From the WSJ:
BlackRock Inc., which scored multiple government assignments during the financial crisis, is a contender for another prestigious gig: helping state regulators size up risks in insurers' investments.Why is this alarming? From POGO:
The money manager and risk-advisory outfit is among a handful of firms that have talked with officials from the National Association of Insurance Commissioners lately about possibly taking on a slice of work now done by the major ratings firms, according to regulators and an official at the NAIC.
Another company that is reportedly under consideration for the contract is PIMCO...To be fair, BlackRock told the WSJ that the company has “very strict policies and procedures in place to protect confidential client information and manage any potential conflicts of interest.” However, there's still potential for abuse if they get such a contract.
To understand why hiring a company like BlackRock or PIMCO could raise the risk for conflicts of interest, just take a look at BlackRock’s latest quarterly SEC filing. As of June 30, 2009, BlackRock is managing a whopping $1.37 trillion in assets, including $510 billion in bonds, $317 billion in cash products, $330 billion in stock funds, and $52 billion in alternative investments such as hedge funds. The company also advises clients on $166 billion in assets, including many of the same types of assets that it would be evaluating for the NAIC. And these numbers will soon be increasing thanks to BlackRock’s recent acquisition of Barclays’ investment unit, which, according to Bloomberg, will create a “company overseeing $2.7 trillion in assets—more than the Federal Reserve.”
It's important to note that this is a severe strike against traditional ratings agencies, who have been increasingly viewed as major culprits in the recent crisis. However, I don't think the solution is to simply ignore them. Consider the fact, instead, that ratings agencies are for-profit institutions, which in and of itself raises conflicts of interest. A hypothetical: suppose JPMorgan goes to Moody's to ask for a rating on some assets they want to securitize. Moody's comes back with a bunch of poor grades. Well, Standard & Poor's could easily jump in with its own 'research', claiming they are able to rate the assets at a higher level which would allow JPM to create a more stable security, though in reality the assets are now of unclear strength. S&P, looking for customers, has every incentive to do something like this when regulatory enforcement is weak. That link has an SEC report about how much conflict of interest exists for ratings agencies, and how the SEC did absolutely nothing about it. All bark, no bite.
One possible solution (and I'm just throwing something out there) is for all ratings agencies (at least, all of the Big 3, or perhaps some combination of the Big 3 and other smaller firms) to be required to independently rate assets when any one of them is asked, and investors be required to use the 'average' of the three ratings. The problem there is increased cost to investors, but perhaps that would give investors incentive to do a little research of their own and not waste time on potentially risky assets. Does this make any sense?
Update: Good read from Fortune on the current state of affairs with ratings agencies.
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Interesting post. A better approach might be to have the rating agencies audited. Essentially, the big 3 "audit" a company's financial position and provide a rating based on the company's assets and ability to service and repay debt. But who is watching the rating agencies? The SEC, who can barely keep up with publicly traded companies that it must regulate? The answer, as I see it, is to audit the rating agencies like any other publicly traded company, in addition to regulation in place. Next, the SEC must swell its ranks to enforce the regulation in place. This allows the SEC to maintain the function as an enforcer of regulation, while the rating agencies are held in check by an independent audit.
ReplyDeleteAfter researching Moody, I realized the company is traded publicly, and audited by KPMG, ltd. McGraw-Hill Co., which is publicly traded, owns S&P and Fitch Group is majority-owned by Fimalac, a French holding company. Now, I feel my last post is not helpful. Either way, the SEC must start doing its job and enforce the regulation in place. Also, the rating agencies should state in a disclaimer, similar to an auditor's opinion, that there is not sufficient information or a standard method in place to rate "x" assets (i.e. CDOs or RMBS).
ReplyDeleteSEC enforcement is a big issue for a few reasons:
ReplyDelete1. Low pay - you don't get the best unless you pay for the best. The best go to the ratings agencies and financial firms instead. Not sure how to solve that.
2. Sometimes, these financial firms hire people who worked at the SEC. In that sense, there's incentive for SEC employees to *not* give those they regulate any trouble, in hopes of future employment. Honestly not sure how to solve that either.
All that said, I agree with you - regulation and enforcement thereof is critical. Lack of adequate regulation was a big reason for the recent crash.
ReplyDeleteLack of adequate regulation was a big reason for the recent crash.
ReplyDeleteIMHO its the lack of enforcement which is a big problem. On paper we always have nice regulations but not proper enforcement. ex. Bernie Madoff didn't run some exotic CDO products, which no one understood. He ran a simple scheme and knew how to get past the enforcing agency. As for the exotic products there have been regulations about leverage etc.