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Government-Sanctioned Credit Ratings

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A recent enforcement action by the Securities and Exchange Commission (SEC) signals that troubles caused by over-reliance on government-sanctioned credit rating agencies, a problem that played a role in the last financial crisis, are not over. For decades, the SEC officially recognized a small group of credit rating agencies and government agencies fostered market participants' reliance on their ratings by incorporating them into their rules. As a result, the three largest credit rating agencies, which enjoyed the SEC's blessing, became very entrenched.

A 2006 law attempted to open the door to more competition by formalizing the process for obtaining the government stamp of approval. Dodd-Frank subsequently required government agencies to get rid of regulatory references to credit ratings, an important change that is not yet fully implemented. Yet both laws also deepened the SEC's oversight of credit rating agencies and thus the perception that credit ratings have a government sanction.

Last week's enforcement action involved one of the smaller credit rating agencies that had secured a government license to issue ratings under the 2006 law. The SEC alleged that the credit rating agency had exaggerated its experience in rating issuers of asset-backed and government securities when it applied to be an SEC-registered rater of those classes of credit ratings. The SEC prohibited the credit rating agency from issuing ratings of that type for eighteen months absent prominent disclosure that the ratings are not from a government-approved source.

Stepping back from the merits of this particular enforcement action, if we are trying to encourage investors to do their own homework before relying on ratings, the current regulatory approach does not seem ideal. It is not consistent with the Dodd-Frank mandate that references to credit ratings be removed from regulations. By highlighting the government's approval or disapproval of particular credit rating agencies, the regulatory framework encourages the same type of unquestioning reliance on ratings by government-approved rating agencies that helped to get us into the crisis.

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Isaac Gorodetski
Project Manager,
Center for Legal Policy at the
Manhattan Institute
igorodetski@manhattan-institute.org

Katherine Lazarski
Press Officer,
Manhattan Institute
klazarski@manhattan-institute.org

 

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.