In an ideal world, the Securities and Exchange Commission would hold a daylong conference entitled: “How to Dismantle the Ratings Agencies and Restore Confidence in the Credit Markets.: Instead, on April 15 – tax day – the SEC will sponsor a “Roundtable to Examine Oversight of Credit Rating Agencies.” Go ahead, yawn. Or if you’re a taxpayer, go ahead and spit.
Despite displaying impressive incompetence during the subprime mortgage debacle, the rating agencies are essentially calling the shots on who shall live and who shall die during this crisis. Even the regulators appear afraid of their power. Last February, they paid visits on bent knee to beg the all-powerful Rating Wizards of Oz to give AIG a second chance on life: No more downgrades, please.
The agencies didn’t downgrade AIG but their cooperation cost US taxpayers in Kansas and across this great land another $30 billion. What we got for our money is unclear. (In a shocking moment of candor before Congress, Federal Reserve Bank Chairman Ben Bernanke rued that he didn’t have the power last September to put AIG, the too-big-to-fail behemoth, into conservatorship. Why that hasn’t happened since leaving the taxpayer so vulnerable is an open question.)
Warren Buffet calls financial engineered products weapons of mass destruction. The credit agencies wield much the same power without the mad scientists or supercharged bonuses. Thus AIG’s brethren in the insurance industry are struggling against the threat of nuclear downgrades; that’s probably one reason the government is likely to share the $100 billion or so still left in the $700 billion TARP pool with what were once viewed as dull, conservative corporations, the Wall Street Journal reports today.
What would happen if the rating agencies faded away or were simply de-fanged? In a recent New York Times OpEd piece, Jerome S. Fons, a consultant and former Moody’s managing director, and Frank Partnoy, a law professor at the University of San Diego, argue that the investment landscape would improve. In fact, they report the SEC “has called for eliminating reliance on ratings, but that proposal has stalled in the face of intense lobbying.” So much for the end of the lobbyist stranglehold proclaimed by President Obama.
But after all that has transpired, now is no time to give up: The rating agencies were instrumental in giving investors the dangerous illusion of safety. They were in fact clueless and when their judgment was most needed, it was lacking. Here’s how Fons and Partnoy envision a world without these false gods. The place to start is with the worshippers:
For their part, investors should stop putting ratings-related language into financial contracts. The terms of credit default swaps and other derivatives should be free of ratings-based triggers. Banking supervisors should insist that loan contracts not refer to ratings. Fund sponsors, pension plan administrators and insurance regulators should remove ratings-based criteria.
The financial markets can function without letter ratings. Instead of relying on arbitrary letters, regulators and investors should consider all of the information available about an investment, including market prices.
Finally, regulators and investors should return to the tool they used to assess credit risk before they began delegating responsibility to the credit rating agencies. That tool is called judgment.
The return of judgment. That would be a great place to start building a New Wall Street.