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FOR IMMEDIATE RELEASE: September 26, 2007

Schumer Urges New Consideration Of Investor-Funded Model For Credit Ratings Agencies

Most Major Agencies Collect Fees From Issuers of the Bonds They Rate, Sparking Conflict-of-Interest Concerns

WASHINGTON, DCU.S. Senator Charles E. Schumer today said it was worth examining the potential benefits of an investor-funded credit ratings structure, as opposed to the current issuer-funded setup that may have raised conflict-of-interest issues that contributed to the subprime mortgage crisis.

 

“I think we should consider the potential benefits of an investor-funded rating agency model.  We should discuss whether we should promote the entry of serious, viable, investor-funded rating agencies to compete against the rating agencies that are purely paid by issuers, or to provide incentives for today’s rating agencies to go back to their roots and have investors pay for the ratings,” Schumer said.

 

Schumer made the comments at a Senate Banking Committee hearing on the credit ratings agencies’ role in the subprime mortgage meltdown. Securities and Exchange Commission Chairman Christopher Cox was due to testify at the hearing.

 

Last week, at a Joint Economic Committee hearing chaired by Schumer on the fallout of the subprime mortgage crisis, Alex Pollock of the American Enterprise Institute noted how, up until the 1970s, most of the major agencies collected their fees from investors. It is only in the last 25 years, he noted, that the agencies moved to the current system, under which the agencies collect fees from the very bond issuers whose paper they are grading.

 

An excerpt of Schumer’s statement, as prepared for delivery, appears below.

 

SCHUMER STATEMENT REGARDING CREDIT RATING AGENCIES

Senate Banking Committee

September 26, 2007

 

One of the major untold chapters so far in the subprime story has been how the risks associated with subprime mortgages were underestimated.  One potential reason for this, which I think merits strong consideration and closer examination by this Committee, is an issue that we discussed last week in the Joint Economic Committee hearing that I chaired on the collapse of the subprime mortgage market.  One of our witnesses spoke about the potential distorted incentives that result from the fact that most rating agencies are paid by the companies they rate rather than by the investors who use the ratings. 

 

There may be potential conflict of interest issues here.  First, the rating agencies market their rating services to the issuers who of course want better ratings.  Could this be creating a tendency to inflate ratings in the marketplace?  And second, rating agencies typically get paid after the issuer decides to accept the rating and have it published.  So when the rating agency has done a thorough, objective job of rating a security, the issuer can pull its business if it doesn't like the rating.

 

Up until the 1970s, all of the original credit rating agencies were funded by the investors.  It is the investors that care the most about the independence of the credit rating analysis, the integrity of the evaluation of credit quality, and the timely review of ratings.  In the 70s, a switch in payment structure took place, and today, the bulk of the major rating agencies ratings-related income now comes from fees charged by the issuers. 

 

I think we should consider the potential benefits of an investor-funded rating agency model.  We should discuss whether we should promote the entry of serious, viable, investor-funded rating agencies to compete against the rating agencies that are purely paid by issuers, or to provide incentives for today’s rating agencies to go back to their roots and have investors pay for the ratings. 

 

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