We’ve note during the well-warranted furor over the dreadful performance of rating agencies in assigning credit grades to structured credits, a business that was handsomely profitable to them, that it was difficult to limit their impact. Ratings are enshrined in all sorts of regulations, from the Fed’s haircuts on its discount window to its alphabet soup of facilities, to Basel II rules on bank capital, to pension fund standards through insurance industry regulations.
Ironically, insurers, which are state-level regulators, would appear least likely to act in a concerted fashion. But their fragmentation means that they are not well targeted by the agencies, who tend to lobby regulators rather than politicians. And the state insurance regulators are considering this idea jointly. Even though they will act on a state-by-state basis, the fact that these regulators are collaborating increases the odds of a coordinated response, that of many states putting similar measures in place.
From the Wall Street Journal:
Insurance regulators are considering whether to substitute analysis from other financial firms with expertise in valuing the securities, officials say. The effects of such a change could trickle throughout the world of bond investing, given insurers’ outsize role in the bond markets.
“We just need to take stock of this reliance on a system that allows that kind of shock,” in the form of swift and severe downgrades, “and frankly evaluate if there are other alternatives,” said New York Insurance Department Deputy Superintendent Hampton Finer in an interview. Amid criticism of ratings agencies, he added, “we’re under quite a bit of pressure to respond.”…
The National Association of Insurance Commissioners is scheduled to hold hearings on the matter next week in National Harbor, Md…
Just this month, the ratings agencies suffered a setback in one part of a civil lawsuit, in which a U.S. District Court rejected some raters’ argument that ratings were protected from lawsuits by the First Amendment…
Insurers have a lot riding on the outcome of the debate. Life insurers are big owners of mortgage-backed securities, which represent about 8.5% of insurers’ portfolios, according to A.M. Best Co. U.S. life insurers had to ante up a total of $2 billion in capital in 2008 to back up residential mortgage-backed securities to satisfy regulators seeking assurance companies have enough money to pay claims, the American Council of Life Insurers said. As of June 30, the insurers were facing a year-end bill of $11 billion to back up such securities, the trade group said.
Under the current capital guidelines insurers use nationally, the lower the ratings on bonds owned by insurers, the more capital they generally have to set aside to satisfy regulators….
Regulators say they have no plans now to move away from the leading agencies for corporate and other bonds considered less-difficult to rate…
Regulators say they don’t have a specific vision of an alternative, but one possibility would be to use the services of firms such as BlackRock Inc., the asset manager, or RiskMetrics Group, the research firm, regulators say.
BlackRock has developed an expertise in valuing bonds through its BlackRock Solutions unit, which has done work managing portfolios for the Federal Reserve Bank of New York during the credit crisis. BlackRock declined to comment and a spokeswoman for RiskMetrics had no comment.
Still, it isn’t clear whether other firms would have the interest or capability to deliver the kind of analytical services regulators would require for the variety of mortgage-backed securities held across hundreds of insurance companies.
Also unclear is how any service would be paid for. Currently, bond issuers — in the case of mortgage securities, typically banks — pay the ratings firms for ratings, which are then publicly available.
In a new scenario, one option might be the National Association of Insurance Commissioners paying for the additional analysis, a cost the NAIC could pass on to insurers in the form of fees. Or the issuers could pay for the extra analysis.
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Egan-Jones has been trying to work as an independent rating agency paid for by the buyer-of-the-bonds customer rather than by the issuer.
Of course it has been a tough row to hoe against the ratings oligopoly.
On a related note an American accounting firm is being sued in Hong Kong for falsifying reports.