With enactment of Dodd-Frank, rating agencies can be sued for significant errors – just desserts for the buckets made scot-free leading to the global crisis. Facing this new legal risk, the agencies barred issuers from citing their findings, freezing the asset-backed securities (ABS) markets until a spooked SEC took less than a day to issue a six-month reprieve. The rating agency shut-down in the face of legal risk is like not having stairs leading to your front door because someone could sue you if they fall down. One might have thought that, given the millions they charged, the rating agencies would have had enough confidence in their bestowals to expect them to withstand legal challenge, just as we like to think our front steps are in good enough repair. Apparently not for the rating agencies, but come up and see us sometime.
Is the rating-agency business model wholly built on legal immunity? If so, then what’s a rating? A wing, a hope, a prayer? Is a rating, especially for a complex ABS, just a good opinion for hire? Are the findings of S&P, Moody’s and Fitch the capital-market equivalent of a saleslady at Neiman-Marcus, who tells a customer trying on an expensive dress how skinny she is?
Views for sale are clearly not worth much, as we’ve all learned to great cost in the financial crisis. But, views for sale premised also on legal immunity are even worse. With their prior insulation from accountability, the rating agencies had the best of all possible worlds – a license to print money without any liability for even the grossest of errors. The premise for this was that agency opinions are free speech protected by the Constitution, although issuers knew all too well how not-so-free the rating agencies were for all the ABS that got AAAs. The second time around on rating reform, Congress read the Constitution differently and took back its putative blessing for this form of commercial speech.
On cue and just minutes after Dodd-Frank was signed into law, all three of the big U.S. agencies told issuers not to breathe their name in prospectuses lest anyone take their judgments seriously. With this, ABS markets – such as they were – froze because so many investors are, by law or practice, so dependent on rating-agency divinations. With this, policy-makers stared down the abyss of another credit-market canyon. Reminded of the awesome power the agencies still exert in the financial markets, Chairman Bernanke trembled before House FinServ and the SEC gave as much ground as it could in the face of an express statutory direction.
Maybe rating-agency reform is the crack of doom or, less dramatically, an ominous rumble that would scare off nervous investors. But, if the simple fact that agencies now can be held as liable for their actions as the rest of us, then we should try to soldier on. Somehow, some way, investors can figure out a way to judge credit risk all by their little selves. And, the sooner they do, the better for a truly stable market, not one dependent on those whose interests are far afield from investors and the regulators charged with protecting them.