Is Congress missing the boat on credit raters?

By Neil Shah - Analysis

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.