If our good friend Joe Lunchbucket is presented with a list of, say, 100 offerings and their (current) ratings, he sees half a dozen or so categories – he also sees that a recognizable name like California is not in the highest rank.

This multiplicity of grades serves to emphasize the idea that the ratings represent graduated scales. I suspect that if the same list is presented to him with only two significantly populated rating classes, he might consider these to be indications of “good” and “bad” … or, perhaps, pass/fail.

Thus, it is entirely possible that spreads between municipals in the (corporate scale) AAA & AA classes will widen from historical norms – which will cost the lower-grade issuers a lot of money – unless, of course, they purchase evil bond insurance.

After all, municipal bonds are not in much competition with corporates for Joe Lunchbucket’s investment – they’re in competition with each other.

I recognize that it is currently so fashionable to blame the ratings agencies for all the world’s ills that little consideration will have been given to the probable effects of changing a 100-year-old system, let alone any actual work. But if you come across any informed research that addresses the above possibility, I would be very interested to see it.

I remain a little unclear on the link between NRSRO certification and the rating scale used for municipalities – can you clarify?

Additionally, it seems to me that, should municipalities be rated on the corporate scale, then they’ll be basically split between AAA and AA, with a few outliers. Will this truly improve the utility of the ratings to Joe Lunchbucket? It seems to me that – given a rational response to a lemons problem, and in the absence of independent analysis – issuers with greater financial strength will achieve no benefit, and end up paying more for funding. Have you seen any commentary on this?

I stand corrected on the criteria being available now, but note per above, the NRSRO designation was established in 1975, yet per your link, the guidelines for qualifying were not published till 2007. Egan Jones suffered repeated rejections of its application with no explanation.

In fact, if you had read the Wikipedia article, the SEC had published a “concept memo” in 2003 which set forth criteria that made new entry just about impossible:

The single most important factor in the Commission staff’s assessment of NRSRO status is whether the rating agency is “nationally recognized” in the United States as an issuer of credible and reliable ratings by the predominant users of securities ratings.

This as you can imagine is a massive chicken and egg problem. You have to be “nationally recognized” to be an NRSRO, yet who is going to take the risk of building up a sufficiently large operation when the approval barrier is high and ambiguous. This provision seemed intended to close the gate behind the current NRSROs.

Again per Wikipedia, the SEC provided guidelines only as a result of Congressional action:

In 2006, following criticism that the SEC’s “No Action letter” approach was simultaneously too opaque and provided the SEC with too little regulatory oversight of NRSROs, the U.S. Congress passed the Credit Rating Agency Reform Act. This law required the SEC to establish clear guidelines for determining which credit rating agencies qualify as NRSROs. It also gives the SEC the power to regulate NRSRO internal processes regarding record-keeping and how they guard against conflicts of interest, and makes the NRSRO determination subject to a Commission vote (rather than an SEC staff determination). Notably, however, the law specifically prohibits the SEC from regulating an NRSRO’s rating methodologies.

I never said that Egan Jones was the most recent rating agency; the Wikipedia link clearly shows LACE.

It is not hard to imagine that those two additions, which brings the list to nine, was in response to the recent criticism of the incumbents.

The big agencies are indeed quite profitable, irregardless of whether or not they’re a protected oligopoly. This is why they are currently under attack by the not-quite-so-profitable, not-quite-so-respected subscription agencies.
Rules for becoming a NRSRO were published in the Federal Register.

You do not need to be a NRSRO to get the “Rating Agency” exemption from Regulation FD, nor do you need to be an NRSRO to sell me a subscription to your your rating service.

You do, however, need to distribute your ratings freely to get the Regulation FD exemption; this is an aspect of the regulations I don’t like at all. It may be logical as far as it goes (the information will not be exploited for gain) but it means that investors cannot perform a fully independent check of the publicly available ratings.

As for the regulatory role of the NRSRO agencies … that’s the regulators’ problem, first and last. I can sympathize with the intent; and the implementation is a tip of the hat to the big agencies’ long and highly successful track record; but the agencies cannot be blamed if the regulators have decided to follow their advice blindly.

Competition is most certainly NOT open in the rating agency business. The SEC determines who is a “nationally recognized statistical rating organization.” It does not publish its criteria for how to become one. It took Egan-Jones, the most recent addition, eight to ten years to get the designation.

The Basel I rules made fairly strong use of ratings; Basel II permits more sophisticated organizations to use their own methodologies. But even the Fed’s discount window uses rating agency classifications to ascertain what is acceptable collateral and what hairicut to apply.

Their role is well enshrined in regulations. Per Wikipedia:

Ratings by NRSRO are used for a variety of regulatory purposes in the United States. In addition to net capital requirements (described in more detail below), the SEC permits certain bond issuers to use a shorter prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimick the safety and liquidity of a bank savings deposit, but without FDIC insurance) comprise only securities with a very high rating from an NRSRO. Likewise, insurance regulators use credit ratings from NRSROs to ascertain the strength of the reserves held by insurance companies.

The rating agencies are a protected oligopoly and as a result, are highly profitable. They are not charities.

The Basel Accords are not quite so mechanical as all that – there is considerable leeway given to national regulators to interpret the principles and apply them to local conditions.

It is my understanding that General Obligation Municipals are assigned by definition a risk-weight of 20% regardless of rating (this is the same bucket as AAA/AA long-term ratings) while Revenue obligations are assigned a 50% risk-weight (which is the same bucket as “A” long-term ratings).

