Call AAA to Rescue the Stranded Obama Administration

The Obama Administration is trying to defend itself from S&P's downgrade by claiming that S&P based its analysis on the projection that US debt would total $22.1 TRILLION in 2021, rather than $20 TRILLION, as the administration predicts.

Given the overwhelming evidence of the administration's ability to make accurate predictions about the economy over one- and two-year horizons, there's no reason to think the same people can accurately predict the size of our national debt 10 years down the road -- when all of the predictors will be long gone from their government jobs.

What's ahead in the next 10 years? Who knows? More wars? Probably. Higher aggregate medical expenditures by Medicare and Medicaid? Absolutely. How much higher? If we extrapolate the trend of the last decade, then spending in 2021 will break the bank.

It's amusing that S&P was villified for giving AAA ratings to mortgage securities that later defaulted. It's amusing because S&P is one of a handful of organizations that have a special government designation. They are Nationally Recognized Statistical Ratings Organizations.

What entity issued the National Recognition? The US government did. Thus, the government has given S&P its stamp of approval.

That stamp of approval meant that no investors questioned the accuracy of the AAA ratings given to mortgage securities containing many sub-prime loans. That oversight was essential to the goal of the government, which was to increase home ownership among people who historically were less likely to own homes and build personal wealth.

Rather than stick with well understood lending practices that demanded borrowers have a decent credit rating, reasonable job prospects and a substantial downpayment, the government legislated changes that allowed borrowers to borrow 100% of the purchase price of a home with nothing more than their "promise" to repay the money.

Now the Obama administration is in offended-mode, and it's trying to malign the S&P decision to reduce our national credit rating to AA+. A classic case of shooting the messenger.

Amid Criticism on Downgrade of U.S., S.&P. Fires Back

By NELSON D. SCHWARTZ and ERIC DASH
Published: August 6, 2011

The day after Standard & Poor’s took the unprecedented step of stripping the United States government of its top credit rating, the ratings agency offered a full-throated defense of its decision, calling the bitter stand-off between President Obama and Congress over raising the debt ceiling a “debacle.” It warned that further downgrades may lie ahead.

In an unusual Saturday conference call with reporters, senior S.& P. officials insisted the ratings firm hadn’t overstepped its bounds by focusing on the political paralysis in Washington as much as fiscal policy in determining the new rating. “The debacle over the debt ceiling continued until almost the midnight hour,” said John B. Chambers, chairman of S.& P.’s sovereign ratings committee.

Another S.& P. official, David Beers, added that “fiscal policy, like other government policy, is fundamentally a political process.”

Initial reactions from Congressional leaders suggested that S.& P.’s action was unlikely to force consensus on the fundamental divide over spending and taxes. Politicians on both sides used the decision to bolster their own long-standing positions.

Officials at the White House and Treasury criticized S.& P.’s move as based on faulty budget accounting that did not factor in the just-enacted deal for increasing the debt limit.

Gene Sperling, the director of the White House national economic council, called the difference, totaling over $2 trillion, “breathtaking” and said that “the amateurism it displayed” suggested “an institution starting with a conclusion and shaping any arguments to fit it.”

Even as the ratings agency insisted on Saturday that its move shouldn’t have come as a shock, it reverberated around the world. Officials from China to Europe scrambled to assess the downgrade’s impact on the already troubled global economy, and political leaders in the United States sought to frame the issue in their favor.

Republican presidential candidates on Saturday seized on the downgrade as a new line of criticism against President Obama, suggesting that ultimate responsibility rests in the Oval Office.

“It happened on your watch, Mr. President,” Representative Michele Bachmann said, drawing applause at an afternoon rally in Iowa. “You were AWOL. You were missing in action.”

In a statement, the White House made no mention of the downgrade. “We must do better to make clear our nation’s will, capacity and commitment to work together to tackle our major fiscal and economic challenges,” the White House press secretary, Jay Carney, said.




