Bloomberg has done a good job keeping the credit raters in the spotlight, and its latest story shines a harsh one on Standard & Poor’s, Moody’s, and Fitch Ratings.
The Berg doesn’t dance around the fact that the credit-ratings firms are key culprits in this crisis. It’s a tough stance—you know, for the truth—that it would be nice to see more news outlets take.
Bloomberg uses an addicted-to-crack analogy to illustrate why it’s so hard to kick the credit-ratings habit:
Everyone from banks to the agencies that regulate them is hooked on ratings…
“Even though few people respect the credit raters, most continue to rely on them,” Partnoy says. “We’ve become addicted to them like a drug, and we have to figure out a way to wean regulators and investors off of them.”
And this is great:
In the run-up to the current financial crisis, credit companies evolved from evaluators of debt into consultants.
Right. This is aggressive journalism, not trying to hide in the mushy middle. Consultants is exactly what the raters were—paid by the people who created all the junk.
They helped banks create $3.2 trillion of subprime mortgage securities. Typically, the firms awarded triple-A ratings to 75 percent of those debt packages.
“Ratings agencies just abjectly failed in serving the interests of investors,” SEC Commissioner Kathleen Casey says.
This is also excellent:
Notwithstanding the role the credit companies played in fomenting disaster, the U.S. government is relying on them to help fix the system they had a hand in breaking.
That’s journalism telling it like it is. Other media would have beaten around the bush with a “critics say they fomented disaster” or something like that. But why? Bloomberg’s assertion is objectively true.
Last week I “downgraded” a Journal story for leaving out the crucial fact that Moody’s, S&P, and Fitch have been granted a monopoly and given quasi-governmental authority by regulators. Bloomberg doesn’t fail us there, either.
And it gives decent space to the central issue: The conflicts of interest at the heart of the raters’ businesses:
At the core of the rating system is an inherent conflict of interest, says Lawrence White, the Arthur E. Imperatore Professor of Economics at New York University in Manhattan. Credit raters are paid by the companies whose debt they analyze, so the ratings might reflect a bias, he says.
“So long as you are delegating these decisions to for- profit companies, inevitably there are going to be conflicts,” he says.
More on that:
The rating companies reaped a bonanza in fees earlier this decade as they worked with financial firms to manufacture collateralized debt obligations. Those creations held a mix of questionable debt, including subprime mortgages, auto loans and junk-rated assets.
S&P, Moody’s and Fitch won as much as three times more in fees for grading structured securities than they charged for rating ordinary bonds. The CDO market started to crash in mid- 2007, as investors learned the securities were jammed with bad debt.
Financial firms around the world have reported about $1.3 trillion in writedowns and losses in the past two years.
It’s not going to be easy to kick the credit-ratings habit, and until we figure out something better, the folks that helped cripple the economy are going to continue raking in the dough:
As lawmakers scratch their heads over how to come up with an alternative approach, the rating firms continue to pull in rich profits.
Moody’s, the only one of the three that stands alone as a publicly traded company, has averaged pretax profit margins of 52 percent over the past five years. It reported revenue of $1.76 billion — earning a pretax margin of 41 percent — even during the economic collapse in 2008.
And Bloomberg finds a good anecdote about the monopoly powers that enable the firms to dictate sky-high prices:
Pollock was president of the Federal Home Loan Bank in Chicago from 1991 to 2004. The bank was rated triple-A by both Moody’s and S&P. He says he recalls an annual ritual as he visited with representatives of each company.
“They’d say, ‘Here’s what it’s going to cost,’” he says. “I’d say, ‘That’s outrageous.’ They’d repeat, ‘This is what it’s going to cost.’ Finally, I’d say, ‘OK.’ With no ratings, you can’t sell your debt.”
Bloomberg also looks at the options for radical change. Some on Wall Street want to empower individuals to do credit ratings, which would benefit Wall Street two ways: It no doubt make it much easier to find raters favorable to the Street, and the increased competition would lower the fees they have to pay raters.
Or, the government could do what’s essentially a regulatory function:
Eric Dinallo, New York’s top insurance regulator, proposes a government takeover of the rating business.
“There’s nothing wrong with saying Moody’s or someone is going to just become a government agency,” he says. “We’ve hung the entire global economy on ratings.”
Unfortunately the very long piece is another example of a not-great Bloomberg edit, but If you can make it through the whole piece, it’s well worth your time.
Applaud Bloomberg for putting the resources into this story and for pushing it aggressively.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.