Rating firms could lose their special status. The latest in our series
IF THE past decade's financial over-engineering was a crime, rating agencies were the getaway drivers. The punishment for putting their stamp of approval on collateralised-debt obligations, bond insurers and various undeserving dross is becoming clearer. On July 21st the Obama administration proposed legislation that is more comprehensive than many expected.
The proposals focus on tackling conflicts of interest and on increasing openness. If an analyst is hired by a customer, his past work will be subject to extra scrutiny. The agencies will have to disclose their fees, ratings history and a lot more about their methodologies. They may not do consulting work for ratings clients.
Such measures should curb the "ratings shopping" that was prevalent in the boom. Greater disclosure will also make it easier for investors to prove in court that agencies were reckless—the industry faces dozens of lawsuits from investors, including CalPERS, a giant Californian pension fund (which, ironically, Moody's put on review for a downgrade this week).
Like the European Union, which approved its own reforms in April, the Americans stop short of blessing a particular way of paying for ratings. The dominant model, in which the bond issuer pays the rater directly, encouraged cosiness between the two. But the alternatives have flaws too. The "|investor pays" approach encourages freeriding among non-subscribers; and investors, like issuers, have incentives to influence the process. A government ratings utility may be tempted to minimise downgrades when the economy sours.