By misreading the risk in mortgage-backed securities and other “structured” products, the rating agencies Standard & Poor’s, Moody’s and Fitch played starring roles in the failure of finance. Their punishment? Oddly, the further entrenchment of their dominance, thanks to the Federal Reserve.
The Fed’s lending programmes, such as its commercial-paper facility and the Term Asset-Backed Securities Loan Facility (TALF), accept only collateral that has been appraised by a “major” rating agency, ie, one of the big three. This marks a setback for the seven rating firms that have been recognised by the Securities and Exchange Commission (SEC) more recently, including DBRS and Egan-Jones. It also sets the Fed in conflict with the SEC, which introduced reforms in 2006 to promote competition by speeding up the approval process for rating agencies.
The Fed has promised to consider expanding the list of eligible raters, but Ben Bernanke, its chairman, recently said he was “comfortable” with the big three’s revamped ratings models. Their rewards could be handsome: up to $400m in TALF-related fees alone, reckons Richard Blumenthal, Connecticut’s attorney-general. He has launched an antitrust probe and accuses the Fed of “rewarding the same companies that helped burn down the house”. Keen to restore securitisation’s credibility, Wall Street’s main trade groups, too, want the TALF opened up to smaller rating agencies.
Dan Curry, head of DBRS’s American business, notes that the Resolution Trust Corporation, which cleaned up the savings-and-loan mess in the 1990s, insisted on using firms of all sizes to rate the mortgage securities it issued. That gave a lift to upstarts, including Fitch. “Public agencies have tremendous power to influence the industry’s structure in times of crisis,” he argues.
The inspector-general for the government’s financial-rescue efforts this week urged the Treasury to scrap the use of credit ratings for TALF securities altogether and do the screening itself. That may seem far-fetched because investors still find comfort in ratings (a proposal to reduce money-market funds’ reliance on ratings was shelved last year after the largest funds voiced opposition). But better no ratings at all, perhaps, than those of a discredited oligopoly supported by a short-sighted central bank.