More Study for Franken Amendment: Possibly the Right Call

 

Al Franken campaign photoAl Franken campaign photo
I missed this when it happened, but it seems that on Tuesday the Conference Committee sort of gutted Al Franken’s amendment on rating agencies. Tim Fernholz explains:
An all-day fight ensued behind the scenes among Democratic members of the Senate delegation over whether to protect Franken’s idea or accept the House’s language. Franken’s proposal, despite a strong vote in the Senate, is still viewed skeptically by some Democrats because it preserves the existing ratings agencies and by others because agencies have lobbied hard against it. Eventually, a compromise was brokered, directing the SEC to implement Franken’s plan — after a year-long study. It’s a classic Washington agreement, at once meaningless and damaging since regulators could ignore legislators’ intent after public scrutiny subsides.
“Today’s compromise is not everything we wanted, but it’s a major step in the right direction,” Franken said later. “The language agreed on by the conference committee means more time and more study than I think is necessary, but it also means definite action will be taken.”
In essence, I agree with Fernholz’s take on the dynamics. But I think further study of this might actually be a good idea. Franken’s proposal is that instead of the issuer of a security picking which rating agency he wants to have rate his security, that instead the security should be submitted to a pool that then randomly assigns it to a rater. In theory, this should curb conflicts of interest that allegedly undermined the soundness of the ratings process.
The thing is that I’m not sure conflicts of interest are really the problem here. For a lengthy account, see my salad-rating analogy, but the short version is that nobody would tell his friends “yeah guys, let’s go see The A-Team, the film critic the studio hired to review it said it was awesome.” The thing is that if you want to read a movie review, you presumably actually want to know if the movie is good. By contrast, there are lots of regulatory-compliance reasons why you might want to buy a AAA-rated security that are to a large extent independent of whether or not the security deserves a AAA rating. You take care of this by changing things on the regulatory side, which I believe both versions of the bill do.
Franken-style randomizing could do some good, or else it could replace a conflict of interest (bad) with a scenario in which agencies have no incentive whatsoever to invest time and money in sound methods (worse). But that may be wrong or there may be good ways around it—I’d actually like to see this studied.


Related

  • Amy Klobuchar (D-MN) welcomed her new colleague Al Franken to the Senate with a fairly rude remark: “It’s important he go against the grain of his past career and really get to know the issues.” As Jon Chait says:

  • I think Al Franken is right about this: Franken wouldn’t relent.

  • I liked this NYT masthead overview of the need for ratings agency reform and some options for doing it, but I thought their discussion of the deregulatory option went a little bit astray: If there is no way to improve raters’ track record, a more drastic step would be to eliminate them, or at least eliminate the legal requirement that some insurance companies, pension funds and other entities hold assets with high ratings, a rule that gives the raters enormous quasi-regulatory power.

  • Pretty much everyone agrees that we have a ratings agency problem. But I think the conventional way of describing it as a “conflict of interest” that’s created by the fact that “banks pay them to rate their securities” leaves some crucial steps out.

  • Sen. Al Franken's mostly kept a low-profile in the Senate. But he's recently announced his intention to bring a major amendment reshaping the rating agency business to the financial-regulation bill.

  • The term “deregulation” is normally associated with the right, but there’s a long tradition of progressive deregulation in this country aimed at bolstering competition and forcing firms to be disciplined by each other rather than by captured regulators. Ted Kennedy, for example, played a key role in bringing price competition to air travel and trucking.

  • Dave Weigel enters the counterfactual sweepstakes and wonders how different America might be today absent the long delay in seating Al Franken:

  • “Ratings firms fear litigation more than they fear regulation because past regulation efforts haven’t “been that draconian.” -Scott McCleskey, a former Moody’s compliance officer who has testified before Congress about the industry. >

 
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