Why Did We Put Ratings Agencies' Ratings Into The Law?

from the good-questions... dept

Problems and potential conflicts coming from the bond ratings agencies were well-known well before our financial crisis hit, but still many are pointing the blame finger at those ratings agencies. And, it's certainly tempting to do so. Just as with the famed financial analysts during the late 90s tech boom, the credit agencies appear to have rated certain debt offerings very highly, despite recognizing how intrinsically risky the investments were. Given what happened following the dot com bubble collapse, it's quite likely that the bond rating agencies Moody's and S&P will get slapped down for their "mistakes."

But that would be a mistake. Both Moody's and S&P were merely expressing an opinion on the credit-worthiness and risk of the various debt offerings. An opinion should never be considered illegal by itself. The problem was that people started relying on these opinions as if they were factual realities. And who's to blame for that?

Well, in part, it's the government -- which wrote the rating agencies' ratings into law, requiring certain regulated institutions to maintain a certain percentage of "highly rated" bonds in order to engage in certain activities. That made it so the real focus was on the opinions of Moody's and the S&P, rather than on what investors believed the actual risk was on those bonds. As the link here notes, why not let the market decide what the actual risk is on these bonds, rather than trusting the (somewhat questionable) opinions of individuals who are biased and conflicted?
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Filed Under: ratings agencies, regulations
Companies: moody's, s&p

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  1. identicon
    Josh, 6 Jan 2009 @ 8:38am


    Gonna disagree with you, Mike. The ratings agencies do need to be held (at least partially) responsible. Here's why. Despite being a private company, the ratings agencies are heavily regulated, as is the entire financial sector. Most people know that a broker needs to pass the Series 7 tests - but most don't know what they are. They are in fact, government (via the SEC) certifications. There are similar tests for financial planners, compliance officers, etc. You can't take these tests as an individual - you have to be sponsored by a company. Those companies are assuring the government that the people performing those jobs are being honest and are properly supervised with adequate oversight. And thus the companies are assuming the risk that if they screw up, they will be fined. The companies take that risk in order to make money - that is their business model!

    The government should be held partially responsible, since I think it was a lack of regulation (again the SEC) that allowed the companies to get away with this for so long. But just because there isn't a cop watching, doesn't mean that running that red light is legal - or safe - or you shouldn't get in trouble if you cause an accident by doing it.

    There is enough blame to go around and the ratings agencies should get their fair share.

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