Thursday, February 14, 2008
Chair Christopher Cox testified today on The State of the United States Economy and Financial Markets before the U.S. Senate Committee on Banking, Housing and Urban Affairs. Below are excerpts from his testimony on the SEC's examination of the role of credit agencies' ratings:
we are also re-examining the wisdom of the legislative and regulatory provisions that have granted a central role to the rating agencies in our markets. More than just providing the markets one view of the likelihood of default, the past several months have demonstrated the power of credit ratings to move markets, and their potential to create cascading effects in those markets. For example, the precipitous downgrade of the ratings of residential mortgage-backed securities and CDOs affected not only the rated securities but the funds and institutions that held and sponsored them; and now, the actual and anticipated ratings downgrades of the monoline insurers has impacted the ability and willingness of money market funds to hold certain assets, and contributed to a retrenchment from risk as some market participants have lost faith in the ratings.
This sensitivity to changes in credit ratings (which extends to the monoline insurers, whose own ratings determine the degree to which investors and issuers are willing to rely on them) is perhaps nowhere more pronounced than in the municipal securities market. In the municipal market, the lack of uniform, timely, and robust disclosure can leave investors with little more than a credit rating to rely on when making an investment decision. In a letter to the Chairman and Ranking Member of this Committee in July 2007, I proposed a more comprehensive disclosure regime to ensure that investors have access to the same high-quality disclosure from municipal issuers that is already required of corporate issuers. The recent problems reinforce the need for such disclosures. I hope the Committee will seriously consider those proposals to provide investors with better information in this important sector of the market.
Government's contribution to the widespread market reliance on credit ratings, by incorporating them into the regulatory and legal framework, has a long history. But the need to revisit the issue was recognized several years ago. In the Sarbanes-Oxley Act of 2002, the Congress rightly focused on whether the government imprimatur for the ratings agencies was wise. The Sarbanes-Oxley Act required the Commission to study and report on the role of the rating agencies — and that report, in turn, contributed in part to the Credit Rating Agency Reform Act, which has now given the SEC the opportunity to write new rules that can create greater competition and transparency in this area.
During the past 30 years, regulators, including the Commission, have increasingly used credit ratings as a proxy for objective standards for monitoring the risk of investments held by regulated entities. We have also used them as a shorthand to determine what securities may be sold through a streamlined registration process. For example, since 1975 the Commission has relied on credit ratings to distinguish among grades of investment safety in various regulations under the federal securities laws. In addition, a number of federal, state, and foreign laws and regulations today use credit ratings in this and analogous ways. The recent market disruptions highlight the limitations of this arrangement. As a result, I have directed the Commission staff to explore alternatives to Commission regulatory reliance on credit ratings where feasible.
I have also directed the staff to develop proposals for new, more detailed rules under the new Credit Rating Agency Reform Act that respond directly to the shortcomings we have seen through the subprime experience. Among the proposals that the Commission may consider as early as this spring are rules that would require credit rating agencies to make disclosures regarding past ratings, in a format that would improve the comparability of track records and promote competitive assessments of the accuracy of the agencies' past ratings. In addition, new rules could be aimed at enhancing investor understanding of important differences between ratings for municipal and corporate debt and for structured debt instruments.