GOOD MORNING. Stocks in Asia closed lower today, European shares are down, and U.S. futures are pointing to a lower open.

The role that ratings agencies have long played for investors could be about to change. Yesterday, the Senate voted to direct the Securities and Exchange Commission to create a credit-rating board that would choose which rating agency initially provides a rating for structured bonds. The directive, a part of the financial reform bill, hints at how the legislation could increase government intervention as it seeks to curb high risk in the financial sector. The credit-rating board, if it makes it into law, will seek to eliminate the conflict of interest ratings agencies have faced, with much of their revenue coming from companies whose bonds they’re supposed to rate.

The vote underscores that “investors have to do their own due diligence and not rely on rating agencies who have failed so badly,” says Tony Danaher, president of Guild Investment Management. In the most recent financial crisis, the agencies proved to be somewhat unreliable, maintaining AAA ratings on subprime mortgage securities even as the housing debacle loomed; in some cases, they were late to downgrade sovereign debt. Even today, it is difficult for investors to figure out how to account for counterparty risk within an agency’s ratings, says Danaher. For example, investors who look to an agency’s ratings for a particular company stock can’t be sure that the ratings include how the company would be impacted if the marketable securities it is invested in suddenly can’t convert into cash.

The uncertainty that ratings agencies have injected into the marketplace could also be contributing to the triple-digit swings in the markets during the past week, with investors questioning whether the agencies are being too easy or too hard on sovereign debt issues. “Now ratings agencies are being ultra conservative and being very difficult on borrowers,” says Danaher. “That minimizes their usefulness if they’re swinging from one pendulum to the other – it’s hard to gauge where the value is.”

In the long run, if the ratings agencies are no longer viewing the entities that they’re supposed to be critical of as their customers, they could become more reliable and add more certainty in the markets, he says. But for now investors appear to be on their own and can expect ongoing volatility as this period of transition to increased government oversight and austerity measures plays out.

IN OTHER NEWS:

  • On Thursday, the Senate also voted on a measure to require large financial firms to increase capital levels for protection during times of financial crises. LINK
  • European stocks fell again today based on debt jitters, this time mostly focused on Spain. LINK
  • Video game sales fell in April due to a weak set of releases, impacting Nintendo, Sony (SNE) and Microsoft (MSFT). LINK

Similar Posts:

Share