This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Credit Rating Agencies Are Here to Stay

Stocks in this article: BAC MHP MCO FNMA FMCC AGO MIB

Following the Justice Department's announcement of the lawsuit against Standard & Poor's, an editorial in the Wall Street Journal highlighted the irony of one government agency taking a ratings agency to task while "another agency continues to endorse it." The Journal went on to say that "the SEC, which had been investigating the credit raters, is not part of this week's lawsuit," and also that "more than two years after the Dodd-Frank law ordered their repeal, SEC rules still force institutions to follow the advice of these government-anointed credit raters."

That last statement is actually unfair to the SEC, because the agency has taken many steps to address the problems with the credit ratings agencies, and is preparing to make other moves to address the potential for conflicts of interest in the "issuer pays" compensation model. The Justice Department's lawsuit also centers on events that took place before the credit crisis.

The SEC in 2010 created a separate Office of Credit Ratings, which has supervisory authority over the credit agencies, and is required under Dodd-Frank to examine each NRSRO annually. An SEC spokesperson said in an email that "the Office is also responsible for developing rules to strengthen transparency of the credit rating process as well as managing conflicts of interest, strengthening internal controls and regulatory governance."

The SEC has also removed 18 references to the ratings agencies from regulations, "and another 13 removals have been proposed and are pending final approval."

Kevin Petrasic, a partner in the Global Banking and Payments Systems practice of Paul Hastings in Washington, says a major challenge for the SEC and other agencies in meeting Dodd-Frank's requirements to remove references to the ratings in regulations is that "these provisions have been in place for decades."

"The challenge is that there is no substitute. What the credit agencies provide is a relative degree of uniform expertise that allows for a relative degree of consistency," he says. When asked whether the answer might be to have a government-run agency handle the ratings process for mortgage-backed securities, Petrasic says "it would be extremely difficult for a federal regulatory agency to do what the private ratings agencies do. There would be a tendency to be overly conservative at times like this and lax during the good times."

"A private-sector solution with incentives to get it right will be the most flexible to take the steps at the appropriate times to make adjustments and have the expertise to build up over time to make the judgment calls on nuanced issues."

Based on the SEC staff report to Congress -- which the SEC carefully said was the opinion of the staff and not necessarily the SEC commissioners -- it would appear that the "issuer pays" model is here to stay.

While the report doesn't say as much, it's pretty clear that the current payment model will continue because that's where the money is.

The SEC staff detailed a proposal to address the potential conflict of interest of having bond issuers pay for ratings, by implementing an "assignment system for credit ratings." Under this system, the SEC would establish a "CRA Board" to dole out assignments for "initial ratings" for specific bond issues. Issuers would still be allowed to have bonds issued by other agencies. According to Frank Mayer, a partner in the Financial Services Practice Group of Pepper Hamilton in Philadelphia, this type of system is likely to be put in place.

"The SEC will interact with the industry and it will have to be done in an equitable and transparent way," Mayer says, adding that "the ratings agencies will now have a higher level of liability and responsibility."

"There will also be standardized reporting," he says, adding that "through the training overseen by the SEC you are pushing conflicts of interest out of the system, so there is nothing wrong with the issuers paying for it."

Another major issue that needs to be addressed when reducing statutory reliance on the ratings is the Basel III capital requirements. Credit ratings are still built in to risk-weighting of securities held by banks and bank holding companies in the U.S. Mayer says there are also "a lot of discussions at the international level," because of new capital requirements for foreign banks with operations in the U.S., "even though they have robust capital requirements at home."

2 of 3

Select the service that is right for you!

Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!


DOW 18,030.21 +6.04 0.03%
S&P 500 2,081.88 -0.29 -0.01%
NASDAQ 4,773.4720 +8.0480 0.17%

Brokerage Partners

Rates from

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs