Shaking up how Wall Street assesses risks, the Senate on Thursday voted to end the ability of financial institutions to choose the credit rating agencies that rate their investment products.
The Senate also voted to end the government's reliance on ratings agencies as a standard for determining credit worthiness, an even more drastic measure that could force financial institutions to vouch for their own offerings.
The success of the back to back votes appeared to catch Senate Banking committee chairman Christopher Dodd, D-Conn., by surprise. The two measures were attached as amendments to a broader package of financial rules the Senate is considering to as a response to the 2008 financial crisis.
One amendment, offered by Sen. Al Franken, D-Minn., would require an independent board to assign ratings firms to assess the risks of new financial products, replacing a long-standing practice where banks select and pay ratings agencies to rate their new offerings.
Critics argue that relationship created conflicts of interest and that the agencies overrated risky investments that fueled the financial crisis.
"This conflict of interest has cost American investors and pensioners billions and billions of dollars because supposedly risk-free investments have failed or been downgraded to junk status," Franken said.
But his proposal raises new questions about how the board would assign ratings agencies to new offerings. The most prominent agencies are Standard & Poor's, Moody's Corp. and Fitch Ratings, but other ratings firms would also be in a queue awaiting assignment.
"Having a sort of wheel of fortune made me uneasy about how this could work," Dodd said after the vote.
The amendment ending government reliance on credit ratings would require a wholesale re-evaluation on how government agencies assess risk. The amendment, offered by Sen. George LeMieux, R-Fla., would give the government two years to adjust to the change and find means to determine the credit worthiness of a broad range of securities and debt.
Ultimately, federal agencies could decide to use ratings agencies to help determine credit worthiness, LeMieux said in an interview. "But it won't be the only way," he said.
"They'll have to prove themselves now," he said. "It doesn't put these credit agencies out of business, they'll still be used, but they're not going to be the sole determiner of credit worthiness as provided for in federal law."
Still, credit rating agencies are relied upon by a host of investment authorities and used to gauge risk by municipal and state governments.
"Unfortunately, the concerns that have been raised don't lend themselves to easy solutions," said Annette Nazareth, a former member of the Securities and Exchange Commission and now a partner with the law firm of Davis Polk. "Many of them could result in unintended consequences."
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