A Better Ratings System Is Just A Start

August 31, 2009 by · Leave a Comment
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Creating a new rating system for multiple obligor securities is a good idea. There is broad agreement that structured products like bundled mortgage-backed securities need to be rated on a scale that provides for a greater degree of precision to more accurately evaluate their risk. The A-B-C system that has been used for generations to rate single obligor securities is simply too coarse a measure.

 But it is incorrect to concentrate the argument solely on the need for a more robust rating scale.

There is plenty of anecdotal evidence — and possibly now even testimony — that bears out that regardless of how makeshift the measures being applied may have been, they were inappropriately applied. Even fraudulently applied.

Structured securities that analysts at ratings firms like Moody’s, S&P and Fitch either knew to be of questionable value or had no ability to accurately evaluate were getting rated A1, A+, AA and higher. This is the problem. Changing the rating system, although necessary, won’t protect investors from its intentional or unintentional misapplication.

Were the inflated ratings due to conflicts of interest? Lack of oversight from a depleted regulatory community? Or the simple inability of analysts to keep up with the volume of business? These are the questions that need answers.

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