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Credit Ratings Agencies Stop Issuing New Ratings in Response to Dodd-Frank

The Dodd-Frank financial regulatory reform bill is now law. And a few unintended consequences of the enormously complex, very long bill are coming to light. The Wall Street Journal* *reports on one provision spooking the ratings agencies:

The nation’s three dominant credit-ratings providers have made an urgent new request of their clients: Please don’t use our credit ratings. The odd plea is emerging as the first consequence of the financial overhaul that is to be signed into law by President Obama on Wednesday. And it already is creating havoc in the bond markets, parts of which are shutting down in response to the request.

Standard & Poor’s, Moody’s Investors Service and Fitch Ratings are all refusing to allow their ratings to be used in documentation for new bond sales, each said in statements in recent days. Each says it fears being exposed to new legal liability created by the landmark Dodd-Frank financial reform law. The new law will make ratings firms liable for the quality of their ratings decisions, effective immediately. The companies say that, until they get a better understanding of their legal exposure, they are refusing to let bond issuers use their ratings.

That is important because some bonds, notably those that are made up of consumer loans, are required by law to include ratings in their official documentation. That means new bond sales in the $1.4 trillion market for mortgages, autos, student loans and credit cards could effectively shut down.

This is bad news if it is impacting the bond market, but should be easy enough for Congress or the ratings agencies’ regulator to fix. The bill instructs the government to study ratings agencies for two years before deciding how to re-regulate them. This change should be delayed until that point — and regulators should work with ratings agencies to help them prepare new practices and therefore avoid seizing the markets when the new changes come into effect.

Still, this highlights a fault of the bill — the tremendous uncertainty of it all. Stephen Spruiell notes: “Sen. Chris Dodd said shortly after the bill was finalized: ‘No one will know until this is actually in place how it works.’ Precisely.”

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