The Wall Street Journal and Bloomberg report that the SEC is mulling regulations for rating agencies. Note that rating agencies have benefited from being a protected class, since the SEC determines who can be a Nationally Recognized Statistical Ratings Organization, yet heretofore has imposed no obligations on them.
In the 1970s, the SEC set regulatory capital requirements on various types of financial institutions; these in turn rested on credit ratings set by NRSROs. The three large incumbents, Moody’s Standard & Poor’s and Fitch were given the designation.
Only a very few firms have been able to join the club since then; the SEC has not only failed to set standards for new applicants, but is also has never acknowledged receipt of applications. Thus NRSROs have the unique advantage of enjoying a high regulatory barrier to entry with no accompanying responsibilities.
And the new SEC proposals are a continuation of this proud, hands-off, no obligations tradition. Its great reform proposal? To require the rating agencies to publish how well their past ratings have done and disclose performance differences among ratings for different product categories.
The latter requirement flies in the face of the myth that the rating agencies have promulgated, namely, that their ratings mean the same thing, in terms of default risk, across products. That practice started slipping in the early 1990s, yet the agencies continued to maintain that their ratings standards were the consistent across products.
Note also that this proposal fails to acknowledge the fundamental conflict of interest that created this mess, that the ratings agencies are paid by issuers, when their ratings are for the use of investors. Taking that one on is too hard for an SEC ideologically opposed to meaningful intervention, no matter how patent the need for it is.
Contrast this attitude with the tough words from an EU regulator, as quoted in Reuters:
European Union Internal Market Commissioner, Charlie McCreevy, warned on Wednesday that if credit ratings agencies did not correct the lack of distinctive ratings for structured finance products, he would take action.
“If the proposals are not forthcoming in coming months, I would not hesitate to move forward to have it addressed with regulatory action,” McCreevy told the Society of Business Economists in London….
“I am not going to be prescriptive today but I will say this: strong independent professional oversight of the credit professionals within the rating agencies…and of the operation of the ratings function is absolutely essential if market and regulator confidence is to be restored with respect to the effective management of the conflict of interest inherent in the rating agencies’ business models,” McCreevy told the audience in London.
Now consider the harebrained statements from the SEC, via Bloomberg:
The U.S. Securities and Exchange Commission may propose new rules for credit-rating companies to help evaluate securities following investor losses related to subprime mortgages, the agency’s chairman said.
The rules would increase disclosure about “past ratings” to help determine whether rankings successfully predicted the risk of default, SEC Chairman Christopher Cox said at a securities conference in Washington today. The regulations may also address the differences between ratings on structured debt and rankings for corporate and municipal bonds.
Investors could then use the enhanced disclosure to “punish chronically poor and unreliable ratings,” Cox told reporters after his speech. “The rules that we may consider would provide information to the markets in a way that facilitates” comparisons, he said.
Punish chronically poor and unreliable ratings? What in God’s name is that supposed to mean? The market already disagrees plenty with published ratings. Has Cox ever looked at the AAA ABX index? And all of this patently obvious repudiation by the market of rating agency grades has had zero effect on their behavior. Even the specter of monoline credit default swaps of MBIA and Ambac priced at distressed levels still has not embarrassed them into making downgrades. Why? They are paid by the issuers! What investors and the market thinks has zero effect on their bottom line. If months of horrific press won’t induce them to clean up their act (the reforms proposed by S&P are similarly cosmetic), a mere tabulation of past performance certainly won’t.
In case you think I am being unfair, consider this excerpt from the Wall Street Journal story:
SEC Chairman Christopher Cox said the potential rules “would require credit-rating agencies to make disclosures surrounding past ratings in a format that would improve the comparability of track records and promote competitive assessments of the accuracy of past ratings.”
He added that the SEC “may propose rules aimed at enhancing investor understanding” about the differences between how ratings are treated for standard municipal and corporate debt, as compared with innovative financial instruments crafted by Wall Street banks.
Translation: the problem isn’t that the ratings are bogus, it’s the investors’ fault that they don’t understand that the ratings are bogus. So we’ll try harder to educate those dumb investors.
Just as the EU is having to do the heavy lifting on antitrust with Microsoft, so too will they with rating agency reform. The US seems unwilling to take steps that will reduce a company’s God-given right to its profits, no matter how much their actions cost the greater economy.