Overhaul iffy for credit-rating agencies

WASHINGTON - Three years after Congress told federal regulators to consider changing the way credit rating agencies are paid, the industry appears poised to dodge a major overhaul.

The ratings firms have been widely criticized for contributing to the 2008 financial crisis by issuing high ratings to toxic securities backed by residential mortgages.

Since then, the way these firms are compensated has come under scrutiny, with critics arguing that the agencies have a conflict of interest because they’re paid for their analysis by the banks and corporations whose products they’re rating.

One proposal designed to end this “pay to play” dilemma comes from U.S. Sen. Al Franken, D-Minn., who is pushing to have the Securities and Exchange Commissionset up an independent board that would assign financial products such as bonds to credit-rating agencies to rate, rather than allow banks and companies to choose which agencies to use.

The approach was debated last week when the SEC held a day-long roundtable to discuss the credit-rating agencies’ business model with industry officials, academics and investor advocates. But several analysts who track the issue say it’s unlikely that the SEC will adopt a plan that separates hiring from payment, in part because doing so is not as simple as it appears.

“There just doesn’t seem to be enough support in Washington to blow up the business model,” said Jaret Seiberg, an analyst with Guggenheim Partners.

Some analysts say the appetite for creating a new bureaucracy is waning at a time when emphasis has been placed on shrinking the government. In addition, the structured finance industry and its Washington supporters are worried about having a board, instead of the ratings firms, determine rating criteria, said Tom Deutsch, executive director of the American Securitization Forum.

“The plan would eliminate independent judgment of the rating agencies and replace it with a government-mandated, government-endorsed ratings assignment board,” Deutsch said.

One alternative idea is to have the users of the rating pay for it. But that approach runs afoul of the notion that all investors should have access to the same information, critics said. If a mutual fund was able to pay to get a rating of one company’s debt but the average investor couldn’t, an information gap would ensue, they said.

In Europe, regulators are experimenting with a mandatory rotation of ratings firms, forcing the issuers of financial products to go to different firms at different times, and undermining their ability to cozy up to the rating agency of their choice. But that idea has not gained much traction in the United States, Deutsch said.

Deutsch and many of the major ratings agencies have developed their own plan. They want regulators to encourage ratings agencies to issue more “credit opinions” - rather than full-blown ratings - on financial products that they have not been hired to rate. This would beef up the existing peer-review system, Deutsch said.

In a meeting with reporters, Franken said Deutsch’s proposal can coexist with his plan. The senator said he envisions a board made up of investors, industry participants and bankers who would decide on ratings methodologies.

“This would restore trust in the system,” Franken said. “If we don’t do this, we’re justsetting ourselves up for another meltdown.”

Franken failed to get his plan included in the Dodd-Frank financial overhaul bill, which called only for the SEC to study the issue. The agency produced a report in December and recommended holding Tuesday’s roundtable.

The SEC has not determined how or whether it will act on the issue, said John Nester, an agency spokesman. “The roundtable will provide a forum for a full range of views that will augment our understanding and inform any recommendation,” he said.

This comes as at least one credit-rating agency faces enforcement actions. The Justice Department and several states have sued Standard & Poor’s, accusing it of deliberately issuing high ratings to toxic mortgage securities in order to boost profits. S&P, the nation’s biggest ratings agency, said the allegations were “meritless.”

Business, Pages 64 on 05/19/2013

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