THE FINANCIAL CRISIS struck in 2008. Two years later, Congress passed the Dodd-Frank financial reform law. Now, nearly three full years after that, the Securities and Exchange Commission finally has gotten
around to holding a hearing on the mess that is the credit ratings system.
Better late than never, but it was just a hearing. No proposals. No rule makings. No votes. The SEC certainly has its plate full, but given the nearly universal agreement that the credit ratings agencies Standard & Poor's and Moody's Investors Service Inc. played a key role in the financial crisis, investors deserve action, not discussion.
The Financial Crisis Inquiry Committee, created by Congress to examine the root causes of the crisis, concluded in its January 2011 report that “the failures of the credit-rating agencies were essential cogs in the wheel of financial destruction.”
SEC member Luis Aguilar pointed out that although AAA-rated securities historically have had less than a 1% probability of default, more than 90% of the AAA ratings given to subprime-residential-mortgage bonds that originated in 2006 and 2007 — the ones that nearly broke the back of the financial system — were later downgraded to junk.
The FCIC called the three biggest credit agencies, S&P, Moody's and Fitch Ratings Inc., “key enablers of the financial meltdown.”
To be sure, the SEC hasn't been sitting idly by all these years. Dodd-Frank required the agency to analyze the current credit ratings process, examine the conflicts of interest associated with issuer pay and subscriber pay models (the two main models used on Wall Street today to pay for credit ratings), take a look at the possibility of establishing alternative ratings and compensation methods, and report to Congress on its findings. It did so in December in a report that raised so many issues that Chairman Mary Jo White decided to hold last week's round table.
HUNDREDS OF PAGES
So after two previous reports in 2011 and 2012, all we have are hundreds and hundreds of pages of analysis, recommendations and public comments, and now a hearing at which the players hashed out the same issues covered in all those reports, with the same biases they exhibited in their public comments.
At the same time, the credit market continues to heal from the crisis. According to Bloomberg, companies have sold $162.9 billion in speculative-grade bonds in the U.S. this year, up from the $132.8 billion sold by this time in 2012, when a record $358.9 billion was issued.
So the fact of the matter is that while all the discussion, analysis and public input is important, it's past time for the SEC to stop talking and listening, and start acting. If Mr. Aguilar and his fellow commissioners, along with Ms. White, really want to be taken seriously as being investor advocates, they'll come out with a clear, concise and workable plan to ensure that the ratings given to corporate bonds, asset-backed securities and other credit risks can be fully relied upon by investors and, importantly, the financial advisers who recommend such investments.
It's not as though there are not ideas out there.
Sen. Al Franken, D-Minn., and Sen. Roger Wicker, R-Miss., have floated a plan to create a board that would select firms to rate structured products. The same idea was contained in the 2012 report.
The SEC already has a program in place by which issuers must disclose to all credit ratings firms the same information about a particular security that they provide to the firm that has been hired to issue the rating. That two-year-old program has not gained traction.
Several new types of models for credit ratings firms have been suggested. They include an investor-owned-agency model, in which sophisticated institutional investors would create and operate agencies that would produce ratings. Issuers would be required to obtain one rating from an investor-owned agency and one from their choice of existing commercial agency.
A stand-alone model would be much like today's issuer pay model, but instead, the credit ratings agency would be compensated through transaction fees imposed on the original issuer. Finally, a user pay model would specify that all users of ratings, including investors, would be involved in compensating the ratings agency.
Each has pros and cons that have been fully hashed out. Other ideas include creating a panel or organization to monitor the ratings agencies and the models they use to rate securities to ensure they are not taking shortcuts to coddle favor with issuers, or putting curbs in to prevent or dissuade issuers from shopping for ratings — going to the agency likely to give the best rating.
The time for talk is over. The time for action is at hand. Investors deserve no less from the SEC.
