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There were many perpetrators involved in the 2007-09 financial crisis and most of them have gotten off scott free. Credit rating firms were a major player that have experienced limited fallout for their role in creating and exacerbating the global financial crisis.

And now it looks like despite a 3-year old Congressional directive for the Federal Securities and Exchange Commission to alter credit rating industry’s business model in which a bond issuer pays for the credit rating, little or nothing will actually be done to change how the industry works. So reports The Wall St. Journal.

This is very unfortunate for a couple of reasons:

  1. An inherent conflict of interest and lack of transparency for investors means that it will be difficult to judge the accuracy of credit ratings on a variety of debt instruments.
  2. The potential for another bubble, which could contribute to another global financial crisis.

The model in which an issuer pays a credit rating agency is inherently flawed because the rating agencies have a financial stake in making their clients happy by assigning the highest rating possible, regardless of the merits of the issue in question. This happened en masse during the housing bubble, when all sorts of questionable mortgage backed securities received top ratings.

Many of those issues later experienced extremely high levels of default, which was a “key cause” of the financial crisis, Congress concluded. Duh.

The SEC conducted a day-long meeting yesterday to get advice from experts about what to do about this problem, but hasn’t said what, if anything, they plan to do with this information. I mean, at this point, what more information do they need?

If they do the right thing, in a few months we’ll see some proposed rules that will change how ratings firms are compensated. If not, nothing will change. Of course, the ratings agencies are firmly in favor of the status quo because it would upset their very profitable apple cart if they had to be paid by investors or supervised more closely.

In the meantime, the U.S. Justice Dept. has somewhat tardily sued S&P — but not Moody’s, the other major ratings agency — for fraud, accusing the company of inflating ratings to gain more business during the real estate bubble. It cites 30 deals in which S&P rated collateralized debt obligations that included bundles of subprime mortgages, most of which fell steeply in value after they were sold to investors.

According to the Wall Street Journal, the Justice Department suit alleges that S&P “knowingly and with the intent to defraud, devised, participated in and executed a scheme to defraud investors.” The Justice Dept.  is seeking $5 billion in what would be the largest fines imposed on any firm for actions during the financial crisis.

S&P has filed to have the case dismissed, saying that the firm is being targeted for failing to foresee the financial crisis and bursting of the housing bubble.

On another front, S&P and Moody’s recently settled civil cases brought by investors. The firms were accused of “negligent misrepresentation” regarding their ratings of several structured investment vehicles.

What does all this mean to you and me? That another one of the major players in the global financial crisis may get off scott free and that a big part of the system that led to the crisis may go on  its merry way, completely unchanged. We can only hope that the SEC may actually do something and that failing that, the Justice Department will get some justice in it’s suit against S&P. Stay tuned…

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