Would You Believe a Restaurant Critic Who is Paid by the Restaurant?

Well, that’s been the way the credit-rating world has operated for years. Companies that need credit ratings to place their credit instruments (like bonds) into the commercial marketplace – a sophisticated way to borrow money – have simply had to engage a credit-rating service, pay for a rating and then access the money in the marketplace based on the rating they paid for. Clearly, the better the rating, the lower the perceived risk to “lenders” (or folks that buy the debt instruments), the lower effective interest rate and the greater the probability of success. There was a mutually-shared myth in the markets that the rating agencies were truly neutral and unbiased. Indeed with millions of such rated transactions on the books, and even a common statutory or regulatory requirement from many government agencies (from local on up) that borrowers must use a “Nationally Recognized Statistical Rating Organization” to access their investment funds (like pensions, state reserves, etc.), the requirement to uses these agencies is deeply imbedded into our economy.

When the subprime market crashed and burned, dragging down the underlying financial institutions and the individual investors, many of those bundles of subprime mortgages had been rating A or better by the relevant top rating agencies. Suddenly, just about every rating issued by such agencies became suspect, and indeed investigation into many rated transactions sustained the newfound skepticism. The economy imploded. We had trusted those rating companies, but they were in the business of competing for clients; they knew they if they developed a reputation for being too tough, clients would simply take their business to a more lenient agency… so they relaxed their reviews, stringency and took their fees with a wink and a smile.

The top names in the ratings field – Moody’s Investors Service, Standard & Poor’s and Fitch Ratings – came under intense criticism, governmental scrutiny and endured more than one lawsuit holding them responsible for what were seemingly unsupportable high ratings on transactions that soured big time. Screams for a new set of regulations on these agencies arose. Experts argued that companies seeking ratings should no longer be able to pick their favored agency, that a blind pool concept would make vastly more sense.

So here we are, more than a year after the markets collapsed, massive levels of positively-rated debt have collapsed, and regulators and legislators have had a chance to sit back and prepare a regulatory response so that the litany of horrible generated in part from inaccurate credit ratings will never happen again. But Washington is well… Washington. Republicans don’t like regulating business, and Democrats and Republicans get big campaign contributions from many of those folks they are regulating. Didn’t even mention the reprioritization of what Congress will or will not consider based on old fashioned horse-trading. And then there’s basic fear on the part of legislators that since the credit markets are so fragile right now – debt is really hard to get anyway – any move to tighten credit ratings would only making the debt markets even more restrictive at a moment in time when the government really wants to get them going again.

So what is actually happening today? First, there appears to be little appetite for a top-to-bottom overhaul of the rules impacting credit agencies; there isn’t even a consensus, much less a groundswell, for major reform. The December 8^th New York Times: “Under bills that legislators are currently considering, the rating agencies will have to contend with greater oversight, stiffer rules about disclosure and a provision that would make it easier for plaintiffs to sue the firms. But nothing in the laws tackles the critic-for-hire problem or threatens the 85 percent market share that Moody’s, S.& P. and Fitch now enjoy.”

With nothing dramatic happening in Congress, a number of states – some with pension funds that got seriously slammed with well-rated debt instruments that collapsed in the financial storm – have taken a more aggressive posture, mostly in the form of litigation against these rating agencies, seeking to hold them responsible for the losses. “Dozens of lawsuits have been filed against the rating agencies, including a case filed on Nov. 20 by the Ohio attorney general on behalf of public pension funds. The Ohio suit, as well as the earlier suits, seeks billions of dollars in damages from the rating agencies and accuses the firms of negligence and fraud.

“When he filed his suit, Ohio’s attorney general, Richard Cordray, said that the ‘rating agencies’ total disregard for the life’s work of ordinary Ohioans caused the collapse of our housing and credit markets and is at the heart of what’s wrong with Wall Street today.’

“After the suit was filed, Richard Blumenthal, Connecticut’s attorney general, said he planned to join the suit and thought that a “coalition of states” would also jump on the legal bandwagon — a potentially grim development for the rating agencies, which could find themselves contending with a phalanx of state officials like the one that aimed at big tobacco in the 1990s.” The Times.

But Congress absolutely can do better. They aren’t talking about a truly-independent credit rating structure, directly supervised by the government, and there no mention of the blind pool concept noted above. The agencies are still the mainstay of corporate lending and apart from the lawsuits, it does appear to be business as usual. But if this economic collapse is insufficient to have Congress to rewrite meaningful regulatory and process requirements, it would seem that nothing would ever justify the obvious reworking that the credit agencies truly need.

“‘There are a lot of complicated issues that nobody knows how to deal with, like water shortages in different parts of the world,’ says Jonathan Macey, a deputy dean at Yale Law School and a member of a bipartisan task force that has conferred with lawmakers about rating agency reform. ‘But this isn’t one of them. We could solve this one pretty easily with a modicum of political will. It’s just mortifying.’” The Times. Yeah, but who’s gonna make Congress do what needs to be done? Voters?

I’m Peter Dekom, and I approve this message.