Goodbye, Ratings?

September 28, 2009 by · 3 Comments
Filed under: General 

On CNBC two weeks ago, Congressman Barney Frank proposed to do away with bond ratings. At the time, it seemed like posturing.

Then it was announced that there will be a hearing for a Banking Sub-committee on September 30th. Among the listed discussion points are a full section on the removal of ratings from statutory references, as well as a draft bill.

The unintended consequences of this action are monumental. It seems impossible to “de-certify” NRSROs and remove ratings from the financial architecture altogether. Ratings are pervasive in the U.S. financial system from banking to insurance, from trust agreements to collateral agreements and investment policies. It is unimaginable to delete their usage.

Banking and Insurance regulators use ratings to evaluate credit quality. So my first question is, “What do the regulators think?”

I think trashing the ratings system seems extreme.

It seems to work for single-obligor securities.

Where the problem lies is in multi-obligor securities.

Let’s enhance and improve ratings for multi-obligor securities.

Let’s recognize what a rating reflects: the probability of default.

The rating is silent on the magnitude of loss.

The 100-year-old ratings system was never able to handle the multi-obligor nature of modern securitization. The inherent flaw in the system was only noticed when housing assets began to depreciate.

Securitization allows for the creation of credit, which enables our modern economy to function. We need to enhance ratings, not eliminate them. In the coming days, we’ll need to watch the hearings closely.

Please watch the video of Congressman Frank’s CNBC interview on 9-21-2009 where he initially put forth these projections:

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