The wrangling over S.& P.’s downgrade to AA+ from AAA stretched on for days. But interviews with both officials from the administration and S.& P. reveal sharply differing perceptions on whether a downgrade was imminent. The rating agency argued that their intentions had been plain for months if the government didn’t take strong action to curb the debt; administration officials claimed they were blindsided.

The drama, which would culminate late Friday and into the weekend, actually began to gather speed Wednesday, when S.& P. executives came to the Treasury Department to meet with a group of administration officials led by Mary J. Miller, the assistant secretary for financial markets.

At the meeting, the S.& P. executives walked the Treasury Department team through its analysis. Government debt was growing rapidly, they said, and the just-completed deal wasn’t going to do enough to slow it down, endangering the AAA rating.

As early as April, S.& P. had changed its credit outlook on the United States to negative. By July, S.& P. warned that if the government did not agree to a deficit reduction package of about $4 trillion, there was a one-in-two chance a downgrade.

Still Treasury officials claim they were taken by surprise on Wednesday. Just the day before, Ms. Miller and her team met at the Hay-Adams Hotel with a group of senior Wall Street executives who advise the Treasury on its borrowing. None of the members believed that the government’s credit rating would be lowered in the near-term.

On Thursday, the ratings agency informed the Treasury that its seven-person panel would meet Friday morning to assess the creditworthiness of the United States government.

Even then, one administration official said, “We didn’t think they would actually do it.”

At 8 a.m. Friday, S.& P. convened a global conference call of its sovereign rating committee including Mr. Beers, Mr. Chambers and others. By 10 a.m., they’d reached a majority decision — the United States no longer was entitled to its top rating. Mr. Beers would not say whether the verdict was unanimous.

Inside Treasury, meanwhile, John Bellows, an acting assistant secretary, flagged a concern over S.& P.’s methodology. In its analysis, S.& P. had projected the nation’s debt as a share of gross domestic product to reach 93 percent by 2021. That was around 8 percentage points higher than the figure administration officials believed the rating agency should have used — what they now call a $2.1 trillion error.

In a Treasury blog entry, Mr. Bellows wrote that the difference raised “fundamental questions about the credibility and integrity of S.& P.’s ratings action.”

Around 5:30 p.m., S.& P. officials called the group of Treasury officials. “You were right,” Mr. Chambers told them, but said he was prepared to proceed because the revisions didn’t meaningfully affect S.& P.’s conclusion.

In one final effort to prevent what was once unthinkable from becoming inevitable, the Treasury officials again pressed S.& P. to reconsider. At 8 p.m., the ratings agency sent them the final press release on the downgrade. By 8:20 p.m., the news was out.

“For those who follow the fiscal situation of the United States, this shouldn’t be news to anyone,” Mr. Chambers said.

Standard & Poors and Moodys -- Government Agencies

What happens when agencies with the government seal of approval then extend their good name to give high ratings to securities of dubious value? Here's what happens. The analysts at S&P and Moodys who helped Wall Street firms by giving high rating to complex securities are rewarded with lucrative jobs at those Wall Street firms. Just like high ranking military officers who become lobbyists for defense contractors.

There are ten firms that are known as Nationally Recognized Statistical Ratings Organizations. Moodys and S&P are two, the best known two. Thus, when it comes to opinions on all the securities these firms evaluate, the government has stood behind them and their word. Big mistake. The government should treat this issue the same way it treats religion. There should be a separation between the Church of Wall Street and Government. Instead, the government has put a premium on the work of the 10 ratings firms. Thus, their words was not doubted and challenged when it should have been. Big mistake.

Raters Draw SEC Scrutiny

U.S. securities regulators are weighing civil fraud charges against some credit-rating companies for their role in developing the mortgage-bond deals that helped unleash the financial crisis, according to people familiar with the matter.

The Securities and Exchange Commission's long-running probe into the deals has widened to the major credit-rating firms, including Standard & Poor's, the people said.

The leading ratings companies have been criticized by lawmakers as "key enablers" of the financial meltdown, helping to fuel the $1 trillion Wall Street mortgage-securities machine before the boom ended.

But the major ratings firms have largely avoided any regulatory crackdown and beaten back private lawsuits. Their business has rebounded as financial markets regained their footing.

