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Where the credit rating industry failed
U.S. Capitol Building
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Renita Jablonski: A good question will be asked at a congressional hearing today: Where were the credit rating agencies to help prevent this mess?
Firms like Moody's and Standard and Poor's were supposed to warn us about bad investments.
The heads of the three biggest ratings companies will be on the hot seat. Marketplace Washington Bureau Chief John Dimsdale reports.
John Dimsdale: As banks and mortgage lenders bundled their riskiest loans into tradeable securities, the ratings firms gave the investments their highest seal of approval. In some cases, says Vanderbilt professor Hans Stoll, those triple-A ratings were still in place when the value of the securities collapsed.
Hans Stoll: Their success in changing the ratings before the market does is abysmal.
Reform advocates say one reason for the inflated ratings is the issuers of the assets are the ones paying the rating firms.
Joseph Grundfest: It's as though you've got all the restaurant reviewers being paid by the restaurant owners.
Former SEC Commissioner Joseph Grundfest recommends that buyers of the securities do the ratings -- and send the bill to the issuers of the securities.
Grundfest: Then, if there is a problem with the way the ratings come out, the buyers have only themselves to blame.
The SEC will consider new regulations of the credit ratings industry sometime this Fall.
In Washington, I'm John Dimsdale for Marketplace.
How can anyone believe that a credit rating company being paid by the company or group they are rating, will provide a fair and objective rating. When I bought my first home in 1991, the first thing the appraiser asked me was "what are you looking for it to appraise for?" His question blew me away, in part because I did not know how to answer it. My first thought was, "so this is how it works". If the credit raters do not give the rating their client wants, they will lose future business from that client. What would anyone do in that situation?
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I think that their failure in the credit rating, is how credit worthiness is rated. From the rating agencies' perspective, the potential profit these companies stood to make was excellent. Further, these companies had seen strong growth for many years. However, the ethics of their behaviour was not scrutinized. In fact, the credit agencies themselves are a business that make money solely on judging how financially successful a company will likely be. Given those criteria only, without looking at the larger picture, we can see how they fooled themselves.
In the consumer market, credit ratings are given out based on how much a person has paid financial institutions, not on a true financial assessment. A person who pays for everything in cash will have no credit rