Senate to Overhaul Credit Ratings Industry

May 16, 2010 Updated: October 1, 2015

Sen. Al Franken has proposed that financial institutions should not pick their own rating agencies, to increase independence and transparency. (Win McNamee/Getty Images)
Sen. Al Franken has proposed that financial institutions should not pick their own rating agencies, to increase independence and transparency. (Win McNamee/Getty Images)
NEW YORK—Many experts believed that the coziness between mortgage bond issuers and their independent credit raters—firms assigned to assess the riskiness of such investments—worsened the recent financial crisis.

A decision last week reached by the U.S. Senate aims to regulate the relationship between security originators and credit ratings firms in a bid to drastically change the landscape of some security issuances.

The law, proposed by Sen. Al Franken (D-Minn.) will bar financial institutions from selecting their own credit rater, and would vest such powers to an independent board established by the Securities and Exchange Commission to assign a ratings agency.

Credit ratings agencies assess risk on a particular security, which is scrutinized by investors in deciphering which securities are more likely to default. An accurate and unbiased ratings opinion is vital for the efficiency of the financial markets.

The proposal only affects so-called “structured securities,” which are mortgage-backed bonds, asset-backed securities, and other debt-like instruments that declined in value during the financial crisis.

Currently, three firms—Standard & Poor’s, Moody’s Investor Service, and Fitch Ratings dominate the credit ratings landscape. In the past, the firm that originates the security would pay the ratings agency, leading to possible conflicts of interest.

But the industry warned that the decision would bar competition. According to S&P spokesperson Edward Sweeney, credit rating agencies will have “less incentive to compete with one another, pursue innovation, and improve their models, criteria, and methodologies.”