The Bloomberg/BusinessWeek headline was enough to ruin your evening: SEC Declines to Sue Moody’s Over Inflated Ratings.

The facts were even worse: Moody’s, the bond rating company, chose not to downgrade inflated ratings on almost $1 billion of debt in 2007. The reason? Concern for their own reputation. The decision came out of Moody’s Investors Service committee in Europe, raising jurisdictional issues.

Our CrowdQuery for this evening:

1. Will the Rating Agencies ever be forced to pay for the massive damage they have inflicted?

2. Is the current system of NRSRO going to change?

3. What is structured finance and bond ratings likely to look like in the future? What should it look like?


What say ye?

Category: Bailouts, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

42 Responses to “CrowdQuery: Will Ratings Agencies Escape Justice?”

  1. As noted yesterday, the rules of Crowd Query are as follows:

    Try to answer any of the questions completely. The goal is for you to share ideas, concepts, arguments, etc.

    Feel free to provide links to others who have addressed this topic.

    Do not hesitate to experiment, spitball, toss out wild conjectures.

  2. Dennis says:

    Its the bond buyers fault. They never should rely on the rating agencies.

    We should remove their protected status, and require buyers to do their own due diligence . . .

  3. blueoysterjoe says:

    Gee, I wonder why Americans are cynical about politics.

  4. We’ve been disappointed too much ?

  5. The Window Washer says:

    To question #1:
    No, the spread between the rating and the true risk is the exposure. That number is so large, it would cover rating on products that haven’t defaulted also, that no one will go down the “Make them pay” road. The money isn’t there, never will be.

    Let me reconsider, the money isn’t there unless we get some kind of program like ZIRP for the Rating Agencies.

  6. algernon says:

    I wish it could be brought out more clearly that the flawed system of the bond seller paying the bill & the rating agencies being an oligopoly flow not from the free market but directly from gov’t regulation!

  7. Tarkus says:

    The ratings agencies were like Moe when Curly would slap Moe’s fist and it would swing around and hit Larry.

    The ratings agencies didn’t pay themselves money to inflate ratings. What is the old Watergate saying again…?

    Just remove the ability to bribe the system.

  8. philipat says:

    It’s tragic that one of the greatest enablers of the financial balloon has been able to keep below the radar screen throughout. I wonder if Saint Hathaway helped?

    It cannot be anything but obvious to any informed observer that the NRSRO’s were involved in a massive “Pay to Play” racket to put AAA ratings on sh*t, which must surely be a criminal offense. And yet nothing has changed.

    I’m not an American but sometimes I continue to be dazed and confused (In the words of the imoortal Led Zeppelin) at the sheer audacity and apparent scale of corruption in the US. It wasn’t supposed to be like this?

  9. JasRas says:

    1: I do not see how they possibly could pay for the damage they’ve inflicted–it’s so massive. They really need to be flushed out of the rating business and criminal charges probably need to be pursued. One of the biggest hinderances to anything getting better is the perceived lack of consequence for doing bad things. We will punish a drug user disproportionating to the white collar activity even though the actions of both bleed out and affect others in society.

    2: We can no longer have the fox looking over the hen house. It hasn’t worked, it won’t work, and will never work as intended. Yet government control has shown to be equally ineffective perhaps do to budget squeezes. Perhaps if government agencies could charge fees that made them self supporting like the Post Office it could work… Perhaps rating could be rolled into a SEC function. It needs to be some entity with a mandate to do things in the investor’s interest and not for a bottom line…

    3: First, rating agencies are largely in place for the retail investor as a ruse of safety. It’s been years–no,…I have NEVER been to a meeting with an institutional money manager of size that didn’t do their own work and have their own internal rating systems. Blackrock? PIMCO? Loomis Sayles? Franklin? any of the insurance companies? Please. They do their own work. So, do ratings mean anything? Do they even have a place in the world of today? Retail investors still need something that can give them a worthwhile way to measure risk. Institutions? You could have flushed all the rating agencies years ago and they wouldn’t have noticed. Those with robust research depts would likely prefer they not exist so their information advantage would be all the greater and mispricings would be even more common…

