The nation's largest credit rating agencies took a hit in Congress on Thursday afternoon, as Senate lawmakers voted to institute tough new credit rating rules and to remove the government's formal endorsement of a handful of firms.
Sen. Al Franken (D-Minn.) had taken aim at what he called “staggering conflicts of interest” in the current structure, in which issuers of financial products can shop for the most favorable ratings, selecting agencies that offered the highest ratings and threatening to avoid those that offered lower marks. Because the issuers also pay the ratings agencies for their services, Franken argued, the agencies have an incentive to issue ratings “orders of magnitude higher than they should be.”
The result, he said, was scores of AAA ratings for subpar securities.
“This conflict of interest has cost American investors and pensioners billions and billions of dollars,” Franken said, “because supposedly risk-free investments have failed or been downgraded to junk status.”
Franken's measure would create a central clearinghouse, regulated by the Securities and Exchange Commission, to assign firms a credit rating agency to give an initial rating on a security, eliminating the practice of banks shopping around for the highest marks. Financial firms could seek out subsequent ratings on the
ir own, but any discrepancies between the assigned and unassigned ratings would be made public.
In addition, Franken said, the move would allow smaller ratings agencies — aside from giants such as Moody's, Standard & Poor's and Fitch — to gain more business if their ratings prove reliable.
“It will incentivize accuracy,” Franken said Thursday of his proposal. “Imagine that.”
Franken's amendment passed 64 to 35 despite opposition from Sen. Christopher J. Dodd (D-Conn.), the architect of the far-reaching financial overhaul legislation currently before the Senate. Ten Republicans voted for the measure.
In a vote that followed, lawmakers approved a parallel amendment by Sen. George LeMieux (R-Fla.) that would remove the federal government's stamp of approval for a small group of agencies. At first glance, it appeared that LeMieux's amendment potentially could undercut Franken's effort.
Asked Thursday afternoon how he would reconcile the two measures, Dodd said, “Very good question.”
Ratings agency officials criticized Franken's amendment, noting that conflicts of interest could exist even if investors or the government paid for rating instead of banks.
“While we support efforts to further mitigate potential conflicts of interest and have taken several important steps toward this goal, the Franken Amendment could result in a number of unintended consequences,” Ed Sweeney, an S&P spokesman, said in a statement Thursday. “Credit rating firms would have less incentive to compete with one another, pursue innovation and improve their models, criteria and methodologies. This could lead to more homogenized rating opinions and, ultimately, deprive investors of valuable, differentiated opinions on credit risk.”
