Bond Rating Agencies Lowering Their Standards to Attract Business! Why Doesn't Someone Do Something?

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Thursday, 01 August 2013 20:42

Sometimes it can be painful to read the newspaper. The NYT had a fascinating piece yesterday that implied S&P is lowering its standards for investment grade ratings in order to attract business.

According to the article, S&P had tightened its standards considerably following the financial crisis. This was causing it to lose market share. In order to regain market share it has recently lowered its standards so that banks can count on much better ratings from their new issues from S&P than the other two major rating agencies.

While this story is striking, the piece neglected an important little bit of recent history. There actually was an effort to crack down on this problem in the recent past.

Senator Al Franken proposed an amendment to Dodd-Frank that would have required the banks to call the Securities and Exchange Commission (SEC) when they wanted to have a new mortgage backed security rated. The SEC would then pick the agency. This takes the hiring decision out of the hands of the bank and removes this obvious conflict of interest. Franken's amendment passed overwhelmingly, getting bi-partisan support. (Note: I had been writing about this idea since 2008 and had consulted with Franken's staff.)

In the House-Senate conference over the bill, Barney Frank replaced the original wording with a two-year study by the SEC (which took almost 3 years). In the course of this study, the SEC was bombarded by comments from the industry all of which said that picking a bond-rating agency was too complicated for the SEC. As a result, the Franken amendment was killed and we now have the NYT telling us that a major bond-rating agency appears to be lowering its standards to attract business.