Ratings reform: Try, try again

The Obama administration seeks to boost transparency on the bond rating process, but it's unclear when its plan might see the light of day in Congress.

By Colin Barr, senior writer

Treasury Secretary Tim Geithner wants to manage conflicts in the bond ratings business.

NEW YORK (Fortune) -- The Obama administration sent Congress its latest plan to spruce up the much maligned credit rating business. But the proposal sidesteps a key issue, and legislators don't seem to be in any rush to act on it.

The Treasury Department says its plan, which it formally introduced Tuesday, would "increase transparency, tighten oversight and reduce reliance on credit rating agencies."

Assistant Treasury Secretary for Financial Institutions Michael Barr told reporters on a conference call that the proposal -- which would also create a new watchdog office within the Securities and Exchange Commission -- would "make an important difference" for investors.

The ratings reform effort is part of the administration's plan to shore up the financial system in the wake of last year's financial market collapse. Poor performance and conflicts of interest at big ratings agencies such as Moody's (MCO) and the Standard & Poor's unit of McGraw-Hill (MHP, Fortune 500) have drawn intense scrutiny on Capitol Hill.

Former Securities and Exchange Commission chief accountant Lynn Turner charged in congressional testimony this year that raters "became blinded by the dollars they were billing rather than providing insight to the public into the perfect storm that was forming."

The Treasury plan would bar ratings agencies from doing consulting work with companies whose bonds they rate, and would force rating companies to disclose fees paid by bond issuers in each report.

It would also oblige raters to use different ratings scales for plain vanilla corporate bonds and so-called structured securities -- bonds made up of slices of other bonds, for instance. Downgrades and defaults on highly rated structured products have been commonplace during the crisis.

One thing the administration plan wouldn't do is restrict the practice of bond issuers paying for ratings -- a conflict of interest that some observers put at the center of the credit crisis. The two leading U.S. ratings agencies, S&P and Moody's, are paid by issuers.

Sean Egan, who runs the Egan-Jones subscriber-paid rating agency in Pennsylvania, says the administration's proposal "changes nothing" because it fails to address the issuer-pays conflict.

Barr said the administration took the conflict issue "head on" and would put in place "tough rules" to manage conflicts of interest. He added that subscriber-paid agencies such as Egan's are hardly beyond reproach, given that "investors would still have a conflict because they own these securities being rated."

But Egan scoffed at the administration's attempts to diminish the importance of the issuer-pays conflict.

"That conflict isn't manageable," he said. "What I'm admiring is the amazing lobbying power of S&P and Moody's, getting Treasury behind this sort of nonanswer."

A spokesman for S&P said the company was "studying" Treasury's proposal. Moody's didn't immediately respond to a request for comment.

Whether Congress will get behind the plan remains to be seen. Barr said the ratings overhaul should be viewed as part of a series of changes to the nation's financial regulatory system, including a consumer financial product safety panel and new rules on executive pay.

"The prospects for our package of reforms is strong," he said. "We have an enormous amount of support."

Barr said Treasury was working with the appropriate committee chairs -- House Financial Services Chairman Barney Frank, D-Mass., and Senate Banking Committee chief Chris Dodd, D-Conn. -- to introduce the ratings legislation.

But ratings reform is hardly a new issue -- the SEC has been studying it for 15 years -- and just when Congress might take up the reform mantle isn't clear.

Frank said Tuesday he was told by House leadership that no piece of regulatory reform will hit the House floor before September. Barr said the administration is "mindful of the chairman's desire to run the process the way he thinks effective."

CNNMoney.com senior writer Jennifer Liberto contributed to this report.

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