Chris Dodd’s Last Gasp

April 7, 2010

By David J. Gernhard

Circle the wagons, folks. The forces of government debt financing – the “we owe it to ourselves” legion – are organizing under the banner of the soon-to-be-retired Senator and Dark Lord from Connecticut, Chris Dodd.  The last battle in the war to prevent fiscal Armageddon and the summoning of the Total State could very well be upon us.

You see, Dodd introduced a new bill that just passed committee last month: “The Restoring American Financial Stability Act of 2010.” Dodd claim’s that his bill will create “a new architecture to make our financial institutions more transparent, more responsible, and more accountable to the American people. It will address the problems of the past, and look forward to the needs of the future.”

The new architecture outlined in this bill will of course do none of those things.  Others have already written on how this bill will not “create a sound foundation to grow the economy and create jobs,” as Dodd claims. (See these articles from The Huffington Post and The Wall Street Journal).

The real danger of this bill is in its seemingly insignificant section on credit rating agencies.  Dodd’s press release gives it one line:  “And we will demand transparency from credit rating agencies and hold them accountable for the quality of their ratings.”  Most mainstream media write-ups on the bill don’t even mention the proposed rules regarding credit rating agencies.  Yet these rules could prove to be more influential to continuing the Obama project than any other, and they do so in a terribly insidious way.

Credit rating agencies act like the Consumer Reports of the investment world. Agencies like Moody’s or Standard & Poor’s (the industry’s best-known examples) specialize in researching the credit risk of individual securities.  Their ratings hold great sway over the management of pension and mutual funds, and many – indeed most – investors consult rating agencies when making investment decisions.

What our central planners seek to do is bring additional regulatory oversight to bear on these agencies because of the agencies’ failure to correctly rate many of the securities that went bad during our latest recession.

Here are a few of the new requirements sought by Dodd et al: 

New Office at SEC: Creates an Office of Credit Ratings at the SEC with its own compliance staff and the authority to fine agencies. The SEC is required to examine Nationally Recognized Statistical Ratings Organizations at least once a year and make key findings public.

Disclosure: Requires Nationally Recognized Statistical Ratings Organizations to disclose their methodologies, their use of third parties for due diligence efforts, and their ratings track record.

Independent Information: Requires agencies to consider information in their ratings that comes to their attention from a source other than the organizations being rated if they find it credible.

Conflicts of Interest: Prohibits compliance officers from working on ratings, methodologies, or sales.

Liability: Investors could bring private rights of action against ratings agencies for a knowing or reckless failure to investigate or to obtain analysis from an independent source.

Right to Deregister: Gives the SEC the authority to deregister an agency for providing bad ratings over time.

Education: Requires ratings analysts to pass qualifying exams and have continuing education.

The question I’m asking is this: Do we really want government to have more control over the private agencies that rate government securities?

Any one of these legislative elements is sufficient to have a chilling effect on the opinions published by credit rating agencies.  Taken together, however, they constitute a blatant violation of free speech.

For example, the treasury department should not be writing the qualifying exams that independent private reviewers must pass in order to evaluate the debt instruments sold by the treasury department.  Doing so forces analysis and researchers to study according to the state standards, undoubtedly forcing them into the government mold of analysis that clearly failed all government bureaus.

Next, let’s consider the conflict of interest forced into such a system.  What happens when government agencies are given the power to “deregister” (shut down) a watchdog group or publication dedicated to evaluating the riskiness of the government behavior.  Does anyone think this would encourage criticism of the state?

And how about disclosure?  Could you imagine the outrage if the New York Times was forced to reveal its sources and method of research every year? Yet, the state thinks it should be given the power to regulate how private research publishers determine their opinion of riskiness.  People would rightfully charge the state with a violation of constitutionally protected freedoms.

That’s what’s going on with this bill: the state is willing to sacrifice freedom of speech for the sake of financial stability.  Unfortunately, when rating agencies’ freedom of speech is sacrificed – even if we do get financial stability, which any sane person should find to be, at best, doubtful – the real price tag will be an explosion in government debt financing.

The United States is already precariously close to a Greece-like situation.  Al Doyle, writing here for MIAToday.com, argues this point.  I’ve argued along similar lines in a February 17 article where I showed how just a small change in interest rates could destroy the ability of the United States to continue financing itself through debt.  Because of this reality, government manipulation in the credit rating industry becomes essential to the survival of the expanding Obama project.

These sorts of proposed regulations make possible the assurances of Tim Geithner, who told ABC News that the U.S. will never lose its AAA rating – especially given Moody’s statement that U.S. government bond ratings will come under pressure in the future unless additional measures are taken to reduce budget deficits.  The Obama jig is up if government loses its AAA rating.

Facing weak demand for recent treasury auctions and bond yields creeping up to their highest points since June of last year, our central planners need all the arm twisting power they can get to keep rating agencies from dropping the AAA status.  When that happens, pensions and mutual funds, which operate on fairly strict managerial guidelines, will sell off a lot of government bonds.  This will further increase the cost of debt financing as new treasury issues will have to conform to rising market interest rates.  The state will either be forced to default, be forced to monetize, or be forced to tax, all of which have been the source of violent uprising throughout history (the American Revolution and French Revolutions, for example.)

This new bill isn’t going to restore American financial stability, as its title and proponents suggest.  Instead, it will increase the government’s ability to engage in deficit spending through the regulatory intimidation of credit rating agencies and the suspension of free speech.  I’m calling it the “Revitalizing American Fiscal Irresponsibility Act,” and it will only further bankrupt our country and its citizens.

The first step to reining in government debt-spending is preserving what little independence these rating agencies have left.  And the first step toward that end is stopping Dodd and his manipulative new bill before it becomes law.