More wet noodles for the ratings agencies

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What’s the difference between a ratings agency and an investment banker? Job security. Banks come and go (Ciao, Lehman!) but ratings agencies are forever — no matter how shoddy their work.

This brings me to Cong. Paul Kanjorski (D-PA) and his hearings on ratings agency reform, held yesterday. The event promised to be a real fire and brimstone moment. Barney Frank had threatened the agencies with death by insignificance for mindlessly slapped triple-A ratings on subprime dreck — much to the detriment of the US and global economy. Kanjorski’s proposed legislation? The agency worker bees will need to fill out a lot more paperwork. LOTS more paperwork. The SEC, which has been working on more stringent rules for the so-called NRSROs since 2007, has made them promise to be more careful in the future. Really. No more rate shopping; better supervision. And lots more paperwork. The WSJ laments in the wake of the Kanjorski hearing:

… despite the path of financial destruction paved by the Big Three raters, Washington still won’t yank their privileged status as Nationally Recognized Statistical Ratings Organizations (NRSROs). Based on the draft reform written by Mr. Frank’s colleague, Paul Kanjorski (D., Pa.), the raters can expect more compliance and legal costs, but no threat to their official role as America’s judges of credit risk.

Further, the payout model remodels untouched: the credit agencies will continue to bet paid by issuers. Somehow, the agencies are not supposed to be influenced by this relationship. It’s really confidence inducing.

The draft law does propose that the NRSROs assume liability for their incompetence. But that’s not all. It also suggests that ratings agencies be held liable for the negligence and incompetence of their peers. Say, what? The NRSROs should lose their liability shield. But should Sears be held responsible if GE makes ovens that blow up on ignition? Should all roofers in your town get sued if one mistakenly removes the roof on your house?

Meanwhile, the SEC’s Daniel M. Gallagher, Co-Acting Director, Division of Trading and Markets, reviewed proposed changes that would extirpate the rating agency roles in some investment and capital rules — important advances in some areas in terms of forcing investors to do their own due diligence rather than relying on the flawed rating agencies. But the SEC can’t bring itself to remove the credit rating agencies from regs for money market funds because the money managers object. So once more the SEC is seeking “additional comment” on a rule change that’s been kicking around for more than a year on this issue. You would think the managers would be fuming or at least complain that the rating agencies had double-crossed them.  No, instead these quivering fiduciaries have actually said that they don’t want the fund boards to have the liability for investing  without the credit rating agency imprimatur.

Breakingviews.com comments that the changes coming at the NRSROs from lawmakers and regulators may prove to be death by a thousand cuts: If Congress and the SEC forces too much paperwork on the beknighted ratings agencies they may decide it’s not worth working as NRSROs anymore — even if the same basic flawed pay structure remains in place. Further, the column suggests that if the regulators can get the agencies out of the woof and warp of our investment system, there would be another amazing benefit:  “Perhaps best of all, removing all official recognition and regulation of ratings would free up time and money for regulators around the world, allowing them to focus on more important things.” Wouldn’t that be nice.

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