The credit ratings industry will be forced to create a more accurate and transparent market to better meet the needs of the investing community, the president of one top firm told CNBC Tuesday, a year after the financial crisis almost broke Wall Street.
“I think there is a recognition that there is a fundamental, unmanageable conflict of interest in this area and there are steps being taken to address that,” said Sean Egan, president and cofounder of Egan-Jones Ratings Company.
Last October, the House Committee on Oversight and Government Reform held a hearing examining the role credit agencies played in the financial crisis. Egan was among those who testified.
Many analysts and observers say credit ratings agencies contributed to the financial crisis because they underestimated the amount of risk involved in many securities issued by financial firms, particularly heavily-leverage ones, such as mortgage-backed securities. What's more, the relationship represented a conflict of interest because the firms issuing the securities pay the ratings agencies to assess them for the investing community.
But, reform for credit agencies won’t come entirely from Congress.
“We don’t think the heavy lifting will be done in Washington, it will be done in the courts,” said Egan.
Last month New York District Judge Shira Scheindlin ruled credit agencies were not guaranteed the first amendment right of freedom of speech in their rating of companies.
The ruling is significant both for the ratings firms, but also for the companies using their services.
“This last case is going to be very relevant in the sense that there is the realization that broker dealers and money managers have to make sure there is an alignment of interest between the agents assessing risk, those rating firms and their ultimate beneficiaries, and ultimately also the tax payers, because the taxpayers are on the hook for about $13 billion because of this whole fiasco,” said Egan.
Egan said by aligning interests, risk will be properly assessed and a more trusted marketplace will emerge.
“We’re getting organized, it will take a little bit of time to do that. But that’s what’s needed to move forward,” said Egan.