The Senate on Thursday took steps to overhaul the credit-rating agency business, widely maligned for its role in the 2007-2009 financial crisis, and opening it up to greater competition.

One amendment to a landmark Wall Street reform bill, from Democratic Senator Al Franken, would set up a government clearinghouse to assign debt rating duties to agencies. The other requires federal regulators to develop their own standards of credit-worthiness rather than rely solely on assessments from credit rating agencies, including the Big Three: Moody's Corp, Standard & Poor's and Fitch Ratings.

The Franken amendment could ease pressures the agencies face to assign overly rosy ratings to debt instruments issued by firms that hire the agencies, its backers said.

There is a staggering conflict of interest facing the credit rating industry, Franken said on the Senate floor.

The plan could bring more competition to ratings, said Bill Bergman, an analyst with Morningstar Inc.

This is a big step ... it seems the doors are open for greater entry into the industry, he said.

Shares of Moody's closed down 2.6 percent after the votes, and Standard & Poor's parent McGraw-Hill Cos fell 2.4 percent on broadly lower trading across the New York Stock Exchange.

The Franken amendment could reduce competition and innovation, said Standard & Poor's spokesman Chris Atkins.

This could lead to more homogenized rating opinions and, ultimately, deprive investors of valuable, differentiated opinions on credit risk, he said in a statement.

Most important, having the rating agency assigned by a third party, whether the government or its designee, could lead investors to believe the resulting ratings were endorsed by the government, thereby encouraging over-reliance on the ratings.

Franken's amendment was approved in a 64 to 35 vote over the objections of Senator Christopher Dodd, the Democratic author of the sprawling bill, which is widely expected to win final approval in the Senate as soon as next week.

Dodd said the Franken proposal had merit but needed more study to prevent any unintended consequences.

A related amendment, from Republican Senator George LeMieux, was also approved, by a 61 to 38 vote. It would require regulators like the Federal Deposit Insurance Corp to develop their own standards of credit-worthiness rather than rely solely on credit rating agencies' assessments.

VOTES MOVE BILL FORWARD

Both votes were steps forward for legislation that promises to be the biggest overhaul of financial regulation since the Great Depression. President Barack Obama is a strong advocate of tighter rules for banks and capital markets.

A parallel crackdown is under way in the European Union, with banks and financial firms bracing for changes on both sides of the Atlantic that look likely to pinch their profits, risk-taking ability and growth potential for years to come.

The Senate on Thursday also rejected an amendment that called for steering troubled financial giants toward bankruptcy, rather than a new process in which government regulators seize and dismantle the distressed firms.

By a vote of 42 to 58, the Senate rejected the proposal from Republican Senator Jeff Sessions.

Dodd's regulation bill already included a provision on credit rating agencies. It would boost the U.S. Securities and Exchange Commission's power to police the agencies. But critics said it did little to address a basic conflict of interest in the agencies' issuer-pays business model.

Bergman said it was not entirely clear that the Franken plan would address the industry's problems. A government body that makes calls on who should or shouldn't be a rating agency, that's not necessarily a cure, he said.

Howard Simons, a strategist with Bianco Research in Chicago, criticized the Franken amendment, saying the rating agencies would always adopt a herd mentality. A government board, he said, does not fix that.

In the run-up to the financial crisis, with real estate prices peaking, agencies assigned high ratings to complex debt instruments issued by banks -- such as collateralized debt obligations, or CDOs -- backed by subprime mortgages.

Those ratings proved to be misguided. When housing prices fell sharply, the ratings were abruptly downgraded, which critics said aggravated a crisis that paralyzed capital markets and tipped the U.S. economy into a deep recession.

The massive U.S. taxpayer bailouts of Wall Street that followed unleashed a wave of reform proposals worldwide and a political backlash that is still rolling through Washington.

FRANKEN PLAN SETS UP BOARD

The Franken plan would set up a board that would assign one agency to evaluate each newly issued asset-backed security.

The board would be made up of at least four investors, at least one issuer representative, at least one rating agency representative, and at least one independent member.

Issuers could hire additional agencies for more ratings if they wanted to. Rating agencies already recognized by the SEC could apply to become qualified to rate various types of asset-backed securities. Once approved, they would be pseudo-randomly assigned deals, said a summary of the plan.

Selection should take into account track records. So the better the rating agency's past performance, the more deals it will get in the future, said the summary.

Martin Weiss, chairman of small rating agency Weiss Ratings, said the Franken and LeMieux amendments could help in breaking up the big three oligopoly in the ratings industry.

He added: With a wider variety of voices and opinions, no single rating agency would have nearly as much impact on a company, making it more possible for rating agencies to act as unbiased analysts, issuing downgrades more promptly and based exclusively on the merits.

Another amendment to the Senate bill in line for debate and a vote would restrain credit card interchange fees charged to supermarkets, convenience stores and many other merchants by lenders every time a customer uses a credit card.

Senator Richard Durbin, the Senate's No. 2 Democrat, wants to restrain the fees -- a proposal of concern to banks and card firms like Visa Inc and MasterCard Inc. Those fees totaled $48 billion in 2008, up from $42 billion in 2007.

Durbin wants to let merchants give discounts to customers who use one type of credit card over another, or who pay by cash or some means other than a credit card. Retailers could also set minimum purchase levels for using a credit card.

Federal Reserve Chairman Ben Bernanke said on Thursday he was concerned about part of the Senate bill that could force banks to spin off their swaps business.

Bernanke wrote in a letter obtained by Reuters that he was concerned this could make the system less resilient and move banks' derivatives activities away from federal oversight.

(Additional reporting by Rachelle Younglai, with Joe Rauch in Charlotte, N.C., and John Parry in New York; Editing by Dan Grebler)

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