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Commentary

It’s the Rating Agencies.

Bloomberg has an interesting article on how rating agencies did a considerable amount of damage by not being quite honest with rating, creating the current crisis.

Relying on a competitor’s analysis was one of a series of shortcuts that undermined credit grades issued by S&P and rival Moody’s Corp., according to Raiter. Flawed AAA ratings on mortgage-backed securities that turned to junk now lie at the root of the world financial system’s biggest crisis since the Great Depression, according to Raiter and more than 50 former ratings professionals, investment bankers, academics and consultants.

“I view the ratings agencies as one of the key culprits,” says Joseph Stiglitz, 65, the Nobel laureate economist at Columbia University in New York. “They were the party that performed that alchemy that converted the securities from F- rated to A-rated. The banks could not have done what they did without the complicity of the ratings agencies.”

The rating agencies – S&P, Moody’s and Fitch at the top end – are supposed to be honest. But they will defend themselves saying they only provide an opinion – which is protected by the first amendment.

Yet, their rating is important in a number of cases – putting up collateral, or finding funding, or debt insurance and even mandatory minimums for public funds. They are not only opinion, they influence a lot of capital. A very strict regulatory regime is required – that they demonstrate their research into ratings, the amount of money they earn, the way they deduce the rating and how they track every factor. Either ratings must be standardised across industries, municipalities etc. or there should be a complete ban on linking any capital (collateral, interest rate etc.) to a rating. And then anyone should be able to rate – i.e. the data used to rate must be made completely public. So if some rating agency decides to independently rate something they must have complete access.

This will kill the business. And this business, as it’s run today, needs to die. They have lost our trust. From now on, we should be free to ignore them.

Still, they were only part of the problem. This was bank greed, lack of regulation, homeowner greed etc. which were as guilty. The problem wasn’t only the rating – the problem was that we trusted a rating, that we based decisions on it. Even that has got to change.