Financial Regulatory Forum

Impasse over model haunts raters again

April 27, 2010

Credit rating agencies are back in the spotlight and, just like a year or two ago, for all the wrong reasons.

Last week a U.S. Senate panel said the clout of Wall Street’s big banks and the thirst for profits drove ratings agencies to inflate ratings on subprime mortage-related products, helping to fuel the worst financial crisis since the Great Depression. Making things worse for Moody’s, S&P and Fitch, the Senators pointed to securities backed by subprime loans that Goldman offered in 2007 — now the subject of an SEC fraud lawsuit — as further evidence of questionable industry practices. Goldman has rejected the accusations.

The latest dose of self-inflicted misery for the raters is unlikely to prompt any fresh regulatory action.

The basic flaw in the whole business model is still unresolved — that the issuer being rated pays the rater and no amount of blue sky thinking over the past three years since the crisis began has come up with a better idea that works.

Have the regulators signalled defeat on this long standing problem?

Greg Tanzer, secretary general of the International Organisation of Securities Commissions told the Reuters Regulation Summit this week that its key focus is on making sure IOSCO members across the world, such as the FSA in Britain and the SEC in the United States, apply its code of conduct for rating agencies — a code the EU sniffily dismissed as ineffective and opted for a harder version in law last year.

For Tanzer, until the boffins come up with a practical alternative to the current ratings business model, the focus has to be on making sure agencies manage conflicts of interest, disclose them and improve the quality of ratings. Regulators have been criticised in the past for failing to follow through on principles adopted so IOSCO is keen to make sure its code takes effect on the ground before considering a further review.

Tanzer doubts the conflict of interest can ever be fully resolved and would simply be shifted elsewhere in some form.

Are regulators being pragmatic or defeatist? Perhaps neither — the broader picture is one of slapping much heavier capital, liquidity charges and other safety belts on banks so that over time, policymakers hope ratings will become far less relevant and influential in the first place to matter.

Written by Huw Jones in London

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