  10. It’s too late.
    Punishment must be swift and significant.
    The SEC is toothless. How sad is that?

    http://blog.mdwoptions.com/options_for_rookies/

  11. Casual Observer says:

    #1 – A RESOUNDING NO!!! The rating agencies will go along unscathed as if nothing ever happened – which is infuriating. Most of the comments I have glance through discuss the perspective of the institutional investor/hedge funds. Let’s take a look at the RETAIL players. Retail brokers/buyers NEED a strong rating to push this stuff on the blue-hairs and novice investors alike. It was/is their seal of approval. Most retail clients eyes gloss over when looking at a balance sheet…but a triple A rating from a vaguely familiar name? GOLDEN. Thats the issue and the current dilemma with our crisis of confidence economically.

    Unfortunately, there will be no perp-walks, no one will do jail time or even face a “harsh tone”. The incompetents that got us here by keeping their mouths shut will STILL walk around with an air of accomplishment. AND…we are all responsible as we will just accept it as business as usual ensuring that IT WILL HAPPEN AGAIN. The only people we seem being able to hold to account are unwed welfare mothers. No righteous indignation from the LEFT OR THE RIGHT on accountability of THIS issue

  12. David Merkel says:

    You know my opinions are different on this one. I blame the regulators that forced immature asset classes to be rated before the agencies had credible data, in order to fit their capital models.

    http://alephblog.com/2010/04/23/in-defense-of-the-rating-agencies-%e2%80%93-v-summary-and-hopefully-final/

    1. The rating agencies already have paid, proportionate to their degree of blame. The regulators have not.

    2. No.

    3. It won’t be much different. There will always be the need in the markets for opinions on securities, without being forced into guarantees. The rating agencies are like Value Line, except that the regulators force regulated entities to only buy rated bonds, and base capital charges off them.

    Smart people don’t rely on ratings, and never did. What damage came from misrating went to those not sufficiently skilled to play the games that they were playing. Ratings are not due diligence; anyone that relies on a rating for economic reasons is a dope.

  13. PushingDaisies says:

    Anybody who’s relying on these agencies’ ratings for their investment decisions deserves what they get. They’ve proven themselves to be just like the rest of Wall Street and folks in Washington, hopelessly hooked on the money and conflicted beyond shame.

  14. ericl says:

    3. You’ve alluded to it before and I believe it’s the best option going forward – open ratings systems. We could generate 10-20B of non govt paid stimulus by requiring all fs providers to become a lot more transparent and publish underlying asset details (and health in real time) to a website that everyone/anyone could use to crunch their own risk analysis heuristics against and then generate a rating which could then be voted on as easy as amazon review helpfullness scores.

    Such a system requires high upfront investment (good for near term gdp boost) and then it’s completely automated – no ongoing costs for fs providers or government. Let’s put some of that 700B of bailout money to use. It’s certainly not getting loaned out.

    Make the ratings agencies irrelevant. In an open transparent system they add no value and have no reason to exist.

  15. Trail of the responsible parties, disgorgement, fines and jail.

    Moody’s board members receive $75,000, $95,000 or $115,000 a year for the six or eight meetings they attend, depending on whether they hold leadership positions, plus $115,002 every year in annual restricted stock.

    Read more: http://www.mcclatchydc.com/2010/04/02/91419/where-was-moodys-board-when-top.html#ixzz0yFWmA255

  16. Frwip says:

    1. Will the Rating Agencies ever be forced to pay for the massive damage they have inflicted?

    No. Assets nowhere in relation to the damage. No point bleeding a rock. At best, there will be some mild, inconsequential hubbub between the NRSROs and the SEC to show that “something is being done”. A round of congressional hearings may be in order. Usual pointless crap …

    2. Is the current system of NRSRO going to change?

    Dunno. Do the actual stakeholders of the system (managers of regulated funds, who actually need AAA) have an incentive to change this system? The answer is non trivial and may be NO, very much like the incentives for Wall Street executives had no relations with the actual needs of their shareholders.

    Otherwise, always bet on inertia.

    3a. What is structured finance and bond ratings likely to look like in the future?

    Dunno. No idea. Probably like crap but with bursts of activity depending on whatever sure-fire-this-time-risk-is-fully-modeled innovation is the flavor of the day.

