Berating the Rating Agencies
Posted on June 16, 2010
Filed Under The Economic SceneMost of the public knows, or think they know, who or what caused the 2008 financial collapse. The usual suspects are the mortgage companies, lax regulations, and banks and financial institutions that used Wall Street like a casino.
But to my mind, other villains deserve equal scorn. Or more.
The major credit ratings firms – Moody’s, Standard & Poor’s, and Fitch – all gave their stamp of approval to smelly piles of toxic crap.
Those three are big names in the industry. They are powerful, profitable and protected. But they got so much wrong, for so very long. In case after sorry case, they gave their triple-A blessings to sub-prime junk, and that, in great part, set up the financial chasm of 2008.
But what especially riles me is the fact that in most cases the banks and companies that issued the securities that need to be rated, pay for the rating! It’s as if MGM and Warner Brothers paid Time magazine to review their movies!
If that were the case, wouldn’t the movie studies shift their business to those reviewers who gave them the best reviews? Doesn’t that seem like a conflict of interest?
Of course it does!
The credit raters deny having their judgment skewed by those payments.
Of course they do.
From our perspective, it would be as if Morningstar got paid by mutual funds for the star ratings it awards. That would be immediately shouted down by the investing public, because mutual funds live in an open tank. Not so the world of the big three rating agencies. Transparency is not part of their business model.
There are several good proposals in Congress that aim to fix this self-serving rating problem. One interesting idea is for an impartial unit to arbitrarily, and somewhat randomly, assign different agencies to rate new issues.
Open and fair markets need objective, untainted advice. Let’s hope some of those proposals pass.
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