Check and Double Check
The SEC recently decided that the rating agencies must reveal more information on past ratings so that investors could compare relative performance. This will be helpful to see whether there is a pattern of preference given one issuer over another. But this will only lead to supposition. Is the issuer just very good at assembling low risk collateralized debt obligations, or are they receiving preferential treatment? We’ll never know.
What is probably more valuable to ensure ratings are justifiable is that the SEC has also ruled that raters must share the underlying data used to determine ratings.
This will establish three important checkpoints: First, competing agencies can offer unsolicited ratings for structured finance products, in essence creating competition to achieve the most precise assessment. Second, investors will be able to examine the underlying data to verify the ratings so rating agencies will be critical of their own work. And third, if a bond does go south, investors will only have themselves to blame for failing to do their due diligence on their own behalf or their clients’. With full disclosure, raters could be relieved of liability. Caveat emptor!
Exposing ratings performance to public scrutiny is one of the most powerful parts of the rulemaking the SEC has undertaken.
Moodys former compliance officer testified to the House Oversight and Reform Committee last month that Moodys did no surveillance of its muni ratings. They issued them and then left them static although they continued to bill the issuer.
This means that retail investors who were sold those securities had no specific or general sense of the accuracy of the rating or the pricing that derived from the rating.
I’m sure that once the ratings are available for analysis we will see lots of market and academic scrutiny of ratings accuracy. Long overdue.
The SEC is requiring the raters to expose the histories in XBRL for more ready comparison. Here is a presentation that I gave at a conference at the FDIC last month on the topic:
http://shopyield.com/2009/10/06/xbrl-and-credit-ratings/