SEC Tackles Lack of Trust in Credit-Rating Agencies

(CN) - Tackling a central problem in the current economic crisis, the SEC convened a roundtable Wednesday to fix the credit rating agencies that are blamed for igniting the recession by mislabeling pooled mortgage securities as secure. "Our members don't trust the industry," said the spokesman for a financial reform group.

"It's clear we don't have an immediate, obvious solution," said SEC chair Mary Schapiro.

Kurt Schacht, representing the Centre Financial Market Integrity, said, "Sixty percent don't think ratings are valid. Seventy percent said they want more government regulation, but fifty percent said they aren't sure they agree with the government's approach."

Sean Egan, from the Egan-Jones Ratings company, added that the securitization market is broken. All agreed.

Of the invited investors and issuers, almost all thought CRAs need more accountability and transparency in how they calculate credit ratings, but how to implement those reforms remained elusive.

CRAs hired by issuers are said to have a conflict of interest because issuers want their securities to earn top ratings. Issuers are known to select lenient CRAs, something called rates shopping. This leads to ratings inflation, said Egan.

To make the situation worse, CRAs are exempt from legal recourse, unlike all other experts, said Paul Stevens from the Investment Company Institute. They are not legally held to any standard.

But Raymond McDaniel Jr., from Moody's Investors Service noted the difficulty in holding anyone accountable for predictions.

Moody's Corporation controls the largest portion of the world credit rating market.

But even if the SEC can figure out a way to regulate CRAs, roundtable participants said this might still not be the answer.

"The Commission and the public need to decide whether the problem is overregulation or under regulation," said Damon Silvers, from AFL-CIO.

It all started in 1936, explained Professor White of New York University, when regulators prohibited banks from investing bonds rated below investment grade, bestowing what White called "the force of law" to the credit ratings.

Regulation is what led to this problem, said Alex Pollock from the American Enterprise Institute.

The government instilled the dependence on credit ratings in the first place. And these ratings, said Pollock, are what got us into trouble.

In 1975, the SEC created the Nationally Recognized Statistical Rating Organization, an exclusive group of ten CRAs. The SEC requires companies to get ratings from this group for certain financial regulations. Commissioner Kathleen Casey called the NRSRO an "oligopoly."

The NRSRO cut competition and diversity in credit ratings, something Professor White says is essential. "We can rely on competition," he said. Under this idea, investors would have many more options to choose from when hiring for themselves a credit rating agency.

Some thought the government would burden the industry with restrictions which would stifle small CRAs, leaving only the large companies.

Still, many saw the government as the best one to hold CRAs accountable.

Some advocated that the SEC require CRAs to disclose their rating processes and Stevens said it should somehow give incentives to agencies which give accurate ratings. Ethan Berman, from RiskMetrics Group, said the SEC should require issuers to rotate CRAs every three years, something companies already must do with financial auditors.

Mayree Clark, speaking as a taxpayer, said investors should pool their money. CRAs would rate companies, and investors could designate that their money go to whichever CRA they think gives the best rating.

Stanford Law professor Joseph Grundfest had a similar idea where investors cooperatively own a rating agency.

Nothing concrete came from the roundtable, and Schapiro admitted that the Committee was left with a lot to think about.

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