The way things are structured now, there’s not a lot of credibility at the rating agencies. Congress’s first reaction was to create more approved agencies because they thought it was an issue of not enough competition. In my view, they’ve got it exactly backwards. The problem with rating agencies is a forum shopping issue. The issuer goes to one agency, and if the agency won’t give the securities a high-enough rating, then it goes to the next one. So if you go from 3 agencies to 9 or 10, you just increase the possibility for forum shopping.
In your book, then, you propose that the SEC appoint a consultant to select a credit-rating agency on behalf of each issuer.
Yes. It’s not a perfect solution, but it focuses on the key problem of forum shopping. For one day, the consultant represents investors, and the consultant’s job is to do an RFP and pick the credit-rating agency that’s going to have the most accurate rating and at a reasonable cost. Once picked, the credit-rating agency will be paid by the issuer. But the issuer won’t pick the agency. It’s this shopping around that leads to this terrible result.
And you think this has a practical chance of being adopted?
This is a case in which you have to think through carefully what’s the real problem, and what are alternative solutions that will at least get you most of the way [toward solving it], although they’re not perfect. I’ve had talks with some credit-rating agencies and they were receptive to the idea. They don’t like the position they’re in now; they want their credibility back, too. And for the sake of the small and middle-sized investors, we need their credibility. Those investors don’t have the resources of an MFS to look at all these bond offerings. They have to accept the credit rating.
Let’s discuss another adoption issue: International Financial Reporting Standards. There’s a lot of uncertainty about how soon, or whether, companies in the United States would convert from U.S. GAAP to IFRS. But in your book, you say that such a change makes sense only for the largest two or three hundred companies in the United States, and that the rest should remain on GAAP. Why is that?
We have to look at this as essentially a cost-benefit issue. Companies that have substantial subsidiaries overseas — this would be true of IBM, Hewlett-Packard, General Electric — are already doing financial statements in IFRS in other countries. They have a real interest in being on one uniform standard, they’re probably spending all or most of the money [for conversion] already, and they get a substantial benefit out of it.
But if you look at the number of companies that really have significant operating subsidiaries — I’m not talking about sales, I’m talking about operating subsidiaries — if you go beyond the top 300 companies, you really have a very small number of companies. What’s the market cap of the last 100 in the S&P 500? It’s actually in the $2–$3 billion range. Those aren’t really big companies.