I know I return to this theme a lot in this column, but the Unintended Consequences Watch needs to be manned day and night. Today let’s talk about 17g-5. This esoteric sounding SEC rule is intended to diminish the perceived failings of the rating agency culture which has been fingered as one of the principal causes of the “Late Unpleasantness”. The notion was that the rating agencies, hired by the issuers, were mired in conflicts of interest and there were few, if any, structural safeguards to protect investors from bad ratings.
17g-5 provides that rating agencies must require a party retaining the agency to rate an asset backed security (including CMBS) to establish and maintain a password-protected website for all other rating agencies. The website must contain all information provided to the rating agency in connection with the rating. This pertains whether information is provided in writing or orally and to information provided by the issuer or by anyone on behalf of the issuer. The information must be loaded into the website simultaneous with its delivery to the retained rating agency. This was purported to provide a structural counterpoint to the pressure for continuously lower levels by issuer procured ratings.
This has some superficial appeal. To the extent that investors were concerned about conflicts of interest, unsolicited ratings seems an antidote to these perceived concerns. Indeed, on first blush, it’s hard to see an argument that unsolicited ratings are bad.
But on first blush I thought the financial crisis that began about three years ago last month, would be over by Thanksgiving. The story of 17g-5 is yet another reminder that financial systems are much more complex than rule makers perceive them and wish them to be. Welcome back, yet again, to the wonderful world of unintended consequences.
In this case, what has flowed from the desire to do good by providing multiple opinions of value to the investors is a system which is likely to degrade the quality of information and analysis available to investors.Continue Reading...