Broken Parts of Our Capital Markets, part one
This post could be a very long, but I’ll keep it short. All I can do is chip away and start cataloging the most broken parts of our financial system. Where do you start when there are so many candidates? I’ve long thought that the rating agencies ought to be high on the list, and this news from the Economist seems to suggest that instead of fixing the rating agency system the Treasury/Fed is going to double down on its reliance of not just the NRSROs, but a subset, the big three of Moody’s, S&P, and Fitch.
The Fed’s lending programmes, such as its commercial-paper facility and the Term Asset-Backed Securities Loan Facility (TALF), accept only collateral that has been appraised by a “major” rating agency, ie, one of the big three. This marks a setback for the seven rating firms that have been recognised by the Securities and Exchange Commission (SEC) more recently, including DBRS and Egan-Jones. It also sets the Fed in conflict with the SEC, which introduced reforms in 2006 to promote competition by speeding up the approval process for rating agencies.
Dan Curry, head of DBRS’s American business, notes that the Resolution Trust Corporation, which cleaned up the savings-and-loan mess in the 1990s, insisted on using firms of all sizes to rate the mortgage securities it issued. That gave a lift to upstarts, including Fitch. “Public agencies have tremendous power to influence the industry’s structure in times of crisis,” he argues.
Essentially the NRSROs act as the capital markets equivalent of the FDA or the FAA, except that they are for profit. And they get paid by the issuers. Is thre any more clear example of a fox in the henhouse? PS, Warren Buffet owns a 20% or so stake in Moody’s. That ought to provide a clue of both how profitable and how embedded he feels they are.
There are actually a number of pretty close parallels where the Federal government performs this function satisfactorily. I know they are not perfect, but the FAA maintenance program seems to work pretty well. Planes don’t fall out of the sky and the pubic generally feels safe about air transport.
OK, so how do other countries do this? What other models are there? …to be continued?