Now, SEC officials are focusing on the question of whether the ratings companies committed fraud by failing to do enough research to be able to rate adequately the pools of subprime mortgages and other loans that underpinned the mortgage-bond deals, according to people familiar with the matter.

It is a common tactic for regulators to accuse financial firms of fraud for allegedly misrepresenting information to investors, either recklessly or intentionally, according to lawyers. In the case of the rating companies, the firms could face allegations from the SEC that they relied on incomplete or out-of-date information supplied to them on the pools of loans in the mortgage-bond deals or ignored clear signs of problems among subprime loans and so gave unduly high ratings to slices of the deals that were then sold to investors, say people familiar with the matter.

The SEC is looking closely at the conduct of Standard & Poor's, a unit of McGraw-Hill Cos., said people familiar with the matter. They said the agency is also reviewing the role played by Moody's Investors Service, owned by Moody's Corp., in relation to at least two mortgage-bond deals.

The inquiry may not lead to charges against any of the credit-rating firms.

A Standard & Poor's spokeswoman declined to comment. Michael Adler, a spokesman for Moody's, said: "Although Moody's is uncertain as to what The Wall Street Journal is referring, we would certainly cooperate with any requests we receive from the SEC."

The inquiry into the rating companies marks a broadening of the SEC's long-running investigation into the sales and marketing of the mortgage-bond deals by several major Wall Street's banks. Goldman Sachs Group Inc. was sued by the SEC last year in the first big case to come out of the inquiry. Goldman paid $550 million to settle the charges. The firm admitted making mistakes but didn't admit or deny wrongdoing.

A new wave of cases involving fraud allegations against banks and other financial firms related to the deals is expected shortly, say people familiar with the matter. They said the agency is aiming for a second wave of settlements in the fall, with a third and final group possible by the end of the year.

J.P. Morgan Chase & Co. is among the first banks in line for a settlement of charges expected by the SEC, people familiar with the matter said. The New York investment bank is expected within weeks to settle these allegations related to its sale of a $1.1 billion mortgage-bond investment, called Squared, as the housing market was collapsing in early 2007. J.P. Morgan and most of the other banks that are expected to face allegations of fraud in relation to mortgage-bond deals are expected to agree to pay about half or less than the $550 million Goldman paid to settle the SEC charges, according to people familiar with the matter.

J.P. Morgan and the SEC declined to comment.

Other financial firms in the SEC probe include Citigroup Inc., Morgan Stanley, Bank of America Corp.'s Merrill unit and UBS AG, according to people familiar with the matter. The companies declined to comment.

The widening of the SEC inquiry to credit-rating companies puts them back in the regulatory and legal spotlight. The firms played a crucial part in the creation of the mortgage-bond deals, known as collateralized debt obligations. CDOs are based on complex pools of mortgages and other loans, made up in part of risky subprime mortgages. The pools were sold in slices to investors.

The ratings firms assigned coveted triple-A ratings to many of these CDO slices in the run-up to the crisis, before doing mass downgrades when the housing market collapsed and the subprime mortgages soured.

To be sure, the credit-rating companies aren't responsible for the accuracy of the data supplied to them to rate securities. But they could be accused of ignoring obvious flaws in the data, such as it failing to reflect the deterioration of the mortgage market, according to lawyers.

The ratings companies also enjoy significant legal protections, which they have used to fend off some lawsuits. In May, the credit-rating firms notched a legal victory when a U.S. Court of Appeals ruled that they can't be held liable for their ratings of mortgage-backed securities. Their ratings, the judges wrote, were "merely opinions" and protected by the First Amendment, a defense the firms have often used in the past.

A rare example of a regulatory case against the companies is the lawsuits filed last year by Richard Blumenthal, the then-Connecticut attorney-general, against Standard & Poor's and Moody's. The suits, alleging the firms knowingly assigned tainted credit ratings to mortgage-bond deals, are being contested by both firms.

Moody's and Standard & Poor's have mostly avoided costly legal settlements since the financial crisis.

