Need for credit rating reform
There's plenty of blame to go around for the crisis that brought the nation's financial system to the verge of colla-pse a year ago.
There were consumers who got in over their heads; preda-tory lenders who enticed people into mort-gages they couldn't afford; Wall Street firms that put together financial deals no-body could understand; regulatory agencies that look-ed the other way as a finan-cial perfect storm approach-ed; and policymakers from both parties who opened up loop-holes instead of closing them.
But much of the blame must go to the major credit rating agencies that played a central, if not well known, role in the financial crisis.
The credit rating industry is dominated by just three firms (Fitch, Moody's and Standard & Poor's) which serve as quasi-official judges of invest-ment risk in the financial mar-kets. Pension plans, mutual funds, banks, insurance companies and other institutional investors depend on their ratings to help them decide what to invest in.
In recent years, however, the credit rating firms issued top ratings to tens of thous-ands of investments that tur---------ned out to be little more than junk. In fact, all three firms had investment-grade ratings for Lehman Brothers and AIG almost to the day they collapsed last September.
It was the worst kind of "grade inflation." Instead of every student getting an A, nearly every investment was getting an AAA rating, includ-ing subprime mortgager sec-urities. The rush of money into these supposedly secure investments created the financial bubble. When rating firms suddenly downgraded these investments, the bubble burst as investors fled with whatever money they could.
The Securities and Ex-change Commission conclud-ed that the credit rating firms were a "principal underlying cause" of the financial crisis because of their deeply flaw-ed, wildly over-optimistic inv- estment ratings. Throughout it all, these firms were collecting hefty fees from the banks and companies whose investments they were rating.
All of this may sound very far away from Main Street. But when financial markets go wrong, it becomes more difficult and expensive to buy a home, pay for college or start a small business. Retirement savings in pensions and mutual funds shrink or disappear. Local governments find it harder to issue municipal bonds for new schools or water treatment facilities.
In other words, when Wall Street catches a cold, Main Street gets pneumonia.
The financial losses from these "toxic" investments are enormous. In its latest estimate, the International Monetary Fund says total worldwide losses will be $3.4 trillion by the end of next year. Yes, that's trillion.
In early October, I met with a panel of finance experts hosted by the University of Minnesota's Carlson School of Management. All agreed that, while credit ratings are essential to the financial markets, the industry is long overdue for reform.
That's why I was the first to join with Sen. Jack Reed of Rhode Island to cosponsor a bill to safeguard the integrity of our financial markets. Our Rating Accountability and Transparency Enhancement (RATE) Act will do several things:
First, it will give the SEC stronger authority to oversee credit rating firms and hold them accountable so their ratings are more accurate and not unduly influenced by conflicts of interest.
Second, it will require the firms to have independent compliance officers to manage conflicts of interest in accordance with SEC rules.
Third, it will require the firms to be more transparent by disclosing information about their methods and conflicts of interest so investors can better gauge the accuracy and performance of the ratings.
Finally, the legislation will change existing federal law that has effectively given these firms immunity. Instead, investors will be allowed to sue a firm that "knowingly or recklessly" fails to review key information in developing its ratings.
Today, we continue to live with the consequences of the financial crisis. In the worst economic downturn since the Great Depression, millions of Americans have lost their jobs, their retirement savings and their homes. Even as we focus on the task of recovery in the short term, we must continue to look ahead and work on the long-term reforms needed to prevent a similar crisis in the future.
Amy Klobuchar, DFL-Minn., is a member of the U.S. Senate.