Getting Government to 'Gold Plate' Credit Ratings Isn't Funny - It's Tragic
How ironic that the most laughable provision in the Wall Street reform bill going through Congress should have been proposed by a stand-up comedian.
Al Franken, satirist and former star of Saturday Night Live, now a Democrat Senator, won bipartisan support for an amendment that puts a government regulator in charge of the credit rating process. Instead of shopping around for a rating from the most favourable agency, bond issuers will be assigned an agency by a board inside the Securities & Exchange Commission. The idea would be comic if it wasn't so tragic.
Flawed credit ratings on mortgage derivatives were at the heart of the credit crisis and reform of the rating process is an important piece of unfinished business - but not this reform. Senator Franken is helping to entrench the primacy of the credit rating and the power of the rating agencies, when what we should be telling investors is this: do your own damn research.
The financial community has been organised to put too much store in the rating agencies' little stamps of creditworthiness, from AAA to B- and beyond, and in their line between "investment grade" and "junk". Investors are in effect outsourcing their due diligence to Standard & Poor's and its ilk. The agencies look at every bond issued, from the US Treasury and local governments, through companies from General Electric down to the most speculative, and on into structured finance whence came those monstrous mortgage derivatives. They look at them and grade them, so you don't have to.
That is why so many banks and pension funds around the world found themselves stuffed with toxic mortgage derivatives. Standard & Poor's or Moody's or one of their rivals had stamped them AAA, gold- plated like a US Treasury bond, and that was good enough. Except that rating agencies are only humans. They err.
It is true that in the case of mortgage derivatives they were manipulated by cleverer kids on Wall Street. It is true, too, that they were conflicted by having their fees for rating securities paid by the very banks that created them. Senator Franken's amendment was seductive because it resolves that conflict, creating a board of investors to sit between issuers and agencies, funnelling business between them on an as-yet-undecided and possibly random basis.
But credit ratings are the work of man, not the word of God.
Christopher Dodd, the chairman of the Senate Banking committee and chief author of the Wall Street reform bill, opposed the Franken amendment. The thrust of his proposals lies in a different direction, and though he had been far too tentative, at least it is the right direction. The bill is trying to fillet out all the laws and regulations that mandate the use of credit ratings. Government agencies are being told to do their own research, and replace credit ratings with other measures of creditworthiness when setting rules. There will also be a two-year study with the aim of sweeping away laws that limit certain types of investor to holding only bonds of a certain credit rating. …