The credit-rating companies have also benefited from a law that was expected to improve their performance. The Credit Rating Agency Reform Act of 2006 bars the SEC from regulating the substance, criteria or methodologies used in the credit-rating models. The current investigation avoids these areas.

Cash Crops -- Growing Dividends

10 Dividend Lions Roaring Now

A quick check suggests the stock market has left the recession in the dust. With the S&P 500 doubling in just 23 months, its quickest 100% rise ever, investors are giddy about growth prospects. Perhaps even better news than the growth opportunities is the strong return to dividends. Banks are allowed to increase payouts again and powerhouse firms are ready to return their cash hoards. Can’t you hear it? Today, the dividend lion rears its head and roars.

It seems like it would be hard for the most actively traded stock to tip-toe around the strong recovery, but that’s exactly what Citigroup (C) appears to be doing. After plummeting from $55 a share in 2007 to $1 in 2009, this global financial services company has only risen to about $4.50 since. The good news is that C will soon return to those middle-double digit prices seen before the recession; the bad news is it's going to do it by using a 10 for 1 reverse stock split. After the split, a tiny, better-than-nothing $0.01 dividend will be reinstated. Management says the real dividend returns will come in 2012. Okay, so not quite a roar yet, but with the upcoming 1% payout ratio, the dividend lion at least looks to wake up in the future.

JP Morgan Chase (JPM) quickly took advantage of allowable dividend increases by bumping its quarterly mark up to $0.25 from $0.05. This actually isn’t that far off from the pre-recession $0.38 quarterly payout. Add in the 5% payout ratio and the outlook for this financial powerhouse appears to be promising. The 2.1% current yield isn’t that attractive, but then again the $8 Billion common share buyback should be factored in to the shareholder value equation. Some might not be keen on the near 50% increase in CEO Jamie Dimon’s compensation during 2010 -- but to be fair, his year-to-year base salary did not change, just his stock option incentives.

From 1984 until 2008, Wells Fargo (WFC) enjoyed a stable history of increasing dividends. Then 2009 happened and its dividend was frozen at $0.05 per share. But confidence is up and payouts are on the rise. This banking giant makes up nearly 18% of Warren Buffett’s Berkshire Hathaway (BRK.B) portfolio, and Buffett himself predicted a substantial dividend increase this year. True to form, WFC issued a special dividend of $0.07 this March in addition to its $0.05 quarterly payout. It still lags greatly from the pre-recession $0.34 a quarter, but a tiny 9% payout ratio suggest returning more value to shareholders is on the way.

AT&T (T) is not a bank, but it is a “dividend champion,” having increased its payout for 27 straight years. With a current yield of 5.6% it certainly deserves to be mentioned in any dividend conversation. It went ex-dividend on April 6, so it is a bit late to catch this quarter’s payout. Still, this telecommunications company shows a bit of everything: High yield, sustainability (51% payout ratio) and growth opportunities if its bid for T-Mobile goes through. The 5% average five-year growth rate isn’t overly impressive, but you don’t need too much appreciation on top of the high yield. The current yield has dropped as of late, but if history turns out to be the map to the future, there shouldn’t be much concern.

Excited about telecommunication companies and high yields, but don’t think the AT&T deal will go through? You could always move down the list to Frontier Communications (FTR). FTR makes waves with its 9.3% current yield. Further, it has showed consistency in the past by paying the same $0.25 quarterly dividend for 23 quarters from 2004 to 2010.

Those saying it is too good to be true might be on to something though, as FTR’s 100%-plus payout ratio proved unsustainable. A dividend cut followed last September, dropping the per-share payment to $0.75 a year. Still, because it yields about three percentage points more than AT&T and Verizon (VZ), it might be worth a look.

Sure, banks are recovering and communications are flaunting big yields, but how about those recent gas prices? And if we’re talking gas, we need to be talking about the $425 Billion market cap of mega giant Exxon Mobile (XOM).

