Credit Rating Agency Reform Act

The Credit Rating Agency Reform Act (Pub.L. 109–291 (text) (pdf)) is a United States federal law whose goal is to improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating agency industry.[1]

Enacted after being signed by President Bush on September 29, 2006,[1][2] it amended the Securities Exchange Act of 1934 to require nationally recognized statistical rating organizations (NRSROs) to register with the Securities and Exchange Commission (SEC).[2][3][4]

Critics had complained that the dominance of "the big three" rating agencies – Standard & Poor's Ratings Services, Moody's Investors Service and the smaller Fitch Rating—were in part responsible for the subprime mortgage crisis of 2006–8.[5] The agencies rated 98% of the trillions of dollars of home-mortgage oriented "structured investment" products. Hundreds of billions of dollars' worth of securities given the agencies highest—triple-A – rating were later downgraded to "junk" status,[6][7][8] and the writedowns and losses came to over half a trillion dollars.[9][10][11]

The Act permitted smaller, newer credit rating agencies to register as “statistical ratings organizations".[2][12] The intent of the U.S. Congress was to increase the choice for consumers by opening the market to a greater number of ratings agencies, and also to incent accurate and reliable ratings.[4][12]

Effectiveness of act

However, in the 12 months that ended in June 2011, the SEC found the big three still issued 97% of all credit ratings, down from 98% in 2007.[5] [13] McClatchy Newspapers found that "little competition has emerged in rating the kinds of complex home-mortgage securities whose implosion led to the 2007 financial crisis".[5]

Critics have complained that the criteria to designate a rating agency as "a nationally recognized statistical rating organization” was written by a "yet-to-be-identified official of one of the big three ratings agencies" and is so difficult it has "prevented at least one potential competitor from winning approval and have dissuaded others from even applying".[5] According to critics, the law has set "odd barriers that are very favorable to the incumbents,” made it “exceptionally difficult for a younger player to qualify” as a SEC recognized agency, and “absolutely slammed the door on any new competition” in structured products – “the most lucrative part of the ratings business”.[5]

See also
Related legislation

References
  1. Sen. Richard Shelby [R-AL]. "Credit Rating Agency Reform Act of 2006 (2006; 109th Congress S. 3850)". GovTrack.us. Retrieved March 1, 2013. This article incorporates text from this source, which is in the public domain.
  2. Marie Leone (October 2, 2006). "Bush Signs Rating Agency Reform Act". CFO.com. Retrieved March 1, 2013.
  3. Sen. Richard Shelby [R-AL]. "Credit Rating Agency Reform Act of 2006 (2006; 109th Congress S. 3850)". GovTrack.us. Retrieved March 1, 2013. This article incorporates text from this source, which is in the public domain.
  4. "Credit Rating Agency Performance Needs Improvement". AccountingWEB. Retrieved March 1, 2013.
  5. Gordon, Greg (August 7, 2013). "Industry wrote provision that undercuts credit-rating overhaul". McClatchy. Archived from the original on September 5, 2013. Retrieved September 4, 2013.
  6. $300 billion collateralized debt obligations (CDOs) issued in 2005–2007 (over half of the CDOs by value during that time period) that rating agencies gave their highest "triple-A" rating to, were written down to "junk" by the end of 2009. (source:The Financial Crisis Inquiry Report (PDF). National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. pp. 228–9.)
  7. McLean, Bethany and Joe Nocera. All the Devils Are Here: The Hidden History of the Financial Crisis, Portfolio, Penguin, 2010 (p.111)
  8. Barnett-Hart, Anna Katherine. "The Story of the CDO Market Meltdown: An Empirical Analysis" (PDF). March 19, 2009. Harvard Kennedy School. Retrieved May 28, 2013. Overall, my findings suggest that the problems in the CDO market were caused by a combination of poorly constructed CDOs, irresponsible underwriting practices, and flawed credit rating procedures.
  9. Bloomberg-Smith-Bringing Down Ratings Let Loose Subprime Scourge| By Elliot Blair Smith | bloomberg.com| September 24, 2008
  10. Smith, Elliot Blair (September 24, 2008). "Bringing Down Wall Street as Ratings Let Loose Subprime Scourge". Bloomberg. Without those AAA ratings, the gold standard for debt, banks, insurance companies and pension funds wouldn't have bought the products. Bank writedowns and losses on the investments totaling $523.3 billion led to the collapse or disappearance of Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. and compelled the Bush administration to propose buying $700 billion of bad debt from distressed financial institutions.
  11. Bloomberg-Smith-Race to Bottom at Rating Agencies Secured Subprime Boom, Bust| By Elliot Blair Smith | bloomberg.com| September 25, 2008
  12. Scheeringa, Daniel. "Dodd-Frank Credit Rating Agency Reform in the Crosshairs". Illinois Business Law Journal. Retrieved December 12, 2015.
  13. Status quo for rating agencies (chart of percentage of outstanding credit ratings reported to the SEC 2007 and 2011; and Moody's revenue and income 1996, 2000, 2010, 2012)| mcclatchydc.com
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