“For decades before the crisis, SEC staff had recognized a small group of private credit-rating agencies—including Standard & Poor’s, Moody’s and Fitch—as official judges of risk. Federal regulators referred to these favored companies in their rules and even forced financial institutions to invest in paper rated highly by this anointed cartel…

…When the members of the cartel turned out to be wrong about the risks in mortgage-backed securities, the result was catastrophic because the government had forced so many other firms to follow their advice…SEC Chair Mary Jo White should now get her agency all the way out of the business of deciding whose opinions about credit risk ought to be followed. Let markets decide whose opinions have value. It will make financial crises less likely.”, “Ending the Ratings Racket”, The Wall Street Journal Editorial Board, September 20, 2015

Opinion

Ending the Ratings Racket

Seven years after the financial crisis, the SEC enacts a critical reform.

U.S. Securities and Exchange Commission (SEC) Chairman Daniel Gallagher speaks at the Sandler O'Neill + Partners, L.P. Global Exchange and Brokerage Conference on June 3, 2015.

U.S. Securities and Exchange Commission (SEC) Chairman Daniel Gallagher speaks at the Sandler O’Neill + Partners, L.P. Global Exchange and Brokerage Conference on June 3, 2015. PHOTO: MIKE SEGAR/REUTERS

America’s financial system is sturdier today thanks to some rare good news from a Washington regulator. Seven years after the financial crisis, the Securities and Exchange Commission has taken a big step toward ending a policy that helped cause the mess.

For decades before the crisis, SEC staff had recognized a small group of private credit-rating agencies—including Standard & Poor’s, Moody’s and Fitch—as official judges of risk. Federal regulators referred to these favored companies in their rules and even forced financial institutions to invest in paper rated highly by this anointed cartel.

When the members of the cartel turned out to be wrong about the risks in mortgage-backed securities, the result was catastrophic because the government had forced so many other firms to follow their advice.

The new rule enacted by the commission this week says that instead of simply holding assets rated highly by the cartel, the operators of money-market mutual funds must instead rely on their own analysis to select securities presenting minimal credit risk. Investors probably assume that’s what mutual fund companies do already, and many of them do. All of them should.

Kudos to SEC Commissioner Daniel Gallagher, who has the welcome habit of breaking Beltway decorum. In various public fora, Mr. Gallagher kept reminding his colleagues that this needed reform was being ignored while they went about drafting rules that had nothing to do with addressing the causes of the last crisis or preventing the next one.

This week’s reform leaves one SEC rule that still carries an endorsement of the ratings cartel—so-called Regulation M for securities offerings. SEC Chair Mary Jo White should now get her agency all the way out of the business of deciding whose opinions about credit risk ought to be followed. Let markets decide whose opinions have value. It will make financial crises less likely.

There’s also need for reform outside Washington. Too many state pension systems still show too much deference to the cartel. A rating expresses a point of view, not a guarantee.

Posted on September 23, 2015, in Postings. Bookmark the permalink. Leave a comment.

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