Open Letter from Former Rating Agency Executives on the Financial Choice Act

"Eliminate the NRSRO certification entirely"

From: Marc Joffe <marc@publicsectorcredit.org>

To: "janelle.relfe@mail.house.gov" <janelle.relfe@mail.house.gov>; "charla.ouertatani@mail.house.gov" <charla.ouertatani@mail.house.gov>; "bill.hulse@mail.house.gov" <bill.hulse@mail.house.gov>; "ben.harney@mail.house.gov" <ben.harney@mail.house.gov>; "marliss.mcmanus@mail.house.gov" <marliss.mcmanus@mail.house.gov>; "chrisbrown@mail.house.gov" <chrisbrown@mail.house.gov>; "david.goldfarb@mail.house.gov" <david.goldfarb@mail.house.gov>; "perre.smalls@mail.house.gov" <perre.smalls@mail.house.gov>

The Financial Choice Act withdraws many Dodd Frank credit rating agency provisions, but leaves in place Section 939A, that mandates the removal of credit ratings from financial regulation.

We recommend that the Choice Act build on 939A by eliminating the NRSRO certification entirely.

Dodd Frank’s attempt to control credit rating agencies arose from a widespread belief that flawed, biased credit rating processes contributed to the Great Recession. As former rating agency executives, we agree with this critique. The systematic mis-rating of Residential Mortgage Backed Securities, Collateralized Debt Obligations, Structured Investment Vehicles and Monoline Bond Insurers resulted in widespread asset mispricing. When the actual risk of the mispriced credit assets became apparent, the repricing process produced shocks to the financial system that destabilized the overall economy.

A return to something resembling the pre-2008 status quo in which a government-sanctioned oligopoly of conflicted companies assess credit quality risks a repeat of the financial crisis. We should remember that credit rating agencies also failed to properly assess Enron and WorldCom in the 2001 downturn, eventually triggering the Credit Rating Reform Act of 2006, passed by a Republican House. The reforms under this legislation proved insufficient. Nor has Dodd Frank resolved the problem: rating agency methodologies and procedures remain deficient in many cases.

Heavy handed regulatory control of NRSROs is not necessarily the solution: it stifles industry innovation and raises the cost of assessing credit. Additional analyst training and extra reporting raise the cost of entering the credit rating business, making it harder for new entrants to obtain and maintain the NRSRO certification. Further, we see evidence of regulatory capture leading to non-enforcement of some Dodd Frank mandates.

A better alternative in our view is to adopt the more radical deregulatory approach of eliminating the NRSRO designation. The NRSRO license places the government’s imprimatur on credit assessments that are too often the result of sloppy procedures and/or commercial bias. Once credit ratings are stripped of a government license, consumers of credit ratings – i.e., fixed income investors – will be obliged to judge them on their intrinsic quality, rather than on the presence or absence of an official signal. Non-NRSRO competitors would be able to play on a level playing field with incumbent NRSROs giving investors more options to choose from.

William Harrington, Private Citizen Advocate

Simon Hu, Independent Economist

Marc Joffe, Public Sector Credit Solutions

Rick Michalek, RJM Consulting

Joseph Pimbley, Maxwell Consulting, LLC

Ann Rutledge, R&R Consulting