June 14, 2013
Along with raindrops on roses and whiskers on kittens, reforming Government-Sponsored Enterprises and rationalizing rating agency regulation are two of my favorite things. The Federal Housing Finance Agency noticed a proposed rulemaking to remove some of the references to credit ratings from Federal Home Loan Bank regulations. This is part of a broader mandate contained in Dodd Frank (specifically, section 939A) to reduce the regulatory privilege that the rating agencies had accumulated over the years. This regulatory privilege resulted from the rampant reliance of ratings from Nationally Recognized Statistical Rating Organizations (mostly S&P, Moody’s and Fitch) in regulations concerning financial institutions and financial products.
The proposed new definition of “investment quality” reads as follows:
Investment quality means a determination made by the Bank with respect to a security or obligation that based on documented analysis,including consideration of the sources for repayment on the security or obligation:
(1) There is adequate financial backing so that full and timely payment of principal and interest on such security or obligation is expected; and
(2) There is minimal risk that that timely payment of principal or interest would not occur because of adverse changes in economic and financial conditions during the projected life of the security or obligation. (30790)
The FHFA expects that such a definition will preclude the FHLBs from relying “principally” on an NRSRO “rating or third party analysis.” (30787)
This definition does not blaze a new path for the purposes of Dodd Frank section 939A as it is in line with similar rulemakings by the NCUA, FDIC and OCC. But it does the trick of reducing the unthinking reliance on ratings by NRSROs for FHLBs. Forcing financial institutions to “apply internal analytic standards and criteria to determine the credit quality of a security or obligation” has to be a good thing as it should push them to look at more than just a credit rating to make their iinvestment decisions. (30784) This is not to say that we will avoid bubbles as a result of this proposed rule, but it will force FHLBs to take more responsibility for their decisions and be able to document their decision-making process, which should be at least a bit helpful when markets become frothy once again.
When the cycle turns, when greed sings
When I’m feeling sad,
I simply remember
my favorite things
and then I don’t feel so bad!