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Q&A: Credit rating agencies and the financial overhaul bill

WASHINGTON — Before the financial crisis, surging home prices led investors to pour trillions into investments backed by mortgages. Investors felt confident because credit rating agencies had judged these investments to be safe.

They weren't. Safe ratings had gone to investments backed by some of the riskiest mortgages. When the agencies downgraded them by the billions, they helped trigger the financial crisis.

The financial overhaul bill before Congress aims, among other things, to hold these agencies accountable for sloppy analysis that produces inaccurate ratings. Yet it barely addresses the agencies' central conflict of interest: They're paid by institutions whose products they rate.

Here are some questions and answers about how rating agencies would be affected by the bill, which Congress is expected to approve:

How would the bill help make the agencies' ratings more accurate?

The agencies could be sued if they recklessly ignored an investment's risks in assigning a grade. It's impossible to sue them now because ratings are considered constitutionally protected free speech.

The agencies would face tighter regulation. A new office within the Securities and Exchange Commission would examine them every year and could fine them for breaking its rules. An agency's right to issue some kinds of ratings could be revoked if the agency's ratings too often proved inaccurate.

How would these rules affect financial institutions?

Banks will be discouraged from shopping around for an agency that will give them the highest rating. Banks and investment companies might sue agencies that issue inaccurate ratings.

Big investors, like pension funds and asset-management firms, will know more about how agencies assign ratings.

How would the changes affect ordinary people?

Pensions and mutual funds will have better information about where to invest their clients' money, supporters say. That could make them more stable and profitable. But if more investment companies choose to do their own research, mutual fund fees could rise.

Where does the bill fall short?

It fails to fix the conflict of interest at the heart of the credit raters' business model: They're paid by the same institutions whose investments they rate. Many lawmakers say agencies issued high ratings before the crisis because of pressure from banks and because the agencies wanted more of their business.

Congress failed to include in the final bill a proposal to randomly assign banks to credit rating agencies. That way, banks couldn't shop for an agency with lower standards. Instead, regulators will study the issue and decide what rules to issue.

Q&A: Credit rating agencies and the financial overhaul bill 06/28/10 [Last modified: Monday, June 28, 2010 9:05pm]
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