Academic

American financial reform doesn't permit regulators to regulate through the credit rating agencies (by discounting capital with reference to bond ratings, for example).  That hasn't appeared to bother the SEC's oversight of money market funds - they are still looking to the credit rating agencies - as William Birdthistle could tell you.  But it has created some other problems.  Basel III requires a risk assessment of the quality of the capital held by banks.  So I guess the Fed has to come up with its own models?  Regulate with an arbitrary bucket discounting of various types of debt, a la Basel I?

The inability to find a solution and the looming deadline is ?a source of a great deal of concern,? says Karen Petrou, executive director of Federal Financial Analytics, a Washington consultancy on regulation. ?The agencies are informally admitting that they are stumped. But the deadline is only six months away, so something has got to happen. The law is very clear. It says there may be no reference to ratings,? she adds. ?We are going to have a hell of a time with the Basel III rules because of the way ratings are still embedded in them,? Petrou reckons, referring to the capital and liquidity standards hammered out by Basel Committee regulators last year, and published in mid-December.

Seems like this is the opportunity to reference those credit default spreads everyone (Lehman's were soaring before its disappearance while its rating remained solidly in the A range) is talking about - but that would mean that the US would be using an untested version of capital adequacy that differs entirely from that of the rest of the world.  It's a really interesting problem.