Friday, December 5, 2008

When in Doubt, Rate It AAA

Jon Cole makes a point that has been on my mind frequently.

Lots of people have lost their collective asses, lots of business and banks have gone under, the federal government (you and me) is spending trillions to shore up this sector of the economy to avert total collapse, corporate CEO’s are being bashed every day in the media and on blogs, everyone hates Wall Street, but as far as I can tell, one group of people has gotten away with their perfidy- the credit ratings companies. Why is Moody’s still in business? Fitch? Standard & Poor? Why are any of them?

A commenter hit on a major problem.

There is an inherent conflict of interest here: the ratings agencies are paid by the financial companies to rate things. Gee, I wonder why all of a sudden the ratings are all spectacular? What are they supposed to say? "Gee, Goldman, I think your CDO sucks and I’m going to rate it junk. But I hope that this doesn’t harm our business relationship, and I really hope you won’t take your ratings business elsewhere. Okay?"

Combine that with the difficulty in figuring out complex financial instruments and the tendency apparently was to just give them a good rating and hope for the best.

I agree with the commenters that the SEC should assume this task. Get some bailout money to nationalize the rating agencies or set up something new to rate securities. Further, if they can't understand a security, they should refuse to rate it or rate it "unknown risk". Moneychangers would yell, but they would be forced to pay attention to what they're trying to peddle.

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