By Zachary A. Goldfarb

Washington Post Staff Writer

Thursday, October 29, 2009

A House panel on Wednesday voted to tighten controls on credit-rating firms in response to complaints that the firms misjudged the risks of many of the mortgage-related securities that sank financial markets last year.

The House Financial Services Committee threw bipartisan support behind a bill that would try to reduce the conflicts of interests at rating firms and make it easier to sue them when they make flawed findings.

The three big credit-rating firms — Moody’s, Standard & Poor’s and Fitch Ratings — have faced stinging criticism in the past two years for giving high marks to mortgage-related securities that were backed by subprime or otherwise risky loans, helping instill a false sense of confidence among investors in the investments being sold by banks.

These rating agencies were falsely elevated to some god-like status that when they put a triple-A rating on something, you could take all of your mother’s savings and invest it in there and you were doing the right thing, said Rep. Paul E. Kanjorski (D-Pa.), the sponsor of the bill.

Regulatory reform

The vote by the House committee was one of several efforts this week to try to improve the patchwork of financial regulation that failed to head off the economic crisis.

On Tuesday, the House Financial Services Committee voted to require most hedge funds and private-equity funds to register with the Securities and Exchange Commission, making them subject to periodic exams. Debate has begun on another bill to give the SEC new powers to reward whistleblowers and increase standards for people who sell financial advice.

These measures come after two other contentious bills made their way through the committee earlier this month. The panel, led by Rep. Barney Frank (D-Mass.), passed legislation to create a new agency to regulate consumer lending, including mortgages and credit cards, and to regulate for the first time the vast market of financial instruments known as derivatives.

The bills are expected to reach the House floor in coming weeks, but their fate is unknown because the Senate is moving on a far slower schedule than the House.

Credit-rating companies such as Moody’s and S&P became more central to the financial markets as the investments they review became more complex. Their simple letter grades can make or break an investment, and the U.S. government deemed some firms to be the authoritative sources on such matters.

In the past, critics accused the ratings firms of being hotbeds of conflicts of interests. They are paid by the companies whose investments they rate. The raters often invoke the First Amendment to defend themselves, saying they are simply providing an opinion.

New powers

The legislation the committee passed on Wednesday would require the firms to tell the public more about how they’re paid for ratings and would give the SEC new powers to oversee how they operate. It also would require the rating firms to appoint more independent members to their boards of directors.

The most controversial change would make it easier for people to sue credit-rating firms if they believe the firms did a poor job evaluating prospective investments.

Credit-rating firms oppose the provision because they say it would bring a flood of new lawsuits against them that would, in fact, be easier to win because of the new legal liability standard. They argue that this could raise costs for all sorts of investors.

Supporters of the provisions point out that credit-rating firms have never lost a court battle, suggesting that there is not a strong enough legal deterrent to their issuing faulty ratings.

Meanwhile, the financial industry has largely coalesced around the bill that would require most hedge funds and private equity funds to register with the SEC for the first time. After a lobbying campaign, the venture capital industry successfully won an exemption under the bill.

The bill includes new recordkeeping and disclosure requirements that would force hedge funds and private equity funds to give more information to the SEC.

The committee is still working on a third bill to beef up the powers of the SEC. The bill would double the SEC’s funding over five years and create a program allowing the agency to pay whistleblowers for information leading to the discovery of corporate crime.