Fed Chairman Ben BernankePAUL J. RICHARDS/AFP / Getty Images
At more than 2,300 pages, the Dodd-Frank Wall Street Reform and Consumer Protection Act was bound to have unintended consequences. It took only a day for the first one to come to light.
Less than 24 hours after President Barack Obama signed the massive regulatory overhaul into law, the Securities and Exchange Commission was scrambling to calm credit markets, which were in turmoil over provisions meant to make credit agencies more accountable for their ratings.
For nearly eight decades, firms such as Moody's Investors Services and Standard & Poor's had legislative protection from being sued if any of their ratings turned out to be wrong. Senator Christopher Dodd and Representative Barney Frank, Democrats from Connecticut and Massachusetts, respectively, took away that cover after credit agencies assigned their highest ratings to the toxic assets that caused the financial crisis.
Facing legal liability for the first time, those firms are now refusing to allow their ratings to be used in offering documents. This created a Catch-22 for companies that were trying to raise money by selling asset-backed debt. The law requires those assets to include ratings in official documents.
The Wall Street Journal reported Thursday that Ford Motor Co.'s financing arm was forced to delay a sale of bonds backed by automobile loans because it couldn't find a rating agency willing to grade its securities. Appearing before the House of Representatives financial services committee Thursday morning, Federal Reserve Chairman Ben Bernanke urged the SEC to deal with the situation, saying the issue threatened to impede credit that already is difficult for companies to obtain from wary lenders.
"It is an issue that needs to be looked at," Mr. Bernanke told the committee, which is led by Mr. Frank. "It does inhibit somewhat the sale of ABS."
The SEC's response was to issue a reprieve.
In a statement issued late Thursday afternoon, Meredith Cross, director of the regulator's corporate finance division, said companies such as Ford will be permitted to issue unrated asset-backed securities for six months. The reprieve relates specifically to securities sold under "Regulation AB," which covers the SEC's guidelines for selling asset-backed securities.
"Although there are currently few issuers in the registered asset-backed securities market, we understand from some issuers that they cannot currently obtain credit ratings in these 'Reg AB' filings," Ms. Cross said. "This action will provide issuers, rating agencies and other market participants with a transition period in order to implement changes to comply with the new statutory requirement while still conducting registered ABS offerings."
Ahead of the SEC's move, Joseph Astorina, an analyst at Barclays Capital in New York, said the confusion has the potential to cause the public securitized debt market to "grind to a halt" because companies would be forced to seek out private deals to obtain funding.
That would have run counter to another one of the themes of the new financial law, which is to push more of the trading of ABS and other derivatives onto public markets.
It remains unclear whether the SEC's fix will be enough to restore confidence in a market that is used to relying on the big credit rating agencies. Those firms must decide if they are willing to accept the risk of getting sued, and if they are willing to do so, how much extra they will charge clients to compensate for that risk.
Issuers face the challenge of convincing investors that their bonds are a safe bet without an independent party to back them up. Investors will have to decide if they want to do research they used to leave to the credit rating agencies.
More clear is the likelihood that there will be more of these episodes.
"The issue is how changes in regulation to one small area can have a negative impact for a larger area that is more meaningful for the economy," Andy Busch, global currency and public policy strategist at BMO Nesbitt Burns in Chicago, said in a note to clients. "This is just the start with much more to come. Stay tuned."