By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen
A few months ago, I wrote a story for The American Prospect about the credit rating agencies, and their thus-far successful effort to ward off any change to their business model, despite their wretched performance during the crisis. This is true even though Dodd-Frank contained a measure, written by Al Franken, to alter the issuer-pays model that incentivizes higher ratings in the pursuit of future profits. The Franken-Wicker rule (the “Wicker” is Republican Senator Roger Wicker) would create a self-regulating organization to randomly assign securities to accredited rating agencies, with more securities over time going to the agencies that rated the most accurately.
When we last left this rule, the SEC was doing their best to avoid implementing in. The usual watering down in Dodd-Frank made this contingent on a study. Although the language of the law stated plainly that the SEC “shall” change the issuer-pays model to the Franken-Wicker vision or some alternative solution it deemed more feasible, this gave the SEC plenty of wiggle room – they could simply decide that the status quo was the most feasible of all.
The study finally came out, six months late, and it read basically like a book report from a distracted high schooler, merely regurgitating public comments given to the agency on a variety of different models. At the end, the SEC recommended only that “the commission, as a next step, convene a roundtable at which proponents and critics of the… courses of action are invited to discuss the study and its findings.”
Franken and Wicker went ballistic, demanding that they get the roundtable within the next three months, and that the SEC moves with all deliberate speed thereafter to implement a new payment model, complete with a written timeline for next steps. The SEC complied in the most under-the-wire way possible, agreeing to set a date for the roundtable – EXACTLY three months to the day after their letter.
That roundtable was held this week. First off, here were the participants at the roundtable. If you strain your eyes you may be able to find a couple reform advocates (Better Markets managed to sneak somebody on), but they’re surrounded by people like the American Securitization Forum’s Tom Deutsch, SIFMA’s Christopher Killian, representatives from all the rating agencies (including one from Mexico), someone from uber-lobby firm Patton Boggs, etc. At this point it was hard for me to even bother to look into what happened at this thing, but I soldiered on.
Predictably, the main thrust of the roundtable, from the market-based participants, was to not rock the boat. Changing the inherent conflict of interest that comes with the issuer-pays model would “create new conflicts,” be “costly and slow to implement,” and “cause uncertainty in the marketplace.” I swear they have these objections on a wheel somewhere, and they just spin it to determine the order in which they say them.
Market participants also touted rule 17g-5, which theoretically gives any rating agency access to the same data that the issuer gives to the agency they paid for the rating. This was going to spur competition, everyone said, as a firm could show themselves to be more accurate than the Big 3 (S&P, Fitch, Moody’s). But two years into the program, not one rating has been produced by an unhired firm.
As Better Markets’ Dennis Kelleher described it, the roundtable consisted of “eight hours with 25 or so panelists and speakers almost guaranteed not to point in any particular direction.”
But there was one interesting moment. Not in Franken’s speech, which just restated his priors, or in Mary Jo White’s wooden address. The real fireworks came from Jules Kroll, of Kroll Bond Rating Agency, and I’m really surprised this didn’t get more attention:
Jules Kroll, a former private investigator who started a bond-rating company after the financial crisis, said the largest credit-rating firms are again putting profits ahead of accuracy amid record demand for corporate debt.
“They’re selling themselves out just as they did before,” the chief executive officer of Kroll Bond Rating Agency Inc. said today at a U.S. Securities and Exchange Commission roundtable in Washington. “If you want to see the next tsunami, wait for the outcome in high yield and watch what washes up on shore.”
The article swings wildly away from Kroll’s comments almost as soon as it finishes the lede, so we don’t get much more information. However, a separate Bloomberg story makes pretty clear that we are all the way back to the golden age of ratings shopping.
Almost six years after the start of the worst financial crisis since the Great Depression, bond issuers are again exploiting credit ratings by seeking firms that will provide high grades on debt backed by assets from auto loans to office buildings considered inappropriate by rivals.
Fitch Ratings isn’t grading a deal linked to a Manhattan skyscraper after saying investors needed more protection. The securities won top grades from Moody’s Investors Service and Kroll Bond Rating Agency Inc. Blackstone Group LP’s Exeter Finance Corp. got top-tier ratings from Standard & Poor’s and DBRS Ltd. in the past 15 months on $629 million of bonds backed by car loans to people with bad credit histories, even as Moody’s and Fitch said they wouldn’t grant such rankings.
Borrowers are finding more options than ever to get the top ratings that many investors require after U.S. regulators doubled the number of companies sanctioned to assess securities to 10 since 2006.
In other words, the additional upstarts in the rating agency biz have just made it easier for issuers to play them off of one another. And this has just driven more garbage securities into the market, tied to commercial mortgages, subprime auto loans (which accounted for an amazing 43% of all car financing in the last quarter of 2012), or whatever else is laying around. Meanwhile, junk bonds are at record sales highs, and of course those are the bonds that have that rating profile; surely, with this running rampant there are plenty of other “junk bonds without portfolio” out there.
No real agenda for next steps came out of the meeting. In fact, I’m sure the SEC would love to drag their feet just long enough for Congress to slow them to molasses. Today, the House votes on HR 1062, which would force an additional layer of “cost-benefit analysis” to any SEC rulemaking. This is designed simply to clog up any SEC rulemaking implementation whatsoever, including but not limited to Dodd-Frank. And it provides an avenue for Wall Street to sue the SEC for not following cost-benefit guidelines on any rule they implement. Incidentally, the Independent Community Bankers of America, who are supposed to be every reformer’s best friend these days, sent a letter to the House supporting the bill.
In the case of the rating agencies, I’m sure the SEC would welcome the opportunity to apply more analysis and talk it out until everybody forgets what it is they were supposed to be doing. Meanwhile, the essential corruption of their business model continues unabated.
I don’t know exactly how critical this would be, but for what it’s worth, the SEC Office of Credit Ratings is accepting comment letters on the roundtable and the proposed alternatives until June 3, if you’re so inclined.