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Credit Rating Agencies

posted by Adam Levitin

Credit rating agencies have begun to be scrutinized as the mortgage market struggles, but the scrutiny has been on corporate credit rating agencies that graded (and essentially blessed) securitized mortgage debt. But what about the consumer credit rating agencies?

Consumer credit ratings were necessary on the front-end of mortgage issuance, before loans were bundled and sold off to feed the ravenous cash flow beast. Were lenders lowering their standards or were consumer credit ratings off? My sense is the former, but it’s worthwhile thinking about these parallel systems of credit rating and their regulation. The corporate credit rating agencies are virtually unregulated; consumer credit rating agencies are subject to a little more regulation (FACTA/ FCRA). As long as policymakers are looking at the regulation of corporate credit rating agencies, it might be time to give consumer credit rating agency regulation another look, particularly as it is a central node in the fight against identity theft.

It’s also worthwhile highlighting how central credit rating agencies (consumer and corporate) have become to the functioning of the American economy. This has been a quiet and generally unremarked develop of the past few decades, but has been one of the key pieces in the development of a national consumer credit economy (with its benefits and problems). The centrality of credit ratings was recently brought home to me by a recent Visa USA survey (hit tip Payments News). The Visa survey press release emphasizes that “Americans Unaware That Employers Can Legally Refuse to Hire Job Applicants with Low Credit Scores.” This is true, but credit scores are designed to tell about an individual’s credit risk, which is rarely a job qualification. (Why is Visa touting this finding? It seems like a clumsy way of saying “you’d better pay your credit card bills or else...”) Still, what we see is credit rating agencies playing the role of paid job reference, which can certainly put a blemish on the “fresh start” of a bankruptcy discharge. Transparency seems to be one of my themes this week and consumer credit ratings are certainly an area which could use more, especially as they become used for more and more purposes.

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Comments

Hi, i agree completely with this article because this opinion is right.

Mr. Levitin,

I happened upon your article while searching for commentary regarding possible collusion and/or conflict of interest between mortgage lenders and Moody's, Fitch, and S & P. Not only was the safety of
these investment vehicles exaggerated . . . contributing to defaults and foreclosures, but as a result, market values were driven ever-higher by artificial demand in the form of consumers that would not have gotten financing if lending guidelines had tightened up sooner.

Recently, I watched a documentary called "Maxed Out" that was produced by AFFIL (Americans For Fairness In Lending). In a nutshell, if you are unfamiliar, the film examines predatory lending targeted to credit card consumers.

The film points out that credit reports contain errors approximately 90% of the time. The credit bureaus are lazy about cleaning up credit mistakes, if not outright resistant. If accurate, this results in higher borrower interest rates for credit cards, mortgages, etc., and is a tremendous and illicit cash-cow for the lenders.

Unfortunately, as I've witnessed first-hand as a mortgage broker, borrowers often are unaware of their credit status until they are actually seeking financing, and then it is typical to have a time constraint that makes it difficult to resolve errors adversely impacting the profile of the borrower.

Thanks for the article and allowing me to give my two cents.

Dear Professor,

You state in your article that the corporate credit ratings agencies are virtually unregulated, but are there regulations of the corporations themselves as to the kind of information they must provide to the agencies, perhaps SEC rules? I'd be curious to know.

thank you,

Noah Gordon
nojgordon@aol.com

Noah--I do not know of any SEC rules that specifically address corporations disclosures to corporate credit rating agencies. Usually the rating agencies request certain information from the securities' issuer, and when something is borderline, the issuer gets an opinion letter from a law firm or auditor for support. Arguably general securities fraud regulations, such as Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, apply to statements made to credit rating agencies because the corporation knows that they will affect the sale of its securities.

The main complaint, as I understand it, is that the rating agencies rated rated debt issuances too highly. If they were fed bad information, that might be a defense. Essentially, though, the complaint is that the rating agencies were negligent (or worse yet wilfully negligent): they didn't ask the right questions or were too willing to accept optimistic assessments without proper inquiry or didn't react to changed conditions by downgrading ratings. The problem is that even if the ratings agencies were negligent, it is not clear that they have a duty of care to anyone.

I can hardly believe that "Employers Can Legally Refuse to Hire Job Applicants with Low Credit Scores.", how come?

Credit rating--because there's no law preventing them. Discrimination by credit score is legal. There's some logic to this--an employee with a bad credit score is probably more likely to be subject to wage garnishment, which is an administrative hassle for employers and a potential source of liability if they goof. Federal law prohibits the firing of an employee on account of a single wage garnishment, but not for multiple garnishments. And there's no private right of action under this law, so it's probably not much of a protection anyhow.

This is sickening to me, since our family has fallen victim to a scam, but people in high places that are invisible and know around the laws, and have brought old accounts that were written-off and are causing our family grief with fraudulent debt collection agencies. How are people to fight these forces of great evil against having a wage garnishment that is unlawful by those who are listed under the "Rip-Off Blogged Posts"? Some of these collection agencies get away with doing this, and it wasn't ever their debt to collect upon. Please advise.

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