The credit raters lose their oligopoly

One Cheer for Barney Frank. WSJ Editorial
The credit raters lose their oligopoly.
WSJ, Dec 23, 2009

The House-passed rewrite of financial regulation is a disappointment for investors and taxpayers. But one portion of the bill represents significant reform—and a vast improvement from an early draft we described in October.

Congressmen Barney Frank and Paul Kanjorski (D., Pa.) have produced legislation that would likely end the credit-ratings racket enjoyed by Standard & Poor's, Moody's and Fitch. During the housing bubble, these government-anointed judges of credit risk slapped their triple-A ratings on billions of dollars of mortgage-backed securities. The consequences for investors were catastrophic.

The Frank-Kanjorski provision that recently passed the House not only eliminates all laws that require the use of these "Nationally Recognized Statistical Ratings Organizations." The bill also instructs all the major financial regulators to remove such requirements from their rules. This is a subtle but enormously important change from the October draft, because most of the federal edicts that guaranteed profits for S&P and the gang were contained in agency rules, not laws.

The House-passed bill also repeals an exemption that credit-raters have enjoyed from the Securities and Exchange Commission's Regulation Fair Disclosure. No longer will they have access to corporate information that is denied to average investors.

Also removed from the bill was a bizarre "joint liability" scheme in which all the credit raters would be responsible for each other's work, so that a bad report by Fitch could be grounds for a lawsuit against Moody's. Unable to restrain themselves entirely from bestowing gifts upon trial lawyers, House Democrats have instead increased liability for the raters on their own work.

The Senate should avoid such public display of affection toward the plaintiffs bar but embrace the House language that strikes at the heart of the ratings cartel. Obliterating investor requirements to use credit-ratings agencies would amount to major reform all by itself. Perhaps the House and Senate should simply agree on that, pass a bill now, and then start over with a new mission for regulatory reform: break up the too big to fail racket.