NEW YORK (Reuters) - Long attacked for awarding pristine ratings to mortgages and other securities that proved worthless, credit rating agencies were essentially spared in the Obama administration’s financial regulation overhaul.
The plan urges Moody’s Corp’s Moody’s Investors Service, McGraw-Hill Cos Inc’ Standard & Poor’s and Fimalac SA’s Fitch Ratings and others to bolster the integrity of their ratings, especially in structured finance.
It also calls for reduced conflicts of interest and for regulators worldwide to tighten oversight.
But the blueprint does nothing to address what critics call the industry’s key shortcoming: That the biggest agencies are paid by issuers whose securities they rate, creating an incentive to win more business by assigning high ratings.
Institutional investors then entrench the system by relying heavily on ratings when deciding what securities to buy.
“The overall impact of existing and proposed regulatory changes on rating agencies is extraordinarily easy to summarize: They reward abject failure,” said Jonathan Macey, deputy dean of Yale Law School.
Investors who buy securities often demand ratings from nationally recognized statistical ratings organizations. S&P, Moody’s and Fitch are the largest of the 11 NRSROs.
The Treasury Department called for rating agencies to publicly disclose how they measure performance for structured credit products, such as collateralized debt obligations that once carried “triple-A” ratings, but later proved toxic.
U.S. President Barack Obama, using a common euphemism, at a press conference on Wednesday described the bankers who created such products as “financial innovators.”
Treasury also called on agencies to disclose, “in a manner comprehensible to the investing public,” default risk and other variables that ratings are designed to assess, as well as “material risks” not reflected in the ratings.
Meanwhile, officials also called on national authorities to “enhance their regulatory regimes” and bolster compliance, consistent with recommendations of G-20 leaders.
S&P spokesman Ed Sweeney and Moody’s spokesman Michael Adler said their agencies favored improved ratings quality and transparency. Fitch spokesman Kevin Duignan said Obama’s plan “appears consistent” with global regulators’ framework.
Glenn Reynolds, chief executive of independent credit research firm CreditSights Inc, said improving ratings disclosure “attracts both financial and intellectual capital” to credit markets.
Speaking at the Reuters Investment Outlook Summit, he nevertheless called the agencies more responsible than any other entity for causing the credit crisis and recession.
“They were driving the bus,” he said, willing “to take a blind flier” in assessing structured credits and fighting legislative attempts to boost disclosure. “They were the enablers. They basically turned the inmates loose.”
While shares of McGraw-Hill and Moody’s are far off their 2007 peaks, they are up by roughly three-quarters since bottoming in the fall when credit markets seized up.
In afternoon trading, McGraw-Hill shares were up 2.3 percent at $30.27. Moody’s shares rose 4.6 percent to $26.84.
A larger overhaul would have threatened the bottom lines of the big agencies’ owners. Moody’s Investors Service, for example, usually generates more than two-thirds of the revenue of Moody’s Corp. Financial services businesses, including S&P, generate about two-fifths of McGraw-Hill’s revenue.
Warren Buffett’s Berkshire Hathaway Inc owns 20 percent of Moody’s, but even the world’s second-richest person does not rely on ratings in making investments.
“Securities laws in this country are not designed to protect people like Warren Buffett, but to protect small, less sophisticated investors,” said Macey, the Yale law professor.
“Any credit rating agency that relies on an NRSRO rating, which is effectively a government subsidy, should be subject to lawsuits by investors,” he went on. “It should also be made clear to professional investors that it is not a defense or a sufficient discharge of their fiduciary duties to rely on credit ratings when assembling portfolios.”
Reporting by Jonathan Stempel; additional reporting by Rachelle Younglai in Washington, D.C.; editing by Andre Grenon