WASHINGTON — In a compromise, lawmakers negotiating a sweeping rewrite of financial regulation agreed Tuesday to weaken tough language that was an attempt to rein in a conflict of interest that allowed both credit-rating agencies and the Wall Street banks that paid them to profit handsomely.
The conflict of interest emerges from the fact that companies pay the agencies to rate the bonds they sell. In the case of complex bonds, ratings agency personnel were often advising the banks about slicing and dicing pools of mortgages.
Senators on a special negotiating panel that's trying to narrow the differences with parallel legislation from the House of Representatives agreed to delay for two years implementation of the tough language that passed the Senate last month.
That language_ offered as an amendment by Sen. Al Franken, D-Minn., and passed with bipartisan support_ would have prohibited Wall Street banks from handpicking ratings agencies when seeking investment-grade ratings for complex bonds backed by pools of mortgages.
However, the compromise offered by House members and accepted by senators gives the Securities and Exchange Commission two years to study how best to implement this change, delaying implementation but not killing it outright.
A McClatchy investigation last year into the causes of the financial crisis revealed how banking titans such as Lehman Brothers and Goldman Sachs routinely played credit-rating agencies off each other to get top ratings for bonds backed by pools of subprime mortgages which later proved to be junk.
Moody's Investors Service, Standard & Poor's and Fitch Ratings all saw profits soar as investors snapped up these bonds, thinking that the Triple A rating was a seal of approval. In the case of Moody's, as the McClatchy investigation found, executives from the structured finance division that packaged the complex and lucrative bonds were promoted throughout the upper echelons of management, pushing out voices of restraint.
That's why senators such as New York Democrat Charles Schumer supported tough action against ratings agencies, which are in effect his constituents. He cited newspaper reports among the reasons why a new approach was needed by the ratings agencies, which are supposed to serve as guideposts for bond investors wary of risk.
Under Franken's original proposal, a new public-private sector council would be formed to assign a ratings agency to each complex security needing a rating. Lawmakers worried Tuesday, however, that it was too abrupt a change.
"Personally I kind of like the study in terms of how you deal with conflicts of interest ... my concern with it is I don't know how you work it," said Senate Banking Committee Chairman Christopher Dodd, D-Conn., who voted against the original amendment but for the compromise. "This way it takes the Franken idea, which has some merit ... it takes the House idea of looking at this, and clearly is saying we shall deal with this conflict of interest."
Following the compromise, Franken said he could live with it.
"Today's compromise is not everything we wanted, but it's a major step in the right direction. Wall Street's broken credit-rating system played an enormous part in our economic meltdown, and it's our duty as lawmakers to make sure that never happens again," he said. "We know that conflicts of interest rewarded cozy relationships instead of accuracy, and we know how to fix the problem."
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