Will US policymakers consider making back-room deals to mitigate a US downgrade?
European policy makers have been actively berating rating agencies for their series of downgrades of sovereign debt issues by Eurozone worry-targets like Greece and Portugal over the last many months. As the Financial Times has reported, the European politicians have called for either an advanced warning period by the rating agencies before they go public with a downgrade (longer than the current 12 hours) or for the private-sector rating agencies to be replaced by a “more independent,” publicly-funded rating body.
In response, Standard and Poor’s President Deven Sharma has taken to the FT with an article arguing for policymakers to reduce reliance on rating agencies. He and other rating agency representatives are likely making the same pitch this week as they appear before a House Financial Services subcommittee looking into credit ratings and the financial crisis.
The same argument applies and should be made more forcibly to regulators, who are struggling with removing rating criteria from rules governing bank’s risk-weighted assets, collateral and even investment requirements. The problem is that they are also having a hard time finding universally agreed to standards for credit risk assessment that can immediately serve to replace ratings.
Thus, rating agencies can easily make statements like Mr. Sharma’s without really worrying about seeing their business suffer from ratings suddenly being stricken from financial market rule books. The stakes get higher, however, as the rating agencies have become embroiled in the politics of a US sovereign debt and the impact of a downgrade to US debt that supports the entire global financial system.
Dodd-Frank Section 939A. Consider for a moment the implications of US rating actions in the context of the Dodd-Frank Act’s Section 939A. According to this section, all federal agencies are supposed to review any regulation referencing assessments of the creditworthiness of a security or money market instrument and any references or requirements pertaining to credit ratings and modify them to remove their ratings reference or any reliance upon them. On Tuesday, the Securities and Exchange Commission did just that, unanimously approving the plan to remove credit ratings from some of its rulemaking procedures.
In their place, the Feds are supposed to put some standard reference of credit worthiness. Given the challenges of finding a standard alternative reference, this is proving to be a major sticking point in issuing some of the critical new regulations stemming from Dodd-Frank. Thus, experts agree that some at least interim fix must be made.
The need for, and potential nature of, this “fix,” it would seem, puts the rating agencies into potential conflict with their ability to speak impartially about the creditworthiness of US sovereign debt. For example, just hypothetically, they can make a lot of noise threatening a US downgrade, and then agree to back off or at least limit the downgrade to one notch in exchange for a back-room deal securing a favorable fix to Section 939A.