XOM, like T, is also a “dividend champion,” having not only paid but also increased its dividend for 28 straight years. The 2% current yield doesn’t do much for income investors, but the 28% payout ratio and near 9% five-year average dividend growth rate appear promising. XOM has been very consistent with its payout increases, so look for another increase this May. Additionally, the increase announcement has not yet taken place, so investors can benefit in two ways: First from the increase in yield on cost and second on the potential upside to positive news. Or if you just want to ride the gas wave to growth, forget the dividend history and go with XOM anyway.

If we’re talking about mega giants, we might as well throw in International Business Machines (IBM). The 1.6% current yield and near 52-week high price don’t do much in the way of saying, “Hey, I’m a dividend value” -- but hold on.

IBM is a member of the “dividend contender” list, having increased its payouts for 15 straight years. In recent years, this machine-turned-service company has not been hesitant in returning value to shareholders. In the last five years, IBM has grown dividends at an average rate of 26% each year. Factor in the 23% payout ratio and dividend investors can clearly see where future payouts will be coming from. Still not satisfied? IBM has been more than consistent with its increase announcements as well. Look for a 10% increase in your yield on cost if you buy in before the expected April 26 dividend increase announcement.

Speaking of dividend increase announcements, let’s take a look at Procter & Gamble (PG). PG is a powerhouse on the “dividend champion” scene, having increased its payouts for 54 straight years.

The 3.1% current yield is reasonable, but might get even better in the next month. PG looks to mirror IBM with an expected 10% increase to yield on cost. In the last four years, increase announcements have come on either the second Tuesday or the third Monday of April. Let’s call it April 18, the third Monday of April. The 53% payout ratio appears to be in line for this consistent consumer goods company. A near 12% average five-year dividend growth rate, coupled with the expected upcoming dividend increase announcement, make PG a play that everyone can see.

Avon Products Inc. (AVP): Small, but only when compared to IBM and XOM, this $12 Billion beauty product manufacturer comes in with a current yield of 3.4%.

AVP has increased its dividend for 22 straight years and can become a “dividend champion” in just three more. This New York-based firm has a notable Fortune 500 female CEO and an apparently sustainable 66% payout ratio. Perhaps a slight concern would be the decreasing dividend growth rate, nearing a 6% average over the last five years. Still, any growth on the current yield is icing for this strong niche company.

AVP products can’t be found in Wal-Mart Stores (WMT), but pretty much everything else can. WMT has been on the “dividend champion” list for quite some time now, having increased its dividend payouts for 37 straight years.

Interestingly, this low price superstore plays as a rich man’s favorite with Buffett and Bill Gates holding substantial stakes. Earlier in the year, the 2.3% yield might have spooked income investors, but a recent increase has lead to a much more acceptable 2.8% current yield. The low 33% payout ratio says "how do you do" to future sustainability, but more impressive is the recent dividend growth rates. In the last five years, payouts have increased by an average of over 15%. If we see that over the next five years, your yield on cost would double.

Dividends are coming back across the board; to be sure, this is just a sampling.

Credit Analysis and Investigations by Sam Spade

It's about time for competitors to the Big Three Credit Rating Agencies to get serious. However, as Wall Streeters know, there are lots of small bond houses that perform credit analysis and exploit the weaknesses and inefficiencies of Standard & Poors, Moodys and Fitch.

Kroll Gets a License to Shoot (Bonds)

Onetime corporate sleuth Jules Kroll is reinventing himself as an investigator of bonds.

The 69-year-old mogul, who founded and later sold security firm Kroll Inc. for $1.9 billion, acquired boutique credit-ratings firm Lace Financial last week in an effort to build staff and get the licenses needed to compete with the three big rating firms, Standard & Poor's, Moody's Corp. and Fitch Ratings.

Jules Kroll made his name in corporate security, not securities.

"There's a need for a credible alternative," said Mr. Kroll, who last year started Kroll Bond Rating Agency Inc. to take on the incumbents. He poured about $5 million of his own money into the venture and hired about a dozen employees, including former executives from Moody's and Fitch, a unit of Fimalac SA of Paris. Then last week he decided with the help of new investors to spend more than $5 million for Lace, a 25-year old company with about a dozen employees that mainly rates banks and other financial-services firms.

