Ours is an era of unmasking: many a former emperor is now seen to be naked. The same fate has befallen the big three credit rating agencies, whose deeply flawed ratings were exposed when the US housing bubble burst. We cannot live with their current practices, but nor can we live without them; their function – assessing the risk of securities – is indispensable. Reform is essential.
Ratings agencies are paid by issuers of securities and not by those who invest in them. They have traded their independence to chase the lucrative business of rating asset-backed securities which came to market in the last decade. Moody’s earnings rose so high, for example, that its profit margin beat that of all other S&P 500 companies.
It is easy to blame investors for blindly trusting the agencies; many let greed or naivety get the better of them. But even the most circumspect could not have avoided the big three. US law enshrines these state-sanctioned oligopolists’ status as “nationally recognised statistical rating organisations”. Various other rules, such as the Basel II framework, refer to ratings to define capital adequacy or the type of securities investment funds may hold.
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