Franken and Sherman Defend Rating-Agency Amendment

Al Franken and Brad Sherman (a California Representative who sponsored an amendment similar to Franken’s that was not included in the financial regulation bill the House passed in December), defended their approach to rating-agency reform ably in a press conference today. Reporters generally seemed skeptical that the Franken Amendment would survive conference, but I didn’t hear any really probative information disclosed on that subject.
Richard Cordray, Attorney General of Ohio, who is supervising a lawsuit against the agencies, was also there, noting that his action is still pending with no discovery schedule and – if I heard correctly – no ruling on the agencies’ motion to dismiss. I hope to write more about state lawsuits against the agencies in the near future.

On the merits, it’s clear that Franken sees the amendment as a way of enabling smaller participants to compete effectively; the idea is that the nonprofit board charged with assigning the rating agency for initial ratings on structured products would give business to smaller players and break up the oligopoly. The approach makes sense if you think that the reason that the 2006 Credit Rating Agency Reform Act failed to produce more competition is that issuers weren’t willing to give business to agencies that failed to play ball.

I’m personally a little skeptical that the new board would be so friendly to newer players. After all, the SEC’s perceived pro-incumbent bias is what led Congress to pass the 2006 Act, which was intended to make it easier for entrants to be designated “nationally recognized statistical rating organizations” (NRSROs). Moreover, the SEC was expressly authorized to attack rating-agency conflicts of interest in the 2006 Act. It’s an issue that bears thinking about because the SEC will establish and oversee the board and will appoint its members.

The reliance on an SEC-appointed board also would have led me to expect that responses to the Franken-Sherman approach would break down more along ideological lines than they have. I would have expected more Republican skepticism about the idea that the Board will do a better job than a market-based reputation mechanism in assigning ratings.
In any event, it’s great that Franken and Sherman are willing to get serious about changing the rating-agency game. A real lack of political will has been in evidence ever since rating agencies were first thrust into the spotlight in the Enron affair. The Financial Crisis Inquiry Commission hearing on rating agencies today ought to further galvanize support for strong action.

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