One key attraction of Frederick, Md.-based Lace is that it has the regulatory licenses with the Securities and Exchange Commission to be a nationally recognized bond-rating firm. "A lot of investors have no choice but to use" a rating firm recognized by the SEC, said Mr. Kroll from his firm's new office in Midtown Manhattan.

Kroll's Plan

How Kroll's credit-ratings venture will try to stand out:

1. Perform more 'due diligence,' beyond data from bond issuers.
2. Accept much of its pay from investors who subscribe.
3. Provide ratings in some cases when issuers don't want one from Kroll.
4. Provide supporting materials with ratings so investors can see why a rating was given

Mr. Kroll's entry into the business is the latest move by an upstart trying to take advantage of perceived weakness from the three largest credit-rating firms, which have been around for decades and have long dominated their important niche of Wall Street: communicating a bond's risk to investors in a simple alphabetical code.

Regulatory advantages helped maintain the dominance of the big three ratings firms. But in recent years Congress has acted twice to reduce that dominance and open up the market to new entrants. In May, research firm Morningstar Inc. paid $52 million to buy Realpoint LLC, which held a license for its work specializing in rating structured-finance transactions.

"It's very clear that major rating firms have not served the market particularly well in the recent past, so it's wonderful that there's some competition for them," said Sean Egan, managing director at boutique rating firm Egan-Jones Ratings Co. "They obviously need it."

Egan-Jones, Lace and Realpoint were designated as licensed credit-rating firms after the SEC opened up the field to more players following the passage of a 2006 law.

But that move has done little to chip away at the market share of Moody's, Fitch and S&P, which is owned by McGraw-Hill Cos. The three industry leaders issued about 97% of all outstanding ratings across five major debt categories, such as corporate issuers and asset-back securities, in 2008, according to a 2009 report by the SEC.

Not much has changed since then, analysts said. "I don't think Moody's or S&P are losing any sleep on new entrants in this business," said Michael Meltz, an equity analyst at J.P. Morgan Chase & Co.

Kroll is still a minnow in the world of bond ratings. With Lace, which will maintain its name as a unit of Kroll, the firm will have about two dozen employees, compared with 1,300 credit analysts world-wide at S&P and more than 1,200 at Moody's. Lace had only about $1 million of revenue in 2009 compared with $1.2 billion for Moody's Investors Service and $1.7 billion for the rating unit of Standard & Poor's.

Mr. Kroll said he hopes he can change that market share. In 1972, he started an investigative firm that tapped into a growing need to chase down assets in foreign countries and research the financial strength of companies' suppliers, customers and merger partners. In 2004, he sold the company to Marsh & McLennan Cos. for $1.9 billion, and personally took home about $120 million in the deal. He remained chairman of the firm until 2008, when he left to pursue new business ventures.

At the time, the subprime-mortgage market was imploding, dragging down the rest of the credit markets and later the U.S. economy. At the center of the blame game that followed were the major rating firms, which had stamped thousands of mortgage related bonds with top triple-A marks, before changing course and cutting their ratings when many homeowners stopped paying their bloated mortgage bills.

"We were looking for public-policy problems that needed private-sector solutions," said Mr. Kroll, who is planning to rate residential- and commercial-mortgage bonds later this year. His new ratings business shares office space with the consulting firm he founded, and he expects to erect a wall to separate them.

With the deal last week to buy Lace, Kroll Bond Ratings also accepted $20 million in funding from investors including Bessemer Ventures Partners and RRE Ventures.

The investors are pouring money into a business that faces hurdles, from heavier regulation to efforts by users of bond ratings to find other methods to assess the risk in their portfolios. Mr. Kroll said, for instance, that he has met with representatives from insurance companies to discuss their efforts to rely less on bond ratings.

Security Analysis -- Credit Rating -- AAA or Junk?

