How To Restore Faith In The Ratings

October 26, 2009 by · Leave a Comment
Filed under: The Ratings System 

The three rating agencies have proposed a number of significant changes to improve the reliability of their ratings. They have also agreed to go along with a number of measures pushed on them by the SEC and the Obama administration to increase government oversight, eliminate “ratings shopping” and to bring more transparency to how ratings are achieved.

These are all welcome, but investors can’t be blamed if they are still anxious. These steps will do nothing to change what is a potenitally flawed business model. The rating agencies are conflicted because they are paid by the issuers of the bonds they are hired to rate.

It would seem to be far more logical and objective for the investment community, the ones who use the ratings,  to be those who actually pay for the ratings. To restore trust in their ratings, agencies need to completely divorce themselves from issuers. Until then the specter of conflict of interest will cloud every AAA rating with the suspicion that the rating is due more to a generous fee than an objective opinion of the investment.

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