RATING COMPANIES SHOULD BE APPLAUDED FOR BOLDNESS, NOT DEMONIZED
Just a few years ago, credit rating companies were the sleuths who didn’t see. In addition to awarding strong ratings to Icelandic banks, Lehman Brothers, and other dubious enterprises, companies such as Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings slapped their triple-A endorsements on shoddy securities constructed from subprime mortgages. When the housing boom exploded, the companies’ hurried downgrades were too late to help anyone.
Lately the rating companies have been both bold and prescient in warning about sovereign debt troubles. Alarmed by Greece’s unsustainable borrowing, they slashed Greek debt to below investment grade. Troubles in Portugal, Ireland, and Spain aren’t as severe, but all are under appropriately close scrutiny by rating services. Even the U.S. has been tagged for a downgrade if it can’t sort out its debt ceiling and spending problems— and maybe even if it can.
Now that rating companies are finally doing their jobs, some European leaders are wishing they wouldn’t. There are calls to revoke the Big Three raters’ European licenses, to encourage the formation of smaller (perhaps more pliant) competitors, or to impose penalties for ratings that turn out to be too pessimistic. One proposal would require raters to give three days’ advance notice of possible downgrades to affected countries, so borrowers can privately lobby for gentler treatment.
Countries already enjoy a 12-hour period to plead their cases in private before a ratings downgrade is announced. Additional delay simply invites a market in inside information. As Fitch’s president, Paul Taylor, told Britain’s House of Lords in May: “You inform the Greeks of a rating decision, and you get phoned up by the French. That is quite disturbing.”
In the U.S., the raters have described what spending cuts they deem necessary for America to retain its prized triple-A credit rating. While this skirts uncomfortably close to the political playing field, such specificity is part of the job. Rating companies can’t limit their work to analyzing the past. Whether rating a sports arena or a superpower, they must shed light on future scenarios and their consequences.
Rating companies still have far to go to establish their independence. They collect much of their revenue by charging issuers for the privilege of being rated, creating ample potential for conflicts of interest. Congress should weigh whether laws need to be revised to eliminate such risk. (Decades ago, rating companies got all their money from investors, their true clients.)
New rules being developed by the Securities and Exchange Commission will soon require additional disclosure of the methods and models used to devise corporate ratings. Meantime, rating regulators around the world are redrawing rules so that ratings work in conjunction with internal bank analyses and market prices in assessing risk.
So far, executives from S&P, Moody’s, and Fitch have done a solid job of explaining their most controversial calls on sovereign debt. It appears that public scrutiny and transparency may be the best medicine for raters and their subjects alike.
HOW FANNIE MAE AND FREDDIE MAC CAN REVIVE THE HOUSING MARKET
The U.S. housing market “hasn’t bottomed out as quickly as we expected,” President Barack Obama pronounced in July. What he really meant was that housing has been like an anchor dragging down the economy.
Normally at this stage of a recovery, home sales and new construction are engines of economic growth and job creation. Obama has resisted more ambitious housing programs in the belief that the market would recover once the overall economy did. Now it appears he must do the reverse: Lift housing to boost the economy.
The government can do so by using Fannie Mae (FNMA) and Freddie Mac (FMCC), the taxpayer-owned mortgage-finance companies, to greater effect. They have received $130 billion in taxpayer support, after all, and together they hold or guarantee about 90 percent of all mortgages. Treasury could direct them to help underwater borrowers who are paying their mortgages and would probably stay current if the principal were reduced. In return, homeowners who benefit from a principal writedown and later sell their property should give up a portion of any profits, an approach called shared appreciation.
The Administration should urge Fannie Mae and Freddie Mac to recognize losses on the millions of troubled and defaulted loans sitting on their balance sheets. One approach would be to sell foreclosed properties to institutional investors. The two companies would then rent some of those foreclosed homes, both to ease the property oversupply and keep a lid on rental prices. (Rents are rising because of higher demand for rental units, now that many families don’t qualify for a mortgage or don’t want one.)
The mortgage-finance companies’ regulator, the Federal Housing Finance Agency, would have to approve most of these changes, and Congress may need to get involved. The FHFA now forbids principal reductions on mortgages that Fannie and Freddie own, not wanting to condone anything that would reduce the value of their assets. That’s like saving a burning building while letting its contents go up in smoke.
By using Fannie and Freddie to help fix the housing market, the Administration could strengthen the companies, too. In the long run, it may cost taxpayers less, and it would take a big weight off the recovery.