Diagnosing the failures that created the financial crisis is a lot easier than fixing them. Credit rating agencies are just one example. The conflicts of interest inherent in their business models have been clear for years. Remember Enron, Worldcom, and Global Crossing? They each enjoyed investment grade ratings until just before going bankrupt.
Investors rely on credit rating agencies to give an objective assessment of the risk a security will fail. In the case of pensions and mutual funds (like money markets), a AAA rating is a requirement for investment. Credit rating agencies -- namely Standard and Poor’s, Moody’s and Fitch -- earn fees from the companies that issue the paper they rate. This gives issuers an incentive to shop around for the agency who will give the most favorable rating. At the same time, that gives the agencies an incentive to issue a favorable rating.
Legislation was passed in the wake of Enron. The Credit Rating Agencies Reform Act of 2006 aimed to open up competition in the market. The Securities and Exchange Commission gave more firms its blessing, giving them the National Recognized Statistical Rating Organization (or NRSRO) designation. The Commission is also trying to open up the standards the agencies use so investors can judge for themselves.
Clearly, more regulation is on the way. The European Commission today laid out new regulations for credit rating agencies, including holding them liable for their opinions and banning them from consulting with banks on how to get their issues top ratings.
For more on this, check out our "Fixing the Financial Crisis" series airing this week.
Comments
I know that recession are part of the economic cycle, but the new investment vehicles that credit rating firms have created and advocate is nothing but pure greed. Someone needs to be punished by giving back the profit that was made. America is not a socialist country, but criminal action must be punished to preserve the common good.
If congress also helps the auto industry, then auto executives, labor, and retirees must work out an agreement with congress.
It is going to have to be give and take with sacrifice for all because the U.S. taxpayers are going to have to sacrifice.
A recession is like the flu. If it doesn't kill you, eventually you will get better. On the other hand, most of time the flu won't kill you but it will make so sick that you wish that it would.
Whenever a rating agency is paid… it will always create favoritism for one over the other. Just to keep itself open. Sounds a little like the mortgage market (appraisals) doesn’t it.
the guilty and the incompetent are not being punished and punishment must be part of the solution. I'm not in the merchant of venice, I want that pound of flesh and I don't care how much blood is spilled. Throw sand and saw dust on it like they used to do on wooden warships...