In a previous post, I detailed how the U.S. ratings agencies (S&P and Moody's) played a key role in making the U.S. mortgage problem a global credit crisis. The Wall Street Journal reported today on documents released at a hearing yesterday of the U.S. House Oversight and Government Reform committee showing that executives at the companies knew their ratings were too high. Rather than SEC regulation of ratings agencies, someone should see an opening in the market and start up a ratings shop.
Ratings agencies in the U.S. and abroad are for-profit businesses.
Everyone knows this. Putting things in their best light, Wednesday's
hearing revealed negligence and poor management on the part of the U.S.
ratings agencies. In their worst light, the hearings revealed the
possibility of widespread fraud. An instant-message conversation
between two S&P employees was recorded as follows:
Rahul Dilip Shah: "btw--that deal is ridiculous"
Shannon Mooney: "I know right... model def does not capture half of the risk"
Shah: "we should not be rating it"
Mooney: "it could be structured by cows and we would rate it"
Shah: "but there's a lot of risk associated with it--I personally do not feel comfy signing off as a committee member"
As a caveat, it is not clear what deal the two were discussing in the message. Nor are the motives clear of Mr. Shah who comes out looking clean as a whistle in this exchange. But it does present some evidence of the well known conflicts of interest that can compromise for-profit ratings agencies. The response of Congress will almost certainly be more oversight of the ratings agencies. But a better response would be to let the market for good ratings encourage entrants.
S&P and Moody's are now scrambling to try and restore confidence in their product. This leaves a gap in the market for international ratings. The bias in ratings that arise from profit-motive conflicts of interest is counteracted by multiple competitors in the market that supplies ratings. S&P will be less likely to fudge ratings if they know that four other agencies are ready to do a better job than them.
Rahul Dilip Shah: "btw--that deal is ridiculous"
Shannon Mooney: "I know right... model def does not capture half of the risk"
Shah: "we should not be rating it"
Mooney: "it could be structured by cows and we would rate it"
Shah: "but there's a lot of risk associated with it--I personally do not feel comfy signing off as a committee member"
As a caveat, it is not clear what deal the two were discussing in the message. Nor are the motives clear of Mr. Shah who comes out looking clean as a whistle in this exchange. But it does present some evidence of the well known conflicts of interest that can compromise for-profit ratings agencies. The response of Congress will almost certainly be more oversight of the ratings agencies. But a better response would be to let the market for good ratings encourage entrants.
S&P and Moody's are now scrambling to try and restore confidence in their product. This leaves a gap in the market for international ratings. The bias in ratings that arise from profit-motive conflicts of interest is counteracted by multiple competitors in the market that supplies ratings. S&P will be less likely to fudge ratings if they know that four other agencies are ready to do a better job than them.
Rick -
Fine points all around, chap.
However, it does beg the question:why hasn't one popped up already?
That is, why weren't there any competitors to begin with?
I don't know know much (ok, nothing) about the ratings business, but my guess would be that the fixed costs of starting such a business are substantial.
You've got to (1) obtain all the information to rate these products and (2) develop a reputation for having good ratings. Both of these are non-trivial costs, but perhaps you're right in that the drop in Moody's and S&P's rep is enough to induce entry.
My sense is that you might find smaller houses that crop up for specific products. Perhaps a company that knows a lot about certain types of assets (for example: mortgage backed securities) would rate them and nothing else.