Ratings Agencies: Too Big to Fail Too?

By James Kwak

I would have thought that the credit rating agencies would be at least one group that everyone could agree to throw under the bus. We know that the powerful chieftains of Wall Street are trying to pin the credit crisis on rating agencies – see page 3 of JPMorgan’s (JPM) blame-shifting attempt, for example. Yet the new Financial Regulatory Reform plan has almost nothing on the subject. Apparently the rating agencies, too, are Too Big to Fail.

Reuters catalogs the provisions relating to the rating agencies. Here’s the summary:

The plan urges Moody’s Corp’s (MCO) Moody’s Investors Service, McGraw-Hill Cos Inc’ (MHP) Standard & Poor’s and Fimalac SA’s Fitch Ratings and others to bolster the integrity of their ratings, especially in structured finance.

It also calls for reduced conflicts of interest and for regulators worldwide to tighten oversight.

But the blueprint does nothing to address what critics call the industry’s key shortcoming: That the biggest agencies are paid by issuers whose securities they rate, creating an incentive to win more business by assigning high ratings. . . .

“The overall impact of existing and proposed regulatory changes on rating agencies is extraordinarily easy to summarize: They reward abject failure,” said Jonathan Macey, deputy dean of Yale Law School.

Also see the Huffington Post, which has this understated but damning criticism:

“Today, the agencies welcome the government proposals, saying that they favored improved ratings quality and transparency.”

Perhaps this is one area where Congress can improve on the administration’s plan.

Update: Krugman:

The plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.

Comments

[Clive Corcoran:]

I am sure that you are right to suggest that their "key shortcoming" is the fact that they "are paid by issuers whose securities they rate, creating an incentive to win more business by assigning high ratings. . ."
Just one other tiny problem is that they had no reliable methodology to measure the risks of a CDO defaulting.

Jun 19 01:52 PM

[Larry House:]

I don't know if they are too big to fail, but they sure have been too wrong to be believed. We can't even trust the rating agencies to give us the truth!

Jun 19 04:46 PM

[Harry Tuttle:]

The agencies were setup to rate primary credits (i.e. bonds issued by companies and municipalities). Thus, they should not be allowed to rate anything else. Yes, I know this means little growth. Pity.

Jun 20 11:42 AM

[TinyTim:]

credit rating agencies are captive to their clients, just like accounting / auditing firms. Terrible conflict of interest.

"credit rating agencies would be at least one group that everyone could agree to throw under the bus."
You have to wonder why this isn't happening.

"willingness to give a seal of approval to dubious securities"
the question is did they realize the securities were dubious? did they take it on faith that they were OK? Did they not bother to investigate? Were the securities too complex for them to get their brains around?

Jun 20 02:44 PM

[dcb:]

The government needs the rating agencies to legitimize the scam they are pulling on the american public. They won't change them very much and they will be expected to play along in transferring the liabilities of the bankers on to the american public. The players will once more be allowed to ruin the economy while making themselves rich (the "hush" money). Except this time we will not have a banking collapse we will have a currency crisis and a national debt collapse. But this who have played along will have enough money so it will not matter to them.

Jun 21 10:56 AM

[dcb:]

when will the baseline scenario start to have the balls to actually come out and say what they heave been saying in a small way in each and every article. The agent of change "Obama", isn't. He is full of sh.... and pulling a fast one on the american public. I hate to say it, but the press, so determined not to be offensive or to editorialize, isn't doing a favor to the american people. they get their news for 30 minutes at 6PM. with 15 minutes local, 5 minutes weather, 5 minutes sports, the rest national. don't forget (commercials take up another 5 Minutes). The nice language helps to hide what is really going on and in fact just serves the interests of our government. It doesn't stir up the people and get them angry which is what has to happen if we are going to have any effective government action.

Jun 21 11:05 AM

[dcb:]

I went to my MBA class graduation yesterday. Most of them really have no clue what is actually happening in washington. they have more immediate concerns and it takes a huge amount of work to know what is happening. they press doesn't come out and state in a clear manner what is going on. If the elites/educated of this country do not see it, then how can you expect the masses to get it. so I ask and beg the press to stop being polite and make sure you get your message to the masses. We got hoodwinked with WMD in Iraq and most american's thinking Iraq had a role in 9/11 because they press didn't do their job effectively. The same thing is happening now, and it shows media has failed to reform itself as well when faced with a systemic failure. so get out there!!!!!!

Jun 21 11:13 AM