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Can we still trust ratings agencies?
Logos of rating agencies Moody's, Fitch Ratings, and Standard & Poor's
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TEXT OF STORY
Kai Ryssdal: The troubles we're having out here in California with our state budget are well documented. The Golden State is proving not quite so golden. It is financially worse off than any other state in the union. And getting worse. This week Standard and Poor's, the ratings agency, knocked California's rating down a peg to A minus. That is still what they call an investment grade rating, in other words, not so bad, but it is going to make it more expensive for California to borrow its way out of its current mess.
But here's the point. After the multi-billion-dollar hole California's dug itself, the worst that happens is that it gets bumped down to an A minus? Maybe that's why the rating agencies themselves get failing grades. Here's Marketplace's Jeremy Hobson in New York.
Jeremy Hobson: Many investors can't buy debt unless it's been rated by one of the big three agencies: S&P, Moody's and Fitch.
Gary Pollack's managing director at Deutsche Bank Private Wealth Management. He takes ratings into account, but says he'd never buy debt based solely on what the agencies say.
GARY POLLACK: It's nice to know what they think, but I think investors should make their own decision with respect to any investment that they make and not rely solely on a rating.
Investors learned that the hard way a couple years ago, when those complex triple-A rated mortgage-backed securities turned out to be junk. But it looks like that hasn't affected investors faith in the agencies when it comes to the majority of debt.
LAWRENCE WHITE: They still do have credibility, especially on the plain vanilla debt.
Lawrence White is a professor of Economics at NYU's Stern School of Business.
WHITE: The straight corporate debt, the municipal bonds, the state bonds of these kinds.
The stuff that's easier to understand, in other words. But critics have long argued the system is broken. They point out that the rating agencies are paid by the very people who are selling the debt that's being rated. White pushes back. He says for the most part, that model has held up for decades.
WHITE: About the biggest criticism you can levy on the rating agencies with respect to their ratings of these more standard securities is that they are usually slow to do the downgrade.
That's a charge echoed by bond investors today who say you'd have to be living in Lala land not to know California's rating deserved to be cut.
In New York, I'm Jeremy Hobson for Marketplace.
About the author
Jeremy Hobson is host of Marketplace Morning Report, where he looks at business news from a global perspective to prepare listeners for the day ahead. Follow Jeremy on Twitter @jeremyhobson
Unfortunately, there was a tiny window where public opinion could have slipped in, and overcome the bribes known as campaign donations to our representatives.
But, the public decided they couldn't understand the math of what happened, got distracted, and any chance for real reform...disappeared.
As for the packaging of bad debt discussed below...its easy when the buyer is only interested in flipping the purchase quickly to the next sucker. But as we see, eventually someone's stuck holding the rotten bag of goods. And if they are smart, they talk to their representative in government, make a campaign donation, and a bailout gets snuck into a bill somewhere...or it becomes its own bill, with other pork slipped in so as to win votes.
Professor White seems to have a bit of a short term memory lapse when he proclaims that the ratings agency model has held up for decades. True, the model held up prior the 1980s, when the agencies were truly independent soothsayers, but since the 1980s, you will find the mismanaged ratings agencies at the heart of every major financial debacle: S & L, Enron, WorldCom, and now Wall Street. When the ratings agencies started offering "consulting services" to the very people they are required to scrutinize, then they lost their credibility. Of course, the cynical view is that investors generally don't care what the agency rates if it's the kind of debt that they are anxious to buy. Are we really going to say with a straight face that mortgage backed securities that are known to be packed with "SUB-PRIME" loans are really not risky? If a consumer buys a new flavor of soda called "Sweaty Socks" and doesn't like the taste, should we really think that he's been bamboozled?
