Is Congress missing the boat on credit raters?

NEW YORK (Reuters) - If U.S. lawmakers and regulators are hoping to put pressure on credit-rating firms for their role in the U.S. subprime mortgage crisis, they may be going about it the wrong way.

The U.S. Securities and Exchange Commission is investigating whether Wall Street bankers, peddling securities linked to risky subprime mortgages, unduly influenced Moody's Corp, Standard & Poor's and Fitch Ratings, by pushing for top-notch ratings on bonds that have since been downgraded and plummeted in value.

The investigation sparked debate in the U.S. Senate Banking Committee on Wednesday over whether the structure of the ratings industry should be changed so that investors pay for ratings instead of bond issuers.

But the lawmakers' focus on conflicts of interest may end up diverting attention from more useful reforms that could revamp ratings in the $3 trillion global structured finance market.

"They're already coming up with distraction solutions, instead of getting to the heart of the problem," said Janet Tavakoli, president of Tavakoli Structured Finance, a Chicago consulting firm.

Glenn Reynolds, analyst for fixed-income research service CreditSights, also thought lawmakers and regulators may be barking up the wrong tree.

"I really don't think (the potential conflict issue) is the critical swing factor. The critical swing factor is quality. The quality comes from either regulation, because you demand it -- and that's hard to regulate -- or because you open up the market to competition," he said.

S&P, a unit of McGraw-Hill Cos Inc., has said it is taking steps to ensure its ratings are sound.

Moody's named three new ratings executives on Wednesday and proposed changes in the subprime rating industry.

Fitch, part of France's Fimalac SA, could not be reached for comment.

DUE DILIGENCE - DO IT

A better suggestion, Tavakoli says, is to make ratings agencies responsible for the quality of the information they use to make ratings.

Raters currently leave it up to Wall Street bond underwriters to perform the necessary "due diligence" on the risky mortgages and borrowers backing a given security. That is because under securities laws, ratings agencies are not required to do so, Tavakoli says.

But agency officials now concede that some of the information they relied upon was unreliable.

Giving raters the right, and responsibility, to pressure bankers for better-quality information "would cause investment banks and rating agencies to be much more careful," Tavakoli said.

Noel Kirnon, executive vice president at Moody's, said the firm is now "getting more independent third party review of the information we receive" and making other efforts to improve the quality of its information.

A spokesman for S&P also said the company is making efforts to improve the data available to it.

SOMETIMES A "AAA" IS JUST NOT A "AAA"

There should also be a clear dividing line between the top "AAA" ratings given to corporate bonds, and those "AAA" ratings stamped on risky subprime mortgage bonds and collateralized debt obligations (CDOs), which have seen massive downgrades this summer as loan delinquencies spiraled, several analysts say.

Gyan Sinha, head of asset-backed securities research at Bear Stearns & Co, said last week at an event sponsored by the American Securitization Forum that, "We have to start to make a better distinction between triple-A's."

"To me, it's always looked like there's a fundamental contradiction," Sinha said. "Yet in the minds of the ordinary public, if it's a triple-A, it's a triple-A."

While investors are ultimately responsible for their own investments, there may be a harmful "education gap" between newer investors in structured products, which have boomed in recent years, and seasoned investors.

Having a single system has long benefited the rating agencies by broadening the pool of investors able to buy structured products. Many investors are under risk restrictions and can only buy higher-rated debt products.

Moody's Kirnon, however, said market participants want the same rating system across debt products and want more information about the liquidity of structured investments.

U.S. and European Union regulators and lawmakers are making efforts to address the role of the rating agencies, but no specific bills have been introduced.