Now that the job of implementing the financial-reform bill has been handed over to regulators, the financial sector is going to do everything it can to loosen them. Yesterday, the ratings-agency cartel went on strike, refusing to rate bonds -- this led to a substantial freeze in trading. While some see this as an economic consequence of the Dodd-Frank bill, that's not really the case: This is a political maneuver, intended to fight back against new restrictions on business practices, and we had better hope that regulators don't give in easily.
As this FT writer points out, ratings agencies were clearly aware of the provision in question that will allow investors to sue them if they “knowingly and recklessly” fail to perform due diligence on the products they rate. (Previously, ratings were considered speech and protected by the First Amendment -- there was essentially no accountability at all, which is one reason many problematic financial products were rated same-as-cash.) In fact, it should worry ratings-agency clients very much that they feel unable to meet that very basic standard. Further, if there are complex products for which the agencies don't feel that they are capable of meeting that standard, why should they even be on the market?
While there's little doubt that the new rule will increase the legal expenses that these agencies face, the argument that these profitable, monopolistic agencies should be so influential over major financial deals without any real accountability is hardly compelling. Their record in the run-up to the crisis was frankly embarrassing, and they only have their own business practices to blame for the new regulations.
In a typical case of financial sector blackmail, the agencies are threatening to stop working for smaller clients and municipalities, hoping to pressure regulators into loosening the rules. The SEC is already considering "transitional" steps to ease the agencies into the new regime, but I hope whatever the commission decides is very narrowly drawn. if this is the first big fight over regulatory implementation, it's important to set a firm line now.
-- Tim Fernholz
