The Wall Street Journal reports this morning that part of the bond market has shut down because credit raters like Moody’s have told issuers they can’t quote their ratings.
Why? Because the financial-reform bill (law in a couple of hours) makes Moody’s, S&P, and Fitch—who were critical enablers of the financial crisis—for the first time liable for what they say. They’ve hidden behind the First Amendment for years.
Once the bill is signed into law, advice by the services will be considered “expert” if used in formal documents filed with the Securities and Exchange Commission. That definition would make them legally liable for their work, meaning that it will be easier to sue an firm if a bond doesn’t perform up to the stated rating.
That is a change from the current law, which considers ratings merely an opinion, protected like any other media such as a newspaper.
And:
The companies say that, until they get a better understanding of their legal exposure, they are refusing to let bond issuers use their ratings.
That is important because some bonds, notably those that are made up of consumer loans, are required by law to include ratings in their official documentation. That means new bond sales in the $1.4 trillion market for mortgages, autos, student loans and credit cards could effectively shut down.
There have been no new asset-backed bonds put on sale this week, in stark contrast to last week, when $3 billion of issues were sold. Market participants say the new law is partly behind the slowdown.
This, needless to say, deserves watching.
This provision seems to have flown in under the radar of the press. The Journal had a nice story about it on June 18, but cut it in half and stuffed it inside the Money & Investing section. I don’t see anything from The New York Times.
But the Journal says ratings agencies were caught by surprise, too:
The change caught the ratings agencies by surprise. The original Senate version of the bill didn’t include the provision. It was only on June 30, when the Dodd-Frank bill was passed, that the exemption was removed.
What else don’t we know about this soon-to-be law? We sure need to know more about this provision.
Ryan,
This seems relevant as an ‘unfooling risk’, properly to be considered by credit raters of mortgage securities. The history of home prices here
http://homepage.mac.com/ttsmyf/RHandRD.html
is kept little-apparent to the people, who are thus ‘fooled’.
Unfooling figures to correlate with lower home prices, which figures to correlate with more mortgage defaulting.
#1 Posted by Ed, CJR on Wed 21 Jul 2010 at 12:46 PM
One thing that annoyed me in the journal's coverage was the careful wording about the new liability that this law "creates." The journal article makes it sound like this new law adds a regulation that makes these firms liable where otherwise no liability would have existed.
The truth is, the law removes an exemption that the agencies have enjoyed for years that had shielded them from liability. The change is similar to congress removing the BP liability shield. But you wouldn't get that from the journal's sloppy or intentionally misleading reporting.
#2 Posted by Jim, CJR on Thu 22 Jul 2010 at 08:56 PM