SEC Tightens Grip on Ratings Agencies
By Staff News & Analysis - September 18, 2009

The US Securities and Exchange Commission passed rules on Thursday to tighten supervision of credit ratings agencies following a torrent of criticism over their role in the financial crisis. Credit ratings agencies, which are usually paid by the issuers they rate, came under fire during the crisis because they gave top ratings to hundreds of billions of dollars of bonds backed by risky mortgages and other loans that are now in many cases worthless. The SEC said on Thursday that ratings agencies must reveal more information on past ratings so that investors could compare relative performance. Banks will have to share the underlying data used to determine ratings, so that competing agencies can offer unsolicited ratings for structured finance products. The SEC said it would remove references to ratings in some of its rules as part of efforts to reduce overall reliance on ratings by investors. It also decided to get public feedback on whether ratings agencies should be subject to potential legal liability under securities law and what the possible consequences might be. – Financial Times

Dominant Social Theme: Let's get it right this time!

Free-Market Analysis: So the SEC, which missed the Madoff Ponzi scheme, is going to supervise Wall Sreet's ratings agencies in order to ensure … what? That they provide information about company risk? That they allow the consumer to comparison shop? At the risk of sounding rude, we ask, what difference will it make? The big three ratings agencies and every mainstream economist of note missed the financial crisis entirely.

S&P, Moody's and Fitch presumably create intricate models to ensure that their ratings of company risk correspond to what might occur. Yet in late 2008, the entire credit system apparently froze up and almost all of the companies that the big three rating agencies evaluated likely had a considerable chance for some level of default. That means the ratings agencies simply missed when it came to evaluating company risk across the board. Here's some more from the Financial Times article:

Fresh proposals were also put forward governing disclosure, including whether any "preliminary ratings" were obtained from other ratings agencies – in other words, whether there was "ratings shopping".

Mary Schapiro (pictured above left), the SEC chairman, said reliance on ratings by investors "did not serve them well" in recent years, and "it is incumbent upon us to do all that we can to improve the reliability and integrity of the ratings process and give investors the appropriate context for evaluating whether ratings deserve their trust".

The moves came amid further evidence that securities with triple-A credit ratings were not as creditworthy as thought. On Thursday, Standard & Poor's said it might downgrade nearly $600bn of securities backed by corporate debt after it changed its ratings criteria for these so-called collateralized debt obligations.

In California, the state's attorney-general, Edmund Brown, announced subpoenas on S&P, Moody's and Fitch to determine whether the firms violated state law when they gave "stellar ratings to shaky assets".

"This investigation is meant to determine how these agencies could get it so wrong and whether they violated California law in the process," he said.

We can save the SEC and sundry officialdom considerable time and energy when it comes to figuring out how "agencies could get it so wrong." Said agencies use Keynesian analysis when they should be using free-market Austrian analysis. It's that simple. If you don't analyze economics with a sufficient understanding of the corrupting impact of central banking, then you are going to fall behind the curve. We bet their models still do not account for it properly.

You know, the ratings agencies didn't just "get it wrong" – they failed to predict what was basically the meltdown of Western fiat money. They failed to predict that the dollar, the world's reserve currency, was – suddenly – basically worthless without the injection of trillions of dollars from central banks.

The ratings agencies proved that their models had, in this most critical instance, absolutely no application to the real world. This was not just a catastrophic failure. This was a failure of almost every financial assumption taught in every Western university and applied and practiced in all of the centers of Western finance as well.

Literally trillions of dollars is invested based on the opinions of the Big Three ratings agencies. Based on their performance over the past two years, their analysis is worthless.

In fact, one can now question quite credibly whether honest accounting and real-life valuations have even a passing acquaintance with what today passes for risk-analysis in Western financial systems. Today, with the benefit of hindsight, we can see that the entire elaborate methodology that was supposed to ensure the viability of Western capitalism, failed – and failed totally. It was only the ability of central banks to print enough money that refloated, for the moment anyway, this artificial system.

Over and over (we have mentioned this before), watching how finance operates in the Western world, we are reminded of the famous fable, The Emperor's New Clothes.

Everyone said, loud enough for the others to hear: "Look at the Emperor's new clothes. They're beautiful!"

"What a marvellous train!"

"And the colors! The colors of that beautiful fabric! I have never seen anything like it in my life!" They all tried to conceal their disappointment at not being able to see the clothes, and since nobody was willing to admit his own stupidity and incompetence, they all behaved as the two scoundrels had predicted.

A child, however, who had no important job and could only see things as his eyes showed them to him, went up to the carriage.

"The Emperor is naked," he said.

"Fool!" his father reprimanded, running after him. "Don't talk nonsense!" He grabbed his child and took him away. But the boy's remark, which had been heard by the bystanders, was repeated over and over again until everyone cried:

"The boy is right! The Emperor is naked! It's true!"

The Emperor realized that the people were right but could not admit to that. He thought it better to continue the procession under the illusion that anyone who couldn't see his clothes was either stupid or incompetent. And he stood stiffly on his carriage, while behind him a page held his imaginary mantle.

The regulators, the ratings agencies, the commercial banks, the investment banks, the central banks – none of them saw the financial crisis coming. Only financial analysts on the Internet who use free-market analysis were able to supply accurate and logical accounts of what was going, and in fact anticipated the meltdown.

But instead of granting the validity of free-market Austrian analysis – and the superiority of the forecasting model – the entire financial and investment establishment has closed ranks. Like the Emperor, they understand that their models, their econometric disciplines — their world view, in fact — are fatally flawed. So they stand stiffly in their metaphorical carriages with their pages holding their imaginary mantles and carry on with "adjustments" to business as usual.

After Thoughts

By all means, investigate the ratings agencies. Hire more regulatory staff. Cut back banker bonuses. Seek more information from hedge funds. Pretend that the looming derivatives debacle doesn't exist. Re-jigger regulation worldwide, if that's what it takes to get you through the day. But never, ever admit your model is wrong. Never admit that it is based on a melancholy lie, that fiat money can over the long-term retain its value. Of course, it can't. It costs nothing to produce and eventually it will revert to its intrinsic value. That is a natural law. Value is intrinsic, based on the difficulty of the achievement in the eyes of the market. History PROVES the only money that can viably retain its full value over time is gold and silver. That is why, sooner or later, a free-market gold and silver money standard, or a variant therefore, will be subject to a serious debate.