    See 2 on incentives. For a lot of money, those who decide and those whose economic interests are at stake are very different crowds.

    3b. What should it look like?

    Not quite sure, but at least, I’m certain about one thing : it would involve a lot of bankers’ heads mounted on pikes.

  17. Cromag says:

    I’m probably the least qualified to respond but here is my 2 cents worth. There is a valid role for ratings agencies as long as there are buyers with insufficient means to do their own due diligence.

    1. It’s unlikely they will be held accountable. I agree with JasRas that the ratings agencies probably could not pay for the damage done. Beyond that, the “smart money” probably understands the flaws in the system and doesn’t rely on them. Congress is either clueless or beholden to Wall Street such that it won’t take any meaningful action and retail buyers are powerless to effect change.

    2. It is highly unlikely there will be meaningful change. See #1 above.

    3. Here is my suggestion for a small step forward: A strong regulator (hope springs eternal) should appoint the rating agency for each issue at random from a group of agencies that have proven qualifications, with the understanding that the same rating agency would not be appointed to rate subsequent issues from the same issuer for some period. There would than be no reason to curry favor for repeat business. If a rating agency were later found to have blown the rating is should be subject to some clearly defined and meaningful fine or suspension period. I would also like to see some similar sort of arrangement for appointing auditors of public companies.

  18. constantnormal says:

    1) No. Nobody pays in Bananamerica, except the “little people”. And the “little people” accept this situation.

    2) No. People want an approved figure of authority telling them pleasant lies, and the people relying on those ratings lack the expertise or motivation to evaluate the risk for themselves.

    3) Pretty much the same as they look today. The prudent investors will avoid them like the plague, and the gullible/ignorant will flock to them — because, after all, they have government-approved ratings.

    The impact of the rating agencies being completely unreliable has not sunk in for the vast majority of the sheeple. They still believe (or want to believe) that it was merely a few isolated incidents, and anyhow, that’s all in the past, right? I mean, if it were serious, somebody would have been charged and prosecuted — because that’s how we handle crimes, right?

  19. t1dude says:

    Sadly, they will get off scot-free. This is the new “American way” where justice depends on your pocket book and laws are applied differently to each person depending on their station in life. We are quickly becoming a nation of men and not of laws. The writing is on the wall: hardly anyone was punished from Enron, Wordcom, or Tyco, not to mention the supporting cast like the accountants and lawyers who helped commit the crimes. Paris Hilton, Lindsey Lohan, and Mell Gibson also are a testament to our new concept of justice. I dunno when this absurd reality started, but I am willing to suggest that OJ Simpson marked the turning point.

  20. scharfy says:

    Simple fix.

    People can admit they were idiots, just like I did when I chased RedHat at 115$ a share. Its very liberating when you realize there’s no one left to blame but yourself.

    Sometimes things are AAA rated until one day they’re not. It’s the nature of sell side ratings. And THAT’S what they are. Sell side analysis.

  21. gethoht says:

    1. Will the Rating Agencies ever be forced to pay for the massive damage they have inflicted?

    Not as long as we have a kleptocracy. Honor among thieves.

    2. Is the current system of NRSRO going to change?

    It might change a little, but a drastic change would be the government admitting to a wrongdoing. It would be an admission of guilt, and politics has this nasty habit of making guilt a vulnerability. So much so that it ‘s even taboo to criticize your wholly imcompetent predecessor, no matter how much of his mess you’re cleaning up.

    3. What is structured finance and bond ratings likely to look like in the future? What should it look like?

    Well if no fundamental change is legally enacted, I would reckon that there will be a PR campaign to make it look like they’re a benefit to society and a legitimate business model. In 18 months when America collectively forgets, they’ll be back to business as usual.

  22. The Window Washer says:

    To follow up.
    #2: yes there will be change. It will take a while to wind down the current system. Should start in about 2015. If it happens sooner Warren with have a tarnished image and NO one will let that happen. The big issue is the pension funds and how they will change, after they change the system can look at changing.

    #3 ratings should look like Consumer Reports. Worked for washing machines and cars. Products should be standardized and will be to certain degree. The more the better so the least will happen.

