Senator and presidential candidate Senator Elizabeth Warren, D-Mass., wants the SEC to take “immediate” and “meaningful action to curb” inflated ratings by bond rating agencies.
In a letter to SEC Chairman Jay Clayton, Warren, citing a recent Wall Street Journal analysis, writes there are “strong indications” that ratings agencies are giving undeserved higher ratings to risky financial products, much like they did in the lead-up to the last great financial crisis. The recession that followed cost the U.S. economy as much as $14 trillion, according to Warren.
At the root of the problem then and now is the “issuer-pays model” whereby a corporate bond issuer pays a bond rating agency to rate their new issues. That provides an incentive for the rating agency “to give better ratings, regardless of the risk,” writes Warren.
She is particularly concerned about the ratings of collateralized loan obligations (CLOs), which are pooled securities backed by corporate loans to risky borrowers and typically used to fund buyouts. “These securitizations have helped enable increased leveraged loans that are generally poorly underwritten and include few protections for lenders and investors, which creates significant risk to the financial system and the American economy,” writes Warren.
She adds: “It is deeply concerning that the SEC has not taken meaningful action to ensure that these securities are accurate and not unduly influenced by conflicts of interest.” The agency was given more authority to regulate the credit agencies under Dodd-Frank, notes Warren.
Warren concludes her letter with a number of questions she wants the agency to answer no later than Oct. 18:
- Why the SEC has failed to recommend a business model for the agencies to replace the current issuer-pays model as required by Dodd-Frank
- Whether the agency is currently in the process of recommending such a replacement business model and if it is, what those processes are
- What the SEC has done to deter conflicts of interest in rating agency practices
- What actions the agency has taken to remove “the perverse incentives in the issuer-pays model to artificially inflate bond ratings”
- What actions the SEC has taken to correct compliance failures by rating agencies and to hold firms accountable
- What resources it’s missing to fully implement reforms made by Dodd-Frank to deter harmful practices of bond ratings agencies.
In all cases, Warren asks for specific details.