What’s in the House Financial Services Reform Bill?
“Addresses the immense reliance on ratings by federal regulators and users of ratings
- 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.
Muni Changes in the Works?
Congress is mandating “best practices.” Should we be measuring munis like corporates?
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 only…”
In 1999 the Clinton Administration and Republican Senator Phil Gramm, the chairman of the Senate Banking Committee, ended the separation between commercial and investment banking required by the depression-era legislation, Glass-Steagall. This change not only paved the way for a series of mega mergers that led to the formation of “too-big-to-fail” financial institutions, it enabled the investment of bank’s side to sell off risk the commercial side assumed when issuing everyday loans.
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 Citigroup’s former CEO, John Reed, was instrumental in getting Glass-Steagall repealed.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.
There Are Many Ways to Be Precise
There appears to be a great deal of consensus that the rating system, as it is applied to single obligor securities, is fine. Problems arise, however, when the same scale is used for multi-obligor securities.
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.
A Better Ratings System Is Just A Start
Creating a new rating system for multiple obligor securities is a good idea. There is broad agreement that structured products like bundled mortgage-backed securities need to be rated on a scale that provides for a greater degree of precision to more accurately evaluate their risk. The A-B-C system that has been used for generations to rate single obligor securities is simply too coarse a measure.
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.
Here we go again! “Wall Street repackages ‘toxic debt’”
This headline takes a financial engineering strategy and boils it down to garbage in, garbage out.
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
