steagall repealed. He has not only called for its return, he has apologized for role he played in revoking it.

This is refreshing on two levels.  First, on the surface it is an apology for the pain caused by the mistake. Second, and more significantly, it is a tacit admission that the investment side wasn’t playing fairly with conventional loans and FDIC insured deposits — a fact kept far from the rating agencies as well as investors.

Unfortunately there are powerful forces aligned to keep Glass-Steagall buried. This puts an impossible burden on the rating agencies to assess the funding for the institutions and securities they evaluate.

Some feel that we need to go to a numerical scale when evaluating a multi-obligor bond. Others present a letter-grading scheme that is more precise than the conventions now being used. Whether we choose letters or some numerical convention it really doesn’t matter.

Whether a high risk bond is rated “60” or a “Ca”, a “CC” or a “CCC”, is irrelevant. We simply need to ensure everyone understands the risk and can decide whether the profile is appropriate for their objectives.

What is far more critical than the scoring convention is to ensure credit rating agency analysts have the information, the time, the tools, and the models he or she needs to precisely ascertain risk.

So if a new rating system is devised, it needs a convention that can be attached at the individual obligor level. Each mortgage in a bundle, for example, needs to be scored on its own merits. These scores can then be aggregated and an accurate risk assessment made.

Once a bond is bundled, it’s too late.

 But it is incorrect to concentrate the argument solely on the need for a more robust rating scale.

There is plenty of anecdotal evidence — and possibly now even testimony — that bears out that regardless of how makeshift the measures being applied may have been, they were inappropriately applied. Even fraudulently applied.

Structured securities that analysts at ratings firms like Moody’s, S&P and Fitch either knew to be of questionable value or had no ability to accurately evaluate were getting rated A1, A+, AA and higher. This is the problem. Changing the rating system, although necessary, won’t protect investors from its intentional or unintentional misapplication.

Were the inflated ratings due to conflicts of interest? Lack of oversight from a depleted regulatory community? Or the simple inability of analysts to keep up with the volume of business? These are the questions that need answers.

The actual text of the story is pretty fair in describing a senior/sub structure, but falls short in the actual details.  Re-REMIC is a local and legitimate activity.  It will allow the secondary mortgage market to open and for prices to reach a realistic level that reflects the economic value, not just the price according to the downgraded rating.

Click the link below to read the entire article:

Remember Me? Wall Street Repackages Toxic Debt – The Associated Press, August 24, 2009