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ra ra ra rating shopping

Everyone has missed the main point of the problem of the Federal Reserve mandating the use of ratings from Moody’s, S&P and Fitch for the TALF program … the problem is rating shopping…

Which means that issuers of the securities that the Federal Reserve is buying have shopped around for the best ratings… selectively disclosed information about the securities to preferred raters and then compensated those rating agencies. So is the Fed really certain of the quality of the securities which it is buying?

By the Fed mandating the use of the three major raters they have legitimized the practice of issuers sharing material non-public information only with the raters who assign the best ratings… and this practice institutionalizes opacity in these markets.

From FT Alphaville…

~~~~ ” Connecticut Attorney-General Richard Blumenthal makes a rather compelling point in this press release:

Attorney General Richard Blumenthal today announced he is investigating why a Federal Reserve bailout program unfairly steers up to $400 million to the Big Three credit rating agencies who helped create the economic meltdown by overrating risky securities.

The attorney general also wrote Federal Reserve Chairman Ben Bernanke asking him to revise the program to stop giving the three agencies an advantage and assure that their seven smaller competitors can compete for the work….” ~~~~

Hey AG Blumenthal… why don’t you investigate why issuers can “rate shop”… here is what Moody’s says about the practice in their latest Comment Letter to the SEC (page 6)…

~~~~ “Rating shopping, in structured finance as well as other credit markets, is a harmful practice engaged in by some Issuers and/or subscribers. The problem exists regardless of whether Issuers or subscribers pay for ratings and stems from Issuers’ control of the information needed to analyze an obligation and assign a rating. It occurs in situations where those paying for credit ratings do not feel constrained by, among other things, market disciplinary forces, to seek the best quality rating. Opaque markets can facilitate rating shopping by limiting the ability of CRAs, other analysts and investors to: (1) assess independently the creditworthiness of Issuers; and/or (2) express opinions to compete with Issuer-Paid or subscriber-paid ratings.

We agree with the Commission that rating shopping should be deterred because it has the potential to have an adverse effect on rating quality. We believe, however, that the best way to achieve this goal is for the Commission to require Issuers to make all the information reasonably considered relevant to an investment decision broadly available to the market and accessible to investors, other market participants and CRAs alike. This approach also would be consistent with what we believe should be the Commission’s ultimate goals: improving rating quality, improving investors’ ability to make well-informed investment decisions, reducing the risk of investor over-reliance on credit ratings in structured finance markets, and promoting fair and transparent markets….” ~~~~

There are profound reasons to require material non-public information be shared with all credit raters in every asset class not just in structured finance… haven’t we just seen Bear, Lehman, AIG, Goldman Sachs, Morgan Stanley and others either fail or require substantial government backstops while rated investment grade by the major raters?

It’s all about “rating shopping”, selective disclosure  and the safe harbor that issuers have… 

The SEC is considering the cure… which is to extend a modified form of Regulation Fair Disclosure to the fixed income markets… yes… all issuers should be required to share all material non-public information with all credit raters (NRSROs) equally… unbind this market… sweep away opacity… let some light in… let credit flow… 


More about the Connecticut AG’s quest…

CNN Money

NYT Dealbook

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