The Securities and Exchange Commission of La Mancha

Stone Street Advisors's picture

This is from Stone Street Advisors

I've long been a critic of the ridiculous regime created by NRSRO
legislation, that is, the Rating Agencies, or really, S&P, Moody's,
and Fitch.  There are so many problems from top to bottom, left to
right that I'm not even going to begin to list them here.  I will,
however, quote what I think is a rather eloquent description of the core
problem from a man far smarter than I: David Rowe in a post he wrote on the Kamakura Corporation blog (emphasis mine, as usual).

the US Securities and Exchange Commission (SEC) is soliciting comments
on various proposals to reform the institutional framework of credit
ratings. The supervisor wants to ensure effective ratings, as if
there is some objective truth that can be discovered as long as the
right incentives are in place.
In fact, when dealing with innovative, highly complex and historically untested structures, no such objective truth exists. The
perceived credit quality of such instruments can be as diverse as views
on whether a given company's shares are a buy or a sell. Imposing a
one-size-fits-all rating scheme risks unrealistically homogenising
market perceptions that should be highly diverse
if adequate
information for detailed analysis was widely available. Furthermore, it
is just such homogenised perceptions that can lead to herd behaviour and
major market dislocations when broadly shared expectations prove to be

Trying to reform market structure in search of a
non-existent objective measure of credit quality and associated risk
amounts to a mission impossible.
It is bound to bureaucratise
and homogenise ratings, thereby creating an inflexible structure that is
vulnerable to a systemic crisis. In fairness, the SEC is only doing
what was mandated by the US Congress. Nevertheless, what should
be done is to seek a framework that will make all the relevant data
underlying such securities readily available in a standard format to a
broad community of analysts.

Attacking the
independence and objectivity of the ratings agencies due to their
business model is easy, but it largely ignores the deeper problem Rowe
describes above.  The ratings agency approach to credit analysis is
inherently and impossibly broken, and efforts to reform it merely amount
to tilting at windmills.

while hardly perfect - far from it - I think the equity model and the
equity-research-centric approach currently adopted by the SEC would be
largely instructive for how to reform the credit research industry.  A
not insignificant amount of the information needed to analyze a firm's
credits is already included in the filings publicly-traded firms already
make to the SEC.  Why not align the reporting requirements for debt and
equity issuers?  Why not incentivize a movement to democratize the
credit market just as the equity market was over the past 30 or so
years?  Seeds of revolution (or rebellion, depending on your
perspective) have long-since been planted with exchange-traded hybrid
securities, ETNs, and a myriad of other products and services.

realize the Herculean (if not downright Sisyphean) effort facing
regulators with their current responsibilities from Dodd-Frank, but why
not kill several giant birds with one stone instead of ignoring keeping
the blinders on until the next inevitable crisis?

The Analyst

Stone Street Advisors

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apberusdisvet's picture

Maybe the SEC would do its job if the porn they watched featured Janet Napolitano Elena Kagan and Ben Bernanke.

janus's picture


I cannot adequately express my joy.  Reading your work, and especially that of Mr. Rowe, reassures ole janus; let's him sleep soundly knowing that all the elements are in place for a smooth and successful revolution...minimal blood, but, all the same, THERE WILL BE BLOOD!

jm's picture

Ratings are a luxury for the lazy, a way to corral the herd.  When lean years come, the lazy get killed.  Thus ratings agencies serve no real purpose over the long haul.  Ratings agencies increasingly ape CDS quote anyhow.

There is a reason for this.  Risk assessment and pricing on complex and structured products are best determined by a market, not some pontificating experts.  But some conditions must hold for a market to process information well.  There needs to be some level of public information available to all buyers and sellers.  The formation of opinion on prices by buyers and sellers needs to be pretty independent of one another--momos and herds screw it up totally.  And offered price at the initial condition needs to be within the basin of the attractor.  This last is a technical assumption.

Call it the wisdom of crowds trumping the "experts".

cosmictrainwreck's picture

Totally agree with your stance, but now mulling WHY anything dramatic or fundamental never happens....? Fear of change? Even little bitty, let alone huge. Too many nests would be destroyed? It's depressing to me that "systems" (seemingly any system) has no trouble building any manner of complex, redundant and tail-chasing stations, but cannot muster the umph to dis-mantle even the smallest parts....

Ever visited an abandoned steel mill or refinery? Mind-boggling, over-whelming. Physical representation of afore-mentioned sytem phenomenon (imo). I guess we need a crash.

Sun Tsu's picture

One Crash made to order coming up!

williambanzai7's picture

Why don't we start with the fact that rating analysts are Wall Street banker wannabes who couldn't make the cut.

Mere intellectual chum when the predator sharks are circling in the water. If persuasive argument and financial engineering does not work, money will.

dearth vader's picture

More than three years ago, Mish already argued that credit rating was structurally flawed, since the SEC put the whole circus upside down by making the rating of new debt a responsibility of the issuer. How can a rating be objective, if the one who pays for it is the issuer? Formerly, a buyer of debt asked for a rating, and paid for it.

In this way, if the rating proved to be inadequate afterwards, the rater could be held responsible for the damage done. So, a rater would think twice before being too optimistic about a product. 

Seems to me, the SEC ought to be abolished, and ratings should be made when asked for by potential buyers of debt, and paid for by those same parties.

Stone Street Advisors's picture

There are far more people who are qualified to work on Wall Street than there are jobs to be had so that's at best a moot argument.


The only point that matters is that the entire system is irreprably broken and the only way to reform it is to destroy it and start from scratch with the ideas expressed by Rowe at their core.

williambanzai7's picture

I agree, we should scrap it. Like the accountants, they have proven over and over that they are not only useless, but superfluous as well.

janus's picture


what you say is another one of those 'too true to be good' kind of things.  to simplify things and avoid the entanglements of titles, i'll say that my father was a sort of forensic accountant -- still is, in a sense -- and he will readily tell you, screw lawyers, you can start with the accountants before you even start passing judgement...just assume, by virtue of their occupation, that they are guilty of some manner of grand malfeasance.  they should be sent back to the gypsy camps and be forced to dance for silver dimes.