Put bank regulators at the top of the list of people struggling to figure out how to downgrade the credit rating agencies.
The Federal Deposit Insurance Corp. said Tuesday it will ask the public to comment on proposals for reducing the use of credit ratings in bank capital rules. Under the Dodd-Frank Act that was signed into law last month, the FDIC has a year to change its rules to reduce their reliance on ratings such as those produced by the leading firms, Moody’s and and the S&P unit of McGraw-Hill .
The rating agencies have been rightly criticized for selling out whatever standards they might have had during the housing boom to chase profit and market share. This led them to rubberstamp dodgy housing-related debt with their supposedly gold-plated triple-A rating.
The investors who put faith in those ratings took a heavy blow as the debt markets unwound in 2007 and 2008 – as did the firms’ reputations. By now, practically the only commentator of any note who isn’t questioning the rating agencies’ judgment is Berkshire Hathaway chief Warren Buffett, whose firm happens to be Moody’s biggest shareholder.
But on the subject of how to replace the rating agencies, Buffett has much company in saying he doesn’t know what might substitute for firms paid by bond issuers to issue a judgment.
“As problematic as ratings were in this crisis and the central role they played, finding an alternative is going to be very, very difficult,” FDIC chief Sheila Bair said at the agency’s hearing on the subject Tuesday. “A year is a short time frame.”
The FDIC proposes, among other things, using market-based measures such as credit spreads for calculating capital requirements. But detractors say this approach can be gamed, and other ideas come with their own caveats. The overhaul, they warn, could end up being worse than the current arrangement — an observation being made about other aspects of the financial reform push as well.
“I do worry there is a little bit of throwing the baby out with the bathwater,” John Dugan (above), the comptroller of the currency who is retiring this week after five years on the job, said Tuesday.
He urged regulators not to act rashly, not that that seems to be a big risk with legislation that dictates dozens of studies on subjects including this one.
“While I hope we come up with credible alternatives, practical alternatives as a result of this process, I worry that we may not,” he said. “If we do not, one person’s view might be that Congress should take a second look at this if we [decide] that full swing was a little too far.”