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SEC offers rating agency reforms

Logos of rating agencies Moody's, Fitch Ratings, and Standard & Poor's

TEXT OF INTERVIEW

Kai Ryssdal: Now that the subprime horse is gone, the Securities and Exchange Commission set about closing the barn door today. It took aim at the credit rating business with a series of proposed reforms that are supposed to prevent one of the things that got us into the credit crunch from ever happening again.

Moody's, Fitch and Standards & Poor's handed out top ratings to bonds that were backed by subprime mortgages only to see those bonds collapse as mortgage defaults soared.

Marketplace's Amy Scott is on the SEC beat today.

Hi Amy.

Amy Scott: Hey Kai.

Ryssdal: So what happened today that the SEC did?

Scott: Well, many of the reforms they proposed involved conflicts of interest and transparency. If the rules are approved, ratings agencies wouldn't be allowed to help structure the bond deals that they rate. They'd also have to publicly disclose the information they use in determining their ratings so that others can go back and check their work. And analysts won't be allowed to accept gifts from issuers worth more than $25 -- there was kind of a cute discussion about whether coffee and danishes are allowed. But one of the biggest proposals concerns the difference between plain vanilla corporate bonds like IBM and what are known as structured securities. These are bonds backed by pools of subprime mortgages and the like, and that's where the rating agencies really got into trouble, by treating theses structured securities like any other bonds when, of course, they turned out to be a lot riskier. So the SEC has proposed a few ways of dealing with this. Ratings for structured securities either would have to be accompanied by a report outlining the risks or the securities would actually get a different label, so instead of a Triple-A credit rating, you might see Triple-Star or something like that.

Ryssdal: Gotta love that after billions lost in the subprime squeeze, it comes down to coffee and donuts, right?

Scott: That's right.

Ryssdal: Let me ask you this, though. Wouldn't some smart investor, whether it's an institutional investor or somebody sitting at home, look at a rating on a product that somehow delineates that it's a structured finance thing and run screaming for the hills, right?

Scott: Well, that is one concern. In fact, one commissioner, Paul Atkins, voted against that proposal. The worry is that a separate rating scale could be confusing on one hand, but also by sort of branding these securities with a scarlet letter, it could spook investors and cause them to dump these securities into a market that's already very leery of them, which would basically make this whole credit crunch even worse.

Ryssdal: What kind of discussion was there of the business model that Standard & Poor's and Moody's and Fitch all employ, which is to say they are paid, generally, by the entities whose products, whose bonds and offerings, they are rating?

Scott: Right, that's often described as a restaurant paying for a review and only paying if it's a good review. There was some discussion of managing that conflict. Analysts involved in rating bonds, for example, would be banned from any discussion of fees and last week, the New York Attorney General tried to address that conflict in a settlement with the big three agencies. Now bond issuers will have to pay any agency that reviews a deal, not just the firm chosen to rate the deal and that's meant to reduce the incentive to boost ratings in order to attract business.

Ryssdal: Is this real reform or are they just putting window dressing on it to make it look like they're actually doing something?

Scott: People that I've spoken to say these are some of the most real reforms we've seen yet. I think the idea is that there is a lot more that can be done, but we've seen the agencies themselves propose reforms, we saw the New York Attorney General come up with a plan last week, international regulators have proposed various voluntary codes of conduct and I think the idea is that the SEC reforms may actually have some teeth, but it remains to be seen.

Ryssdal: Marketplace's Amy Scott in New York City. Thanks Amy.

Scott: Any time.

About the author

Kai Ryssdal is the host and senior editor of Marketplace, public radio’s program on business and the economy.
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