July 25, 2008
To the Securities and Exchange Commission:
Thank you for the opportunity to comment on the proposed rules (Release No. 34-57967 File No. S7-13-08) for Nationally Recognized Statistical Rating Organizations (NRSROs).
My recommendation is that the Securities and Exchange Commission (SEC) should withdraw these proposed rules. To proceed with these proposed rules, or anything that resembles them, would be a serious mistake in public policy. These proposed rules, if implemented, would likely lead to a greater stultification and rigidification of the ratings process and the discouragement of innovation and new processes and procedures.
The proposed rules are intended to improve the performance of the NRSROs. But improving the overall performance of the NRSROs is a task that regulation is unlikely to achieve.
Instead, improved performance of the bond rating industry is a task that the financial markets can accomplish, through the imposition of market discipline, if the market participants are allowed greater freedom of choice as to which ratings firms they can heed. This freedom of choice has been denied to them for at least the past three decades (and, arguably, longer), because of financial regulatory requirements that the major players in the bond markets heed the NRSROs' ratings (and only the NRSROs' ratings). It is not surprising that, with a guaranteed market for their ratings, NRSROs could become sluggish and less careful, and market discipline erodes.
With greater choice, the financial markets can impose market discipline, based on which rating firms have been the most reliable, which have had the best "track records" in predicting defaults, which have had the least conflict-of-interest problems, which have revealed the most information (e.g., about their methodologies and procedures) that the markets consider important, etc. Competition will work, if given a chance. New ratings forms, procedures, and participants may well emerge. Innovation will have an open field.
The Credit Rating Agency Reform Act of 2006 (CRARA) instructs the SEC to not dictate the business models of the NRSROs. But, by influencing the procedures and methods of the NRSROs and possibly their "symbology" as well, the SEC would inevitably be affecting the NRSROs' business models.
As an alternative to these proposed regulations, the SEC should instead proceed along the path that it has outlined in its subsequent proposed regulations (i.e., Release Nos. 34-58070, 33-8940, and 34-58071 File No. S7-18-08 and Release Nos. IC-28327 and IA-2751 File No. S7-19-08) that would withdraw the explicit references to NRSROs' ratings in its existing rules. Indeed, the logic of these latter proposals should be pursued further, and SEC should eliminate the entire NRSRO designation itself. I will offer additional comments on these latter proposals at a future time.
I have attached an "op-ed" piece that expands on these ideas. This article appeared in the online DowJones Newswire "Talk Back" section on June 16, 2008. I would like this article to be included as part of my formal comments on these proposed regulations.
Greater details as to my views on these matters can be found in some of my earlier writings on these matters, which are listed at the end of these comments.
Lawrence J. White
"Don't Like the 'Power' of the Bond Rating Firms? Basel 2 Will Only Make It Worse," in Bumps on the Road to Basel: An Anthology of Views on Basel 2, Centre for the Study of Financial Innovation, 2002.
"The Credit Rating Industry: An Industrial Organization Analysis," in R.M. Levich, G. Majnoni, and C.M. Reinhart, eds. Ratings, Rating Agencies and the Global Financial System, Kluwer, 2002.
"An Industrial Organization Analysis of the Credit Rating Industry," in M.K. Ong, ed., Credit Ratings: Methodologies, Rationale and Default Risk, Risk Books, 2002.
"The SEC's Other Problem," Regulation, Winter 2002-2003 reprinted in C.H. Rajeshwer and S. Jutur, eds., Credit Rating Agencies: Emerging Issues, ICFAI University Press, 2005.
"Good Intentions Gone Awry: A Policy Analysis of the SEC's Regulation of the Bond Rating Industry," Policy Brief #2006-PB-05, Networks Financial Institute, Indiana State University.
"A New Law for the Bond Rating Industry," Regulation, Spring 2007.(Attached File #1: s71308-42.pdf)