“Just like a credit rating any regulation or reform [of ratings agencies] should be based on the evidence” says a leader in Tuesday’s FT.
Ratings agencies such as Moody’s, Standard & Poor’s and Fitch are being charged with being idiots that misunderstood the risks of structured financial products at one end of the scale, or purposely overrating bonds to secure bigger profits at the other.
However, it is important to be clear about their involvement: yes, they have been forced downgrade bond after shoddy bond, but that is not to say that they made a mistake in the first place, says the FT.
Firstly, ratings are affected by market value and there is no guarantee that they will remain static. Furthermore the rating denotes the likelihood of an outcome, not a guarantee. Admittedly triple-A rated bonds are supposedly the safest, but you can’t compare government bonds to Bob’s mortgage backed flea market bonds, which is what the triple-A rating given to both implies.
The ratings were probably wrong – but they were certainly misleading.
Secondly, there is the question of data. Given that there was a relatively small amount of data and the sharp increase in subprime defaults, did the ratings agencies use all available information responsibly? It seems unlikely that any regulatory body would have made a better call…
So potentially regulators should look at how ratings are presented, but more serious is the charge that credit ratings are distorted by the fundamental conflict of interests. If that is the case the leader suggests that…
A better option would be for issuers to pay into an independently managed pool, which would then assign a rating agency, thus breaking the commercial incentive to rate bonds high.