All this is mere hair-splitting, however. An investor who takes free advice without even asking what the advice means would be better advised to find an advisor.

The ratings agencies do what they do because they want to do it. If anybody has a better idea, they’re welcome to compete. Let a hundred flowers bloom, a hundred schools of thought contend!

That is rating agency attempts at revisionist history, now that their practices are under the spotlight. Rating agencies have historically claimed that their rating were consistent across issuer and product; indeed, why would so many regulations (Basel I and II, pension fund and insurance), simply designate gross ratings limitations (AAA, investment grade, and so on) without specifying the grade per type of issuer if it was known that the ratings were NOT consistent as to risk? That defies all logic.

Consider this statement from a paper published last year by Joseph Mason and Joshua Rosner:

The value of ratings to investors is generally assumed to be a benchmark of comparability it offers investors in differentiating between securities. Credit rating agencies (CRAs) have long argued that the ratings scales they employed were consistent across assets and markets. Not long ago Moody’s stated “The need for a unified rating system is also reflected in the growing importance of modern portfolio management techniques, which require consistent quantitative inputs across a wide range of financial instruments, and the increased use of specific rating thresholds in financial market regulation, which are applied uniformly without regard to the bond market sector.”6 In a similar pronouncement in 2001 Standard & Poor’s stated their “approach, in both policy and practice, is intended to provide a consistent framework for risk assessment that builds reasonable ratings consistency within and across sectors and geographies”.7

You can read more, and the citations, starting on page 8.

I have also seen (but can’t recall where) quotations of statements from the agencies the early 1990s that were much firmer regarding the consistency of ratings.

As I understand it, this is precisely why a different scale has been used for the past 100 years. According to Moody’s: Compared to the corporate bond experience, rated municipal bond defaults have been much less common and recoveries in the event of default have been much higher. As a result, municipal investors have demanded, and rating agencies have provided, finer distinctions within a narrower band of potential credit losses than those provided for corporate bonds.

Like the bond markets themselves, Moody’s rating approach to municipal issuers has been quite distinct from its approach to corporate issuers. In order to satisfy the needs of highly risk averse municipal investors, Moody’s credit opinions about US municipalities have, since their inception in the early years of the past century, been expressed on the municipal bond rating scale, which is distinct from the corporate bond rating scale used for corporations, non-US governmental issuers, and structured finance securities.

Compared to Moody’s corporate rating practices, Moody’s rating system for municipal obligations places considerable weight on an overall assessment of financial strength within a very small band of creditworthiness. Municipal investors have historically demanded a ratings emphasis on issuer financial strength because they are generally risk averse, poorly diversified, concerned about the liquidity of their investments, and in the case of individuals, often dependent on debt service payments for income. Consequently, the municipal rating symbols have different meanings to meet different investor expectations and needs. The different meanings account for different default and loss experience between similarly rated bonds in the corporate and municipal sectors.

Moodys also reviewed their consultations with real live investors in their testimony to the House Financial Services Committee.

The feds are desperate to plug the holes popping up all over the placre and they will fail. Good article in FT discussing divergence of CDS from equity prices heretofore. As for the what about the pensioners crowd, well what about them? stocks are but an asset class and the prudent manager is cutting their exposure not selling the same old saw that you invest for the long term. Who was it that put the 98-07 study together which said if you invested for the long haul you underperformed treasuries. For all you pensoioners, word to the wise, the mutual fund complex and 401K complex is a business in which they generate fees off you. They have a vested interesd in seeing you put money into equities just like the investment banks have a vested interest in seeing companies do transactions, regardless of value.

The reflation theme is simply delaying the inevitable. The Fed can do anything they want to mortages the fact remains thomes are still WAY too expensive on a relative valuation basis. Therefore, cut away, morttage rates arn;t falling anyway. back in the seventies, houese were 2x avg salary versus the 5x today. Interest rates in the mid seventies compare favorably to today. Where is the sympathy for the savers whohave been repeatedly waterboarded for prudence? No we instead spend out time worring about the 1-2$ of all households that bought houses that they couldnt afford with no money down. The ownership society is a joke. It is a populist political slogan come agitprop. If we assume that all these people are at the low end of the socio economic ladder and lets say it is 1-2M homes at an average cost of 250K we are talking a few hundred million to fix the problem, no? That is a few days interest for Buffet and he could get a tax writeoff. Somehow the numbers don’t add up when we hear the bleeding heart stories – which leads one to conclude as virtually any person equipped to drive a car alone knows that this is entirely about the banking sector bail buckets. Perhaps the gentleman who defends bailouts should enlighten us as to how a contraction in credit (which is happening notwithstanding whether a bank fails or not) is a bad thing structurally for the US economy? Oh you mean we can’t spend 9T on consumer goods anymore to inflate GDP to unsustainable proportions. We can’t build structures that have no chance of occupancy, but boosts GDP? My heart bleeds. Take a look at GDP per capita numbers from around the world – Europe, Europe is half the US approximatly. Convergence will occur and I think the market is telling you the United States is deflating.

Also, where is the sympathy for the repeated waterboarding of the savers in this equation. No we should collect

The structural issues that have created such massive global dislocation have become third rail in the United States. Obama says tax credits to companies that invest in the USA. Yeah that solves the labor arbitrage. This solution is akin. That is like giving the crack addict heroin and marking him off cured.

IS it any wonder the comptroller of currency resigned.

Sorry state of affairs