Hip Deep In Trouble?

State insurance commissioners have a right to be angry that twice in recent memory, they have been handed a big mess—troubled bond insurers and A.I.G. But I wonder if the biggest mess they face awaits if they wade hip deep into the rating game.

The rating agency “E” working group of the National Association of Insurance Commissioners, Kansas City, Mo., just concluded its second public hearing examining reasons for recent rating shortcomings, including municipal bond ratings. It is one of several reviews planned prior to presenting its findings to the NAIC and possibly (more like probably) to Washington. The NAIC also announced on Nov. 17 that it has selected PIMCO as a financial modeler to help regulators determine risk-based capital requirements for RMBS.

One of the panelists said that if regulators decide to put less reliance on rating agencies, there is no need to change the system that currently exists. That’s a thought worth holding on to. Reinventing the wheel is costly and time consuming, even if there is plenty of talent among regulators and the staff of the Securities Valuation Office.

The complexities of rating residential mortgage-backed securities and the heat it has caused the rating agencies offer a cautionary tale. Now granted, a part of that tale is a certain laxness that existed in rating these complex securities as well as a lack of logic. It didn’t take a financial modeler to figure out that a lot of people who shouldn’t be getting mortgages were and eventually reality catches up, in this case with investors including insurers who hold these securities.

But it also doesn’t take a financial modeler to determine that if the NAIC, in its final report, actually does decide to take the plunge into ratings, that it is a tremendous commitment of resources. I wonder if what they are wading into is quick sand where the rating agencies are currently mired.