Jonathan Macey, the J. DuPratt White Professor of Law at Cornell Law School, testified March 21 on investor protection and credit rating agencies in front of the U.S. Senate's Committee on Governmental Affairs, which is investigating the collapse of Enron. Macey, an expert on banking and securities law, delivered a statement and answered the committee's questions on what might be done to prevent future crises that mirror the Enron case. He argued for changes that would limit the government's reliance on information provided by credit rating agencies (the main agencies are Standard and Poor's, Moody's, Fitch and Duff & Phelps) and called for increased agency accountability. Below are excerpts from Macey's statement.
"The massive publicity surrounding the collapse of Enron Corporation has given regulators and lawmakers a valuable opportunity to examine and, hopefully, to correct some of the pathologies that plague the U.S. financial system. The collapse of Enron should prompt a frank assessment at all of the institutions -- corporate boards of directors, corporate board audit committees, accounting firms, stock exchanges, market analysts and credit rating agencies -- that investors rely upon for protection against fraud and abusive practices. My testimony today will focus on the role of credit rating agencies, which, over time, have assumed a unique role in society as nationally recognized statistical ratings organizations [NRSROs].
"Most Americans think that the large, well-known credit rating organizations like Moody's and Standard and Poor's are purely private enterprises. They are unaware of the fact that these organizations are, in fact, more properly viewed as quasi-governmental entities ... because they have been given the power to grant regulatory licenses to various types of businesses. ...
"New regulations created demand for the rating agencies to rate securities before they were issued and caused a significant increase in the business of credit rating agencies. This work ... places the rating agencies in the position of performing a delegated governmental function -- bank monitoring and supervision -- on behalf of the comptroller of the currency. ...
"Credit ratings can have a significant impact on the profitability ... as well as on the viability of broker-dealer firms. ...
"The possibility that artificial demand for the services of rating agencies has been created by regulation cannot be ignored. ...
"Credit ratings do not provide useful or timely information about the credit-worthiness of companies in today's markets. Academic studies tend to show that the information in credit ratings is of marginal value at best because ... [it has] already been incorporated into share prices. One well-known study showed that the ratings provided by rating agencies lagged the information contained in securities prices by a full year.
"An unfortunate side effect of the poor quality of credit ratings is that credit ratings have become so entrenched in both regulatory policy and market practices that they threaten to distort the process by which capital is allocated among corporations. ...
"It is easy to identify the problems of rating agencies. It is more difficult to craft a workable solution. One of the reasons that the problem is so intractable is that ratings are so convenient to use. ... They provide [information] in a convenient format. Clearly, getting rid of the regulatory dependence on rating agencies would make the job of the regulators much more difficult. ...
"My own view is that Congress should commission the relevant regulatory agencies, such as the SEC [Securities and Exchange Commission] and the Department of the Treasury, to study those regulations that require the use of NRSROs. The use of such NRSROs to fulfil regulatory functions should be abandoned where possible. ... Where firms choose to use credit ratings instead of credit spreads to satisfy regulatory requirements, the rating agencies should, at a minimum, be held accountable for their actions.
"The market is, by-and-large, unharmed by the poor quality of ratings, because market participants are sophisticated enough to ignore the ratings. The real problem with the declining quality of credit ratings is that regulators are using credit ratings in a wide range of situations as a substitute for regulation. To the extent that ratings are of poor quality, the quality of these myriad regulatory schemes are compromised. The quality of U.S. financial regulation is being compromised by its pervasive reliance on credit ratings."
| Cornell Chronicle Front Page | | Table of Contents | | Cornell News Service Home Page |