It is not good that we are learning at this late hour, for instance, that credit-rating agencies—Moody’s, etc.—are paid by the very Wall Street houses whose bonds they rate; that the agencies gave the same grade to bonds backed by loans to people who couldn’t afford a down payment as to bonds backed by loans to people who could; and that the shakier the bond issue, the more ratings agencies make, and that without these ratings, there are no bonds.

This has a familiar ring to us casual business-press readers.

It was not so long ago that the business press discovered—too late!—that Arthur Andersen and other accounting giants made more from consulting for Enron and other corporations than from auditing them, and hence were increasingly willing to fudge the books to please the client—and thereby retain the lucrative consulting business.

The business press, also not long ago, was shocked, shocked to learn, from the New York attorney general, of all people, that Wall Street stock research was indirectly funded by the very companies the analysts were analyzing. That research—paid for by Citigroup, Merrill Lynch, CSFB—all the major Wall Street firms—turned out to be fraudulent. Bogus. The business press then learned, also courtesy of Eliot Spitzer (that would be Governor Spitzer to you, WSJ editorial board) that insurance brokers made insurers pay them “contingent commissions,” also known as “kickbacks,” in return for steering them commercial business.

How long had these practices been in place? Decades.

And how long have the ratings-agencies labored under their own conflict? Since the 1970s, according to Jesse Eisinger in Portfolio, when the Securities and Exchange Commission designated them a “public good” and required them to drop their subscription model and charge the subjects of their work.

Point is, the financial system is riddled with conflicts of interest. Some are unavoidable. Many can be managed. But all must be watched. This is why we have a business press, in my view.

It is good to point out that information providers such as McGraw-Hill Companies’ Standard & Poor’s overrated the quality of some bonds in order to win more business and fueled the “subprime mess.”

“CREDIT AND BLAME: —- How Rating Firms’ Calls Fueled Subprime Mess —- Benign View of Loans Helped Create Bonds, Led to More Lending

The Wall Street Journal
Aug. 15

But, as the lead paragraph explains, S&P did that seven years ago.

in 2000, Standard & Poor’s made a decision about an arcane corner of the mortgage market. It said a type of mortgage that involves a “piggyback,” where borrowers simultaneously take out a second loan for the down payment, was no more likely to default than a standard mortgage….

But credit-rating firms also played a role in the subprime-mortgage boom that is now troubling financial markets. S&P, Moody’s Investors Service and Fitch Ratings gave top ratings to many securities built on the questionable loans, making the securities seem as safe as a Treasury bond.

Now you tell us. You don’t have to be an S&P analyst or a business reporter to know that someone who borrowed a down payment is more likely to default than someone who didn’t.

That’s why I put a higher premium on this kind of business reporting. Check the date:

Still, the rating agencies have yet to downgrade large numbers of mortgage securities to reflect the market turmoil…Meeting with Wall Street analysts last week, Terry McGraw, chief executive of McGraw-Hill, the parent of S.& P., said the firm does not believe that loans made in 2006 will perform ”as badly as some have suggested.”

Nevertheless, some investors wonder whether the rating agencies have the stomach to downgrade these securities because of the selling stampede that would follow.

“Crisis Looms in Mortgages”
By Gretchen Morgenson
The New York Times
March 11

Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014).

Follow Dean on Twitter: @deanstarkman.