Obama Plan Spares Rating Agencies

President Obama's regulatory reform plan appears to be a good beginning for restoring the confidence in the financial system, but there are many areas where it does not go far enough, like the revamp of the rating agencies. Despite their significant  role in the credit crisis, the impact of the proposed changes in the plan on rating agencies is minimal.

The rating agencies play a crucial role in the capital markets by rating everything from simple corporate bonds to complex structured investments like mortgage backed securities. Institutional investors rely heavily on credit ratings while deciding their purchases. Banks are also required by law to take ratings into account when investing in bonds.

Top rating agencies like Moody's (MCO - Analyst Report), McGraw-Hill's (MHP - Analyst Report) S&P Rating Services and Fitch Ratings are paid by issuers whose securities they rate, thus creating an incentive to assign high ratings in order to win more business. This system creates a conflict of interest and at times companies are even threatened with lower ratings if they don't pay particular ratings agencies.

The plan does nothing to address this key shortcoming of the system -- the "issuer pay" model.

Many of the mortgages and other securities which were awarded high ratings by the rating agencies later proved worthless, fueling the financial crisis.

The plan does make many comments and suggestions to improve oversight of the ratings process and to better manage conflicts of interest. However, the proposals are similar to the changes that were already being considered by the SEC, or even the rating agencies themselves.

The proposal also calls for regulators to reduce their reliance on agency ratings in regulations and supervisory practices wherever possible, but does not offer an alternative to the current system.

The plan proposes that the SEC continue its efforts to strengthen the regulation of credit rating agencies, and it would also require the agencies to differentiate between credit ratings assigned to complex mortgage-related investments and more traditional bonds.

The rating agencies have also escaped any liability for their ratings which later proved to be worthless under First Amendment protection, and the proposal does not change that, which may result in continuation of their irresponsible behavior in the future.