With federal lawmakers battling over a deal to give the U.S. government more borrowing authority, major credit rating agencies have lent a sense of urgency to the proceedings by threatening to issue a downgrade, which experts fear could throw financial markets into turmoil and impede the economic recovery.
But according to a confidential report obtained by The Huffington Post, one prominent analyst is saying markets should not be so reliant on the pronouncements of these companies, which have repeatedly proven themselves to be poor judges of credit quality. The rating agencies, which offered rosy assessments of financial products that later went bust, deserve to have their government seal of approval revoked, argues Janet Tavakoli, president of the Chicago-based consulting firm Tavakoli Structured Finance.
"Either through intention or incompetence the rating agencies lied in the sense that they made false statements that had grave consequences for investors and the global financial markets," Tavakoli says in the report, dated Tuesday.
"The rating agencies do not merit the [Nationally Recognized Statistical Rating Organization] designation," or the government stamp that makes ratings a centerpiece of the regulatory structure, Tavakoli says.
Credit rating agencies, including Moody's Investors Service and Standard & Poor's Financial Services, provide assessments that investors around the world relied upon in the years leading up to the financial crisis -- and continue to rely upon today. But their judgments have repeatedly proven misleading, sometimes to disastrous effect.
These companies helped inflate the speculative bubble in subprime mortgage-linked investments that ultimately ravaged the broader economy, an April report by the Senate Permanent Subcommittee on Investigations concluded. By easing their standards when they rated complicated securities issued by Wall Street banks, the rating agencies blessed instruments that in actuality were far more dangerous than the agencies suggested, helping make the entire financial system more vulnerable to collapse, said the report. (A spokesman for Standard & Poor's said in response to the report that the company has worked to improve the independence of its ratings since the financial crisis.)
In large part, it's the government that has given the rating agencies a significant measure of authority. Regulations often require institutional investors, such as pension funds, buy highly rated securities, relying on private companies for that judgment.
The NRSRO designation has been bestowed by the Securities and Exchange Commission upon 10 organizations, giving their ratings what Tavakoli calls an "appearance of being issued from a position of authority."
The major credit rating agencies have placed the U.S. government's rating on review, warning of a downgrade if lawmakers don't reach a deal to lift the debt ceiling on time and reduce the long-term federal deficit. Even if the government doesn't default, its rating might still be downgraded, S&P has said.
If one of these agencies downgrades the credit rating of U.S. government debt, that could push up interest rates as the debt would be perceived as risky. It would become more expensive for the U.S. government to borrow money, worsening the budget deficit still further.
Interest rates throughout the economy that are tied to the Treasury rate would likely rise, making it more expensive for Americans to borrow money and potentially threatening the broader economic recovery.
Despite the rating agencies' failures, Tavakoli, who has long been a critic of the NRSRO designation, says the companies continue to wield authority in financial markets. The Dodd-Frank Act, which targeted other financial institutions for reform, leaves intact the rating agencies' role as arbiters of credit quality.
One remedy, she says, is that investors should be required to do their own research, to make sure ratings are appropriate.
Another would be for a third party to institute a standardized scale, to make sure the meanings of ratings from different companies are defined and consistent, she says. The Senate panel, in its April report, recommended that the SEC rank the major credit rating agencies by the accuracy of their ratings.
"The rating agencies just made stuff up," Tavakoli says in the report. But, she adds, "regulators and investors rely on this pseudoauthority."