  23. loub215 says:

    They will spill the blood of the least guilty to save the arses of the archetects. No justice, but plenty of foolish fun at the lynchings!!!

  24. philipat says:

    On the opinions above that anyone who relies on Ratings is a dope.

    1. So why do we need Ratings Agencies?
    2.So why are there Regulations which force various Funds etc to invest ONLY in AAA rated paper?
    3.So why do the Investment Banks insist thr instruments that caused the problem were sold only to “Sophisticated Investors”. Return to Item 1.

  25. philipat says:

    Just to add to the above, my point being that if Ratings are simply a conspiracy between Wall St and the Ratings Agencies to screw “Dopes” because “Sophisticated Investors” don’t either want or need them, that might mean that the problem is different, but it doesn;t mean there is no problem. And Wall St can’t have it both ways. Either the ratings were needed to screw dopes or, if, as they say, their customers were all sophisticated investors, then they shouldn’t have been needed ratings?

  26. philipat says:

    Just to add to the above, my point being that if Ratings are simply a conspiracy between Wall St and the Ratings Agencies to screw “Dopes” because “Sophisticated Investors” don’t either want or need them, that might mean that the problem is different, but it doesn;t mean there is no problem. And Wall St can’t have it both ways. Either the ratings were needed to screw dopes or, if, as they say, their customers were all sophisticated investors, then they shouldn’t have needed ratings?

  27. philipat says:

    Just to add to the above, my point being that if Ratings are simply a conspiracy between Wall St and the Ratings Agencies to screw “Dopes” because “Sophisticated Investors” don’t either want or need them, that might mean that the problem is different, but it doesn;t mean there is no problem. And Wall St can’t have it both ways. Either the ratings were needed to screw dopes or, if, as they say, their customers were all sophisticated investors, then they shouldn’t have needed ratings?

  28. philipat says:

    Sorry for Duplicates, it wasn’t me. There was a site response issue.

  29. Sechel says:

    Everything has changed, so nothing needs to change. The rating agencies will continue issuing meaningless ratings that do not serve to warn or indicate credit risk while investors will rely on those ratings less and less and do more of their own due diligence.

  30. Sechel says:

    In response to David Merkel.. I doubt very many ever really relied on the ratings as a risk tool, but rather the power of the ratings was regulatory and had everything to do with risk based capital standards and other rules put in place by regulators regarding if a position could be held and ho much capital to hold against the position which was very much ratings driven.

  31. philipat says:

    @Sechel

    Money for nothing, chicks for free?

  32. “2. Is the current system of NRSRO going to change?

    It might change a little, but a drastic change would be the government admitting to a wrongdoing. It would be an admission of guilt…” –gethoht, above

    an important point..
    ~~

    the NRSROs were created to solve a Marketing problem, that they, ultimately, created a ‘Market’-problem, should (have) come as little surprise..

  33. 1. No, the rating agencies will not be forced to pay, as long as the financial oligarchy owns Washington DC and there is no meaningful rule of law (just little PR hand slaps) for the big players in the financial industry.
    2. Same answer as 1, with “pay” replaced by “change”, regarding the NRSRO
    3. The correct rating model is Egan Jones buyer payment for ratings which will always be far more responsible due to correct incentives, instead of the government preferred incentive toward fraudulent behavior which funds more campaign contributions from all that benefit from the fraud.

  34. Raleighwood says:

    No – they can’t be held accountable – they were (are?) the cornerstone of the whole façade. Remove them and it all comes crashing down – all the little emperors would be revealed for the greedy, thieving, unpatriotic bastards that they are.

  35. NoKidding says:

    1. Will the Rating Agencies ever be forced to pay for the massive damage they have inflicted?

    What are you high on crack?

    2. Is the current system of NRSRO going to change?

    Superficially, in a way that increases data collection but ignores data quality and hides detail.

    3. What is structured finance and bond ratings likely to look like in the future? What should it look like?

    Maybe numeric instead of alphabetic, with a handy converter chart to translate for old timers.
    Same as it ever was. Same as it ever was. And the days go by, water flowing under ground.

  36. carleric says:

    Am I tge only one w ho sees the humor is Moodys trying to defend their reputation and the SEC playing along? What reputation? I know prostitutes with higher levels of credibility..

