Regulators unlikely to change rating agency incentives: Occupy Wall Street

NEW YORK (Reuters) – Regulators are unlikely to take action to address the way rating agencies are rewarded for their work, despite concerns that the current practice involves conflicts of interest that helped enable the financial crisis, an official of Occupy Wall Street said on Tuesday.

Regulators “don’t seem to have plans to change the underlying incentives in the system,” Cathy O’Neil, principal with the Alternative Banking Group of Occupy Wall Street, told the Reuters Global Investment Outlook Summit.

Lawmakers and analysts have worried that the longstanding practice in which the debt issuer pays agencies to rate the strength or weakness of a debt instrument influences the agencies’ decisions.

O’Neil, a former quantitative hedge-fund analyst who now works to make the financial system more accountable and transparent, said that the Dodd-Frank legislation to reform Wall Street was so watered down that it resulted in no concrete changes to regulators’ approach to rating agencies.

The three main agencies — Moody’s Investors Service, Standard & Poor’s and Fitch — have long handled the vast majority of credit-rating business in the United States.

The three have been singled out for criticism from lawmakers and economists for their ratings during the financial crisis, when they often gave top-level marks to complex structured finance products that, in fact, suffered from major underlying weaknesses.

The collapse of those products proved a major driver of the crisis that hobbled the world’s biggest economy. The three rating agencies are still roundly criticized for not only failing to warn investors of the dangers of investing in many of the mortgage-backed securities at the epicenter of the financial crisis, but benefiting by not pointing out deficiencies.

The U.S. Department of Justice is suing S&P for $5 billion in civil damages for the agency’s actions during the crisis.

Among federally sanctioned rating agencies, the Nationally Recognized Statistical Rating Organizations, S&P, Moody’s and Fitch are responsible for about 96 percent of all outstanding ratings, according to a December 2012 report from the Securities and Exchange Commission.

The ratings are important because some investors, such as pension funds, are barred by law from investing in instruments with below-investment-grade ratings. As a result, higher grades are important in making debt instruments available to a wide swath of the investment market.

The ratings agencies defended their practices.

“No payment model is completely immune to conflicts of interest, whether from investors, issuers, governments or regulators,” Fitch said to Reuters in a statement on Tuesday. “What matters most is how well those conflicts are managed and how transparent they are to the market.”

S&P said that it has worked to reinforce the performance of its ratings over the past five years. “S&P has taken to heart the lessons learned from the financial crisis,” the company said in an emailed statement.

S&P said it has “changed the way we rate almost every type of security that was affected by the financial crisis,” citing residential mortgage-backed securities, commercial mortgage-backed securities, collateralized debt obligations, banks and insurers.

Moody’s declined to comment.

Still, if regulators have not changed their perspective much, investors have, O’Neil said.

“People know not to trust the credit rating agencies,” she said. “So having a rating doesn’t necessarily mean that investors automatically believe it.”

(Corrects spelling of O’Neil in fourth paragraph)

(Reporting by Luciana Lopez- Editing by Leslie Adler)