Credit rating agencies looking for more bubble wrap

Bubble Wrap

Image by ArtByChrysti via Flickr

The quest to fix the credit rating agencies continues on Capitol Hill today and the credit rating agencies are responding the only way they know how — by wrapping themselves in more bubble wrap. The agencies are in a state of deep denial over their role in the credit market meltdown and have shown virtually no remorse — except the remorse of someone who hates to get punished.

Today, Stephen W. Joynt, CEO, Fitch Ratings, has the gall to say in  testimony before the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises that more competition among the rating agencies should de facto result in “a better work product.” But the rating agencies do not operate in a normal competitive environment. Unlike most arenas, the greater the competition the worse the so-called work product in ratings-land. Economist Umair Haque has a chart on that.

The reasons for the upside down relationship on competition are several: First, the debt issuers pay for the ratings and can therefore shop for the best rating. The more places to shop among, the more likely they are to find what they are looking for. The system is set up to degrade ratings — to wit, subprime mortgages masquerading as triple-A investments. Second, by law (!) rating agencies are protected from any real liability for their ratings. Third, they take a “not my responsibility” attitude toward their work. One of the more shocking details to emerge from the mortgage securities fiasco was the willful ignorance of the rating agencies: They didn’t even conduct random checks on the loans backing complex mortgage products to see if they had been properly underwritten. And Joynt continues to assert that checking debt offerings for their integrity just isn’t and shouldn’t be on the credit rating agency to-do list.

At least one other expert testifying today would beg to differ: Gregory W. Smith, general counsel of the Colorado Public Employees’ Retirement Association. and co-chair of the Council of Institutional Investors. Smith notes that debt investors first determine how much risk they wish to take on before selecting individual bonds.  “Ratings are used at that time, serving as a first cut to identify instruments eligible for further consideration and analysis. Without such a tool, we and many other investors would have no initial way to screen literally tens of thousands of new instruments that we consider each year.”

Smith, for one, would like to see the agencies held a little more responsible. He and others would like to see the fees publicized and perhaps paid out differently. Many have said that Wall Street compensation should be risk-adjusted. So should the fees to credit agencies: If they need to downgrade within a preset time — say up to one year — then the fee should go down some percentage, based on a sliding scale. There could be a bonus for underestimating the creditworthiness of issuers.

We have all seen just too vividly how incentives to underperform are very effective. If we can’t simply get rid of the credit rating agencies (something I’ve suggested) then we should at least get the incentives right so we can get more reliable work out of them.

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3 thoughts on “Credit rating agencies looking for more bubble wrap

  1. The credit rating agencies are like Narcissistic Personality Disorders. They have the air of entilement, and as Nancy noted, their only remorse is their dislike of consequences. Psychopaths don’t respond well to treatment, so there is no point in trying to rehabilitate them. Although John Q. Public (me included) used to believe in them, they have lost our trust. There is no going back.

  2. You say: “There could be a bonus for underestimating the creditworthiness of issuers.”

    Take it easy there… we do not want either to miss out on some great growth opportunities, decent jobs creation or climate change mitigation or adaptation just because the credit rating agencies underestimate the creditworthiness of issuer or lender.

    You see playing with risks is no kid game… as the regulators, thinking themselves Gods, have been thinking

    • I was being a little tongue-in-cheek with that last suggestion. I’m interested in what you say about the regulators thinking of themselves as gods. Please elaborate.

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