  37. AHodge says:

    Escape? yes
    compensation and reforms? no
    key is that the govt is protecting them
    just an example from yr ago when the House Investigations committee rounded up two Moodies whistleblowers, with hair curling testimony.
    I tried to bet on that, in Sept 2009, shorting Moodies. House investigations committee hearings were scheduled, Republicans asked for a week’s postponement. Then Kanjorsky comes on CNBC, announces his committee is taking over, will hold rating agency hearings including calling their CEOs, and will have legislation within weeks. Then dead silence. The only testifier 9 months later was Moody’s owner Warren Buffet. In his most disgraceful public appearance ever, announces we must forgive the raters, because who could have foreseen the housing crash? In his defense, he was unwillingly forced to testify.

    As you point out SEC and Shapiro also clearly a stooge in this. The top three are easily liquidatable on their record. there are private lawsuits going forward, but the continued govt blessing will help the raters there.

    raters are an essential link of securitization. Bad accounting and selling overpriced unanalyzed junk is the basic business model wall st wants to restore.

    Without decent accounting, or raters making their own adjustments, it is functionally, existentially impossible for a rater to produce better than garbage.

    i had a running dialogue with the chief econ of a big three on this. he went from
    the usual “everything is fine we can price all these asset backed at hold to maturity” in mid 2008,

    to conceding valuations were bad, they needed a new model by end 2008,

    to back to “we can price all this stuff unmarked” by mid 2009,
    and why not? “everyone” agrees with him? and is paying for his stuff.

  38. AHodge says:

    when i asked a hill majority insider what happened w the hearings above, he said “somebody got a phone call” then totally clammed up.

    and thats —the rest of the story!

  39. rd says:

    1. No. There is no money. They are effectively a consulting firm that spins off cash flow. Their assets walk out the door every night.

    2. No, although it needs to. Reform is hard and requires thought. Both of these are anathema to our current political class.

    3. I think it needs a different model. It is effectively a consulting service that has been granted a monopoly. What is unusual about the ratings firms is that the monopoly is granted to the firms only and not individuals. Other professions with government-granted monopiles like medicine, law, engineering, accounting, hair dressing etc. have licenses granted to individuals who now bear some personal responsibility for negligence.

    Each rating should have a licensed rater assigned to it who will sign off on the rating. As a PE myself, trust me – nothing focuses the mind on the quality of your work quite so much as having to personally sign off and seal a design. The raters would develop standards of care that could be used to assess negligence. If they commit gross negligence then they could have their personal license pulled.

    I don’t believe the rating debacle would ever have occurred if individuals were responsible for the ratings. There is a reason why we don’t have avalanches of falling new buildings, people dying after every doctor office vist etc. the work of most regulated professions is done within an overall framework of general responsibility and ethics if policed properly.

  40. JimmyDean says:

    They most likely will escape real justice, or if they get justice, it will be announced as punishment with a good deal of fanfare to the public but it will not have much substance to it. The US is just as much a constituent of the rating agencies as any other big sovereign or corporation with a lot of debt outstanding. If the US wants to stay the world’s reserve currency we need the “better than AAA” credit-rating. If the US is downgraded from AAA, some institutions will be forced by mandate to lighten up their US holdings. If the rating agencies go away and investors are left to do their own due dilligence then very likey that would also induce some pretty major selling. So, with only adverse outcomes to the US (in the form of higher interest rates) if there is real rating agency reform or dismantling, it is in the US Gov’s best interest to keep the status quo re rating agencies rather than dismantle them or hang them in the public square (as they should be). This is why regulators, congress, the administration et al. have gone easy on them IMO. I say careful what you wish for here, an market-driven interest rate spike is the last thing this “recovery” needs.

  41. TomL says:

    Ratings agencies want to wrap themselves in the flag and hide behind the first amendment.

    Ok, but only if they clearly label their ratings as fiction.
    Acceptable categories would be: comedy, mystery or action/adventure.
    Or perhaps with plain brown wrappers, under the ‘XXX-rated adult’ genre.

    But their ratings should never be listed as non-fiction.
    That would be misrepresentation or outright fraud.