The Credit Ratings Scandal

The international credit ratings agencies (Moody's, S&P, Fitch's, etc.) are the financial world's eyes and ears. Now, it turns out they were sending the wrong signals to its brain.

The top three ratings agencies of the world, Moody's, S&P, and Fitch's, have done the investing world a huge disservice by taking payments from the very entities whose credit worthiness they propose to rate.

Ratings News: Credit Agencies Under Review for Downgrade December 1, 2008 US Credit Agencies Sued for Underrating Munis August 1, 2008 Moody's Now Backtracks on Claims of Innocence May 28, 2008 Ratings Agencies to Face Tougher Industry Code May 28, 2008 ... but still no sign of official recognition that the built-in conflict of interest is the real problem. Bernanke Blames Ratings Agencies for Credit Crunch April 11, 2008 Interesting that he never blames himself. Ratings Agency Under Review March 22, 2008 The SEC is now looking at "conflicts of interest". Ha! Moody's, Fitch, Bow to Customer's Demands March 21, 2008 A perfect example of the evil of ratings agencies accepting money from the entities they rate. Moody's, S&P, Delay Cuts on AAA Subprime Debt Bloomberg, 03-11-08 Moody's Warns of States' Woes Bloomberg 2-14-08 Moody's Cuts FGIC Houston Chronicle 2-14-08

That creates a serious conflict of interest, to say the least. Current attempts by international regulating bodies to change the way these ratings agencies do business merely fudge around the edges. For example, one proposal includes creating an "ombudsman" position who will listen to "complaints" about how these agencies hand out tripel A ratings. Needless to say, that after the fact window-dressing will not solve the problem.

Here is an article that lays out the basic problem in stark, but realistic, colors.

The following is a blog entry from the Common Sense Forecaster that provides valuable background on the - so far useless - efforts to fix the problem.

There is another issue on top of all this. A good argument can be made that municipal government's credit ratings should be far higher than they are because their bonds are such safe investments (on average, corporatye bonds have a 94 percent higher default risk than muni-bonds). But the "big three" ratings agencies won't play ball.

The question is: Why not?

The answer may be that the big three bond insurers who are all top customers of the big three ratings agencies won't need to insure the muni-governments then - but that would mean they won't be able to charge the governments hefty fees for their insurance, thus lowering the bond insurers' profitability.

And since the "big three" bond insurers are such good customers of the "big three" ratings companies, they may have some leverage on whether the ratings agencies will agree to issue these desired higher ratings or not.

... and the conflict of interest strikes again.

This is all just speculation on my part, of course. Yet, it at least provides a reasonable explanation why the ratings agencies won't raise the ratings of the muni-governments, which would otherwise have to remain unexplained - or maybe even inexplicable.