No One Expects Rating Agency Regulation

Larry Summers, no wimp he, went all wimpy when Maria Bartiromo asked him about regulating the credit rating agencies:

"I think there are some practices there that are going to be adjusted, and we'll see just how they evolve in the course of the legislative debate."

These words were so mushy, Larry might just as well have served Maria a steaming bowl of Cream of Wheat with no raisins.

It’s clear the rating agencies screwed up badly. It’s less clear why the Obama administration has decided to punish them with the Soft Cushions from Monty Python's “Spanish Inquisition” torture scene.

The President’s White Paper says these firms “should be required to maintain robust policies and procedures for managing and disclosing conflicts of interest and otherwise ensuring the integrity of the ratings process.” Take that, rating agencies! This assumes, rather optimistically, that the agencies can police themselves, and that their conflicts of interest are manageable. (To be fair, the SEC said in this Time story that it would like to change the agencies' current fee structure, in which Those Who Create It Can Pay Those Who Rate It.)

One bright spot in the White Paper is this statement, which probably deserves more attention than it’s getting: “Regulators should reduce their use of credit ratings in regulations and supervisory practices.” Now here's where a bunch of bureaucrats could really go medieval on Moody's. The government has incorporated ratings into zillions of regulations and guidelines over the years, on the theory that a high rating is a proxy for low risk. As the excellent Frank Partnoy wrote recently, “ratings dictate the net capital requirements of banks and broker-dealers, the securities money market funds may hold, and the investment options of pension funds.” The truth is, regulators largely keep the rating agencies in business, and they could put them out of business - if they want to, which they probably don't.

Another disappointment is that Obama’s plan doesn't even mention the silly laws and court cases that have let rating agencies dodge liability on First Amendment grounds. For having the chutzpah to make (and win) that legal argument, these agencies must be punished. Fetch the Comfy Chair!


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