Thursday, October 1, 2009

Ratings Agencies

This article, in my opinion, misses one major point:
 
The notion that you can just disband the ratings agencies implies that there is some better way of doing things than relying on them. AAA doesn't mean completely safe, it means lowest risk. People make mistakes. Say what you like about Moody's, Fitch and S+P, but they are no worse than any other institution that rates securities and publicizes their findings - in fact, given how bad most public raters are, they're probably the best we can do.

The big problem is that anyone with a talent for rating securities will make a lot more using that talent on the buy side - to operate a hedge fund or mutual fund, or invest money, than they will for telling people about it. There is no easy quantitative method for rating securities that doesn't require human discretion. So while the NRSROs have plenty of problems, the solution isn't to disband them for a worse alternative, it's to help people understand that they're not guaranteed ratings - everything has risk.
 
The notion that they can be sued for bad ratings is thus appalling to me. If they had material information and chose to not publish it, that's different, that's misleading, and I understand that the corporate culture at these places, as well as the way in which the companies are paid, very much incentivize telling people what they want to hear instead of what they need to hear. But if they just made bad decisions, not dishonest ones, suing them isn't really reasonable.

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