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Home Publications Blogs Beat the Press Congress Gets It Right on Credit Rating Agencies

Congress Gets It Right on Credit Rating Agencies

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Friday, 14 May 2010 04:17

Thanks to Senator Al Franken it appears the Senate took the obvious step to end the conflict of interest associated with issuers paying the credit rating agencies for rating their new issues. The Franken amendment to the financial reform bill requires the Securities and Exchange Commission (SEC) to assign the raters. This would mean that the rating agency has no reason to bend its rating to curry the favor of the issuer, since the issuer does not control whether they get hired in the future.

The Post reported on this amendment and then gave the rating agencies complaint, that this will remove the rating agencies incentive to improve their ratings. This is not true. As my friend Peter Eckstein has pointed out, it would be very easy for the SEC to keep a record of the accuracy of ratings (scoring upgrades and downgrades) and then assign business in proportion to the agencies' relative track record. This will ensure that the agencies have incentive to improve their rating systems.

Comments (24)Add Comment
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written by richard, May 14, 2010 6:24
Looks like Senators are finally starting to get the message, and vote against the banksters, and for the people. Not only did they pass rating agency reform, but also, nibbled away at the huge debit card swipe fees charged by banks. Hey Senators, long as you're on a roll, how about regulating and standardizing ATM fees?
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written by izzatzo, May 14, 2010 7:57
Ed Sweeney, a Standard & Poor's spokesman, said in a statement. "Credit rating firms would have less incentive to compete with one another, pursue innovation and improve their models, criteria and methodologies. This could lead to more homogenized rating opinions and, ultimately, deprive investors of valuable, differentiated opinions on credit risk."

Imagine that. The impact of effective competition driving out branding and economic rent as the good or service in question becomes the commodity that it is.

Next thing you know the socialist comedians in Congress will be crushing capitalism with endorsement of independent ratings from sources like Consumer Reports which twisted the knife with a "don't buy" rating after it was plunged deep into the belly of Toyota by commie regulators for acceleration problems.

Stupid liberals.
Not so easy
written by skeptonomist, May 14, 2010 9:32
"it would be very easy for the SEC to keep a record of the accuracy of ratings"

Not so easy; to do this right would require keeping track of defaults which would take many years to implement. Using rating changes would provide an incentive for raters not to change ratings. Having essentially a double layer of ratings bureaucracy would improve ratings but it would not come free. Could and would the SEC actually do any of this without major change and increased funding? Here is a NYT piece about the SEC's stonewalling of Freedom-of-Information requests:

http://opinionator.blogs.nytimes.com/2010/05/13/stonewalled-by-the-s-e-c/?hp

I suspect that part of the problem is that the SEC just doesn't have enough money or personnel to deal with the things it is supposed to be doing now. A major part of the Bush administration financial strategy was to cut down on funding of regulatory agencies and stuff them with partisan appointees.
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written by rickstersherpa, May 14, 2010 9:40
Gee, the guy from S&P needs to go on the Daily Show. Like can anyone believes these ratings anymore? After 1 trillion dollars of supposedly AAA CDOs have just blown up? According to Michael Lewis's "The Big Short," all the rating agencies wanted was to keep having the investment banks chanel as much crap as possible through them to collect their fees. Moody's revenues went from 600 hundred million a year in 2000 to 3.2 billion in 2006. Once public, the CEOs duty is to "increase profits for shareholders," within the boundary of the law, not to promote the public interest. Hence, a law is needed.
Still getting it wrong
written by zanon, May 14, 2010 10:04
Dean Baker:

Ratings agency still only gets PAID if security is issued. Bank will not issue security UNLESS it gets the rating it needs ("AAA"). Therefore, even with this so called "randomization" process, rating agency will not assess credit risk and will instead do what it needs to do give security inflated value so it will be issued and they will be paid. This includes all old fraud when bank paid them directly.
Free Markets
written by dweb, May 14, 2010 12:12
Well Izzatzo....where in the existing system was there any protection for the investor? WAMU for example, was paying property assessors under the table to inflate their assessements so they could write larger mortgages and pocket more money. Traders were making after hours trades to their benefit for mutual funds, Goldman Sachs was packaging crap it knew was crap and selling it...all the while creating its own schemes to bet against the crap and make more money...for themselves.

If we believe in the "merit system," by what methodology do you agree that Goldman Sachs folks should continue to get giant bonuses when it was their own actions that nearly brought world markets to their knees. I'd frankly propose elimination of bonuses......they artificially skew reasoned decision making and not to the benefit of the market...but to the person seeking the bonus.
Starting gun goes off repeatedly
written by skeptonomist, May 14, 2010 2:42
I declare a false start; everybody back to the line again. The simplest and most obvious solution to this and several other problems is to have a government-run market for securities; that market or another government agency could determine ratings. This may not be the best solution ultimately, or (more likely) it would not be politically feasible, but the fact that everyone including Dean Baker is starting from inconsequential band-aid solutions like assignment of rating companies shows how badly broken the system is and how far we are from real reform.
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written by zinc, May 14, 2010 5:07
"that this will remove the rating agencies incentive to improve their ratings." Duh

I can improve their ability to rate things in the time it takes to write this response: Mortgage backed securities and their derivatives, unless backed by the full faith and credit of the US Government, can never be AAA, ever.

There. Now, where do I send the bill.
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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