There are no mysteries about assessing the quality of a bond or other fixed-income security. Credit analysts have been at it for a long time. But if we know what we are doing, why do we sometimes get it wrong, horribly wrong? In a nutshell, through good intentions, the government made a mess of things.

Put the Rating Agencies Out of Their Misery Before It's Too Late

A pillar of the financial crisis was rating agencies slapping triple-A ratings on junk mortgage products only to be mystified when the securities blew up. In the 2007 transaction involving the recent Goldman Sachs (NYSE: GS) CDO fraud saga, almost half of the debt was downgraded from triple-A (perfect) to junk (perfectly worthless) in short order.

Fool me once ...

Now, a sober person would think the rating agencies have learned from these flubs. But that makes too much sense. Truth is, they're as miserably inept as ever.

Last summer, Standard & Poor's invoked the ghost of 2005 when it rated a set of CDO-esque securities triple-A, which implies essentially zero probability of default.

Last week, it downgraded the same securities all the way to junk. That's triple-A to junk in less than a year. Again. Recall Einstein's definition of insanity, and feel free to smash your head against the nearest wall.

"The downgrades reflect our assessment of the significant deterioration in performance of the loans backing the underlying certificates," cried S&P. This is mildly true at best, and more likely a product of the same deceptive shell games rating agencies are now infamous for.

Here's your pig, there's your lipstick. Have at it.

These securities, you see, weren't new products created last summer when S&P initiated the ratings. They're called "re-remics," born from an alchemical process of taking existing bonds struggling for survival, slicing them up anew, and giving the new pieces a fresh set of ratings. The idea is that you can take a low-rated mangled mortgage bond, extract the pieces that still have a heartbeat (even though they share the same characteristics as the rapidly defaulting mortgages), and pronounce the new security triple-A.

So to be sure here, the same material that S&P called triple-A last summer was, at nearly the same time, rated far below that. David Blaine can't even fathom this stuff.

During a flood of re-remics last fall, The Wall Street Journal wrote an article questioning their validity "partly because re-remics rely on ratings firms -- faulted for failing early on to identify problems with mortgage-backed bonds -- to rate the new securities." That was spot-on, as was a comment by Rep. Dennis Kucinich, who warned, "The credit-rating agencies could be setting us up for problems all over again."

That's exactly what's happening, and it's time we do something about it. One of the central flaws in the rating agency world is that large-scale investors such as money market funds are required to hold assets scored by a rating agency registered as a Nationally Recognized Statistical Rating Organization, or NRSRO. Only a handful of raters are blessed with this status, and Moody's (NYSE: MCO), S&P, and Fitch are kings of the court. They're privileged to what amounts to guaranteed business and no threat of new competition.

While it's certainly well-intentioned, there's fairly universal agreement that the NRSRO has created the ability, if not the incentive, for rating agencies to produce wildly flawed work. They have nothing to lose. Investors have to use their services. S&P can recklessly issue wacky ratings (as it just did), and business goes on as usual.

Hedge fund manager David Einhorn summed it up perfectly: "Nobody I know buys or uses Moody's credit ratings because they believe in the brand. They use it because it is part of a government-created oligopoly and often because they are required to by law." In any normal market, new competition and customers' disgust over shoddy analysis wouldn't let this happen.

Let's do something about this

Fortunately (though long overdue) Congress is waking up. Two amendments in the just-passed Senate financial overhaul bill could euthanize the flawed parts of the rating system.

One amendment would eliminate all mention of the NRSRO from federal regulations. The organization could still exist, but language requiring investors to use products rated by an NRSRO rating agency would vanish. Competition from eager rivals like Morningstar (Nasdaq: MORN) and KPMG could then step in and sanitize the industry.

A separate amendment would create a clearinghouse set up to assign rating agencies with deals. That way, banks that issue credit products couldn't shop around for the morally bankrupt rater that's willing to assign triple-A status to toilet paper just to bag a nice fee. Both amendments aim to end a kink in the financial system that benefits exactly nobody except the rating agencies and the banks that sell glorified debt products.

We'll be patiently watching as the Senate and House reconcile their respective versions of the financial overhaul bill. Stay tuned.