Downgrade Fever
Credit rating agencies continually prove that they do not serve you or me, and that they remain unaccountable for the opinions they place into the public arena. The global financial crisis illustrated how the rating agencies took advantage of a hands-off regulatory environment, employing faulty rating methodologies and engaging in blatant conflicts of interest to increase their profitability. In an attempt to alter this dynamic, Dodd-Frank changed the rules by which credit rating agencies are governed so that they no longer can engage in their previously commonplace irresponsible practices. Credit rating agencies have displayed their dissatisfaction with the new law, lobbying hard to slow and weaken its implementation. However, prominent Professor of the University of Missouri-Kansas City and Levy Institute Scholar Michael Hudson argues that they went too far when they threatened the U.S. credit rating, and when Standard & Poor’s actually issued a credit rating downgrade.
To give historical context, before the Dodd-Frank Wall Street Reform Act became law, rating agencies did not answer to investors or the public; instead, they answered to their clients, the investment banks. Investment banks would go “shopping for ratings,” paying the agencies to rate the banks’ securities. Careful not to bite the hands that fed them, agencies slapped AAA ratings on garbage, such as subprime mortgage loan securities. The incentive for credit agencies to keep their clients happy led to more and more securities—many of which the credit agencies could not understand—being given the coveted AAA status. To give further perspective, only eight U.S. companies enjoyed AAA status in 2005. By 2008, AAA ratings were ubiquitous, with thousands of securities brandishing the AAA stamp of approval.
Dodd-Frank changed the rules of the game. The Wall Street reform bill creates an Office of Credit Reporting, with authority to administer SEC regulations over credit rating agencies’ practices, and to fine them when they violate those regulations. Further, rating agencies must establish procedures for assigning ratings, and disclose those procedures as well as the underlying data on which they rely to make their rating decisions. These reforms are intended to allow users of credit ratings the ability to evaluate the accuracy of their findings. Most importantly, Dodd-Frank subjects credit agencies to liability for the statements they make. They can no longer claim that their ratings are merely “opinions,” for which they should not be held responsible.
The rating agencies vociferously opposed the financial reform bill and continue to oppose attempts to implement Dodd-Frank. They realize that their unbridled ability to profit from rating trash as gold will end. According to federal lobbying disclosure forms, S&P’s parent company, McGraw-Hill has spent $600,000 this year through June 30 to lobby on “Credit rating agency issues,” “S&P issue,” “SEC issues” and “the regulation of nationally recognized statistical rating organizations.” Another credit rating agency, Moody’s has also spent over $600,000. The final of the big three agencies, Fitch, has spent $100,000, lobbying on “issues related to the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act” and “regulation reform of ratings agencies.” Public Citizen’s Craig Holman has expressed concern over these agencies’ inherent conflict of interest. They put themselves out to the public as independent organizations, while spending vast sums of money to curry favor so that they can be immune from reasonable regulations.
Michael Hudson suspects there is something more sinister occurring with the agencies and the U.S.’s recent downgrade is proof. He believes that S&P retaliated against the U.S. government for undermining its business model. Hudson posits that the viewpoint of the credit rating agency industry is, “We want to make money on selling our opinions, and we don’t want to have to take any responsibility for them…We’re going to threaten to downgrade the U.S. government until you say, ‘OK, we don’t want to hear your risk assessments anymore, because you’re hurting us.’”
It’s not clear where the economy is going, but it is clear that credit rating agencies are not doing the economy any favors by playing politics. If their antics during the mid-2000s did not teach us our lesson, I hope we learn now that credit rating agencies’ excesses must be curbed, they must be accountable to the public, and they must maintain independence from Washington influence peddling. The strong implementation of Dodd-Frank will achieve significant progress toward these objectives.
Micah Hauptman is the Financial Campaign Coordinator for Public Citizen’s Congress Watch division.