Shopping for Ratings

Good piece from the WSJ on how things have changed…or not…with regard to the conflict of interest that exists when the issuers are the ones that pay the fees of the rating agencies.  Whether ratings shopping, biases, etc. actually exist or not, the perception and possibility of this sort of behavior will always be present as long as the issuer pay system prevails.  A user pay system – where investors fit the bill for the ratings they use, not the issuer – removes all possibilities of this type of conduct. But is it viable as a commercial enterprise?

‘Ratings Shopping’ Lives as Congress Debates a Fix – Wall Street Journal, May 24, 2010

S & P President’s Letter to the Editor

Interesting commentary from Deven Sharma, president of Standard and Poor’s.  Say what you will about the rating agencies and their role in contributing to the credit crisis (we would agree with much of the finger pointing, although certainly not all of the blame goes to them), but he makes some good points about the REASON ratings should be used.  More specifically, he makes the case that ratings should be used because the market finds value in them, not because government / regulatory language mandates it.  Given the events of the past two years, institutions should be decreasing, not increasing, their reliance on ratings.  And they should certainly have the choice to do so.  Anything else, such as government mandated reliance on third-party ratings, presents a prime opportunity for poor assessment of the true value of securities (“market value” becomes misaligned with true economic value) – overstating market value when a security gets a “clean” bill of health and understating it when a security is downgraded to “junk” status.  This again highlights the issue of why marking-to-market does not always represent true economic value for investors.  Third-party ratings are a pervasive reason this misalignment exists!  Check out some of the resources on this website to learn more about this disconnect and how third-party ratings contribute to it.

Why Rating Requirements Don’t Make Sense – StandardandPoors.com, January 19, 2010

Will New Ratings Reforms Be Effective?

The attached article talks about how the House recently made extensive progress towards eliminating all language from both laws and financial regulation rules that references rating agencies (NRSROs).  The “system” will no longer depend on such agencies.  These are the first steps of progress towards reform and are commendable.  However, the real wood that needs to be chopped is determining what the new system will look like when it no longer relies on the agencies.  This new system must consider many factors, but to ultimately be effective it must lead us to an economic value attached to the assets that are rated versus the simple “good” vs. “toxic” diagnosis that we currently have.

Here is the article:

One Cheer For Barney Frank – WSJ.com, December 23, 2009

A New Player in the Game

This is an interesting development in the evolution/restructuring of the credit rating infrastructure!  We have a NEW player now that will provide ratings – on a limited basis to start out – but they will NOT be charging the companies that they rate.  This removes the conflict of interest that has potentially been a source of so many problems and could lead the other, larger rating agencies to eventually follow the same model.

Morningstar Enters the Credit-Rating Game – Los Angeles Times, December 2, 2009

Breaking Away

The rating agencies are slowly showing more signs of independence, as well as analytical leadership.  Not just with regards to ratings securities, but in evaluating financial institutions and their macro risks.  They may not be making new friends in the process, but this tension is necessary and more of it will help keep things in check!

Credit-Ratings Firms Show Some Independence – WSJ.com, November 29, 2009