Talk:Credit rating agencies

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"The spotlight is about to return to the culpability of credit ratings agencies in the global financial crisis following a decision by the biggest pension fund in the US to sue over "wildly inaccurate" ratings on the $US600 billion ($750bn) of synthetic derivatives sold to investors.

This, coupled with a court case to be heard in NSW Federal Court this week, could open the floodgates for third-party litigation against the credit rating agencies. It should also corral the regulators into finally doing something about the so-called independence and enormous power of agencies such as Moody's Investors Service and Standard & Poor's.

Litigation funder IMF Australia is involved in financing the case put forward by three Australian councils, which lost hundreds of millions of dollars after they were allegedly misled into investing in the complicated financial instruments.

The councils are seeking to overturn a deed of company arrangement (DOCA) that was approved by the creditors of Lehman Brothers Australia last month. IMF also represents 38 other local councils that want the deed set aside. If they succeed in overturning this -- and the Australian Securities & Investment Commission will be there to argue that it should -- it will allow them to sue third parties, including the credit rating agencies, for their role in the sale of these highly questionable products.

Right now there is a pipeline of $400 million of legal actions relating to synthetic derivatives products in Australia, but it could easily balloon to $4bn over the next few years, according to IMF."

".... We believe that the new securitization reforms proposed by President Obama, along with regulatory initiatives in Europe and elsewhere, will help further reduce the potential for conflicts of interest,” Sharma said."

The nation’s largest public pension fund has filed suit in California state court in connection with $1 billion in losses that it says were caused by “wildly inaccurate” credit ratings from the three leading ratings agencies.

Did the ratings firms get off easy?

That’s the buzz among some in the financial blogosphere today, on what some see as the lack of emphasis on credit raters in the raft of proposals put forward in that big white paper.

Essentially, when it comes to firms such as Moody’s, Standard and Poor’s and Fitch, the paper hands off the issue to the SEC, hazily urging that agency to shape the ratings firms up. Here’s the germane snippet from the report:

“The SEC should continue its efforts to strengthen the regulation of credit rating agencies, including measures to promote robust policies and procedures that manage and disclose conflicts of interest, differentiate between structured and other products, and otherwise strengthen the integrity of the ratings process.”

"The paper was developed in response to a request from the Financial Stability Forum (FSF) for the Joint Forum to conduct a stocktaking of the uses of external credit ratings by its member regulatory authorities in the banking, securities and insurance sectors. The Joint Forum prepared and circulated to member authorities a questionnaire on the use of credit ratings in their jurisdictions. The questionnaire was designed to elicit information regarding member authorities’ use of credit ratings in legislation (statutes), regulations (rules), and/or supervisory policies (guidance) governing, generated by, or affecting such authorities. The report focuses on the responses concerning the usage of credit ratings. It also describes respondents’ assessments regarding the impact of their use of credit ratings."

"There’s a hardening consensus around the idea that a key factor that lead to the current crisis was collusion between the issuers of mortgage securities and the ratings agencies to inflate ratings, fooling investors into thinking they were buying safe paper. This leads people to think that there’s an easy way out—simply ban issuers from paying for ratings and make buyers pay instead.

Unfortunately, this view is way too simplistic. In reality, the corruption of ratings is far more thorough than people think. And that corruption means that changing who pays the ratings agencies probably won’t do any good.

The poor performance of highly rated credit instruments, especially those tied to the subprime mortgage market, is great evidence that there was something deeply wrong with the ratings process. And the fact is that the business model of ratings agencies did change from the buy-side paying for ratings to the sell-side paying for ratings. While this may have contributed to the poor quality of ratings, the consensus view over-estimates the causation."

  • On the history and origins of credit agencies, see Born Losers: A History of Failure in America, by Scott A. Sandage (Harvard University Press, 2005), chapters 4-6.
  • On contemporary dynamics, see Timothy J. Sinclair, The New Masters of Capital: American Bond Rating Agencies and the Politics of Creditworthiness (Ithaca, NY: Cornell University Press, 2005).
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