The main three credit ratings agencies have told Wall Street in recent weeks that underwriters won't be able to use their credit ratings in documents selling asset-backed securities for fear of being sued.
While it has already placed the ABS market on hold and has securitization professionals up in arms, there are several ways for banks to continue to sell ABS going forward.
The US financial regulatory overhaul has eliminated protection of credit ratings agencies from lawsuits when underwriters include ratings in documents used to sell ABS, which prompted the three agencies - Fitch Ratings, Moody's Investors Service and Standard & Poor's -- to ask underwriters not to use their ratings.
At the same time, the Securities and Exchange Commission already prohibits the sale of ABS without ratings in offering documents. The two rules put together have brought the ABS market to a standstill.
Although credit ratings agencies' dramatic move threw an immediate freeze on the ABS market, there are several possibilities to revive it.
Credit ratings agencies have more to lose from not participating in the ABS market than from lawsuits at this point and will most likely find a compromise. Already in its statement asking Wall Street to refrain from using its ratings, Standard & Poor's also noted that it is exploring mechanisms outside of the registration statement to allow ratings to continue to be disseminated.
The SEC could also modify its rules that ask underwriters to include ratings in offering documents.
At the last resort, ABS issuers could always try to sell unrated bonds. It may not be a bad idea considering how credit ratings from these agencies have been off the mark when it comes to securitization. Unfortunately, it may be difficult, if not impossible, to convince investors, especially those with strict investment guidelines like pension funds and insurance companies, to buy the debt.
So instead of making sure that credit ratings agencies can still disseminate their ratings on ABS, regulators should revise investment guidelines of these conservative investors, who often are asked to rely too much on credit ratings. Investors should be asked to have qualified staff that can properly evaluate bonds. Then credit ratings won't be necessary anymore and ratings agencies won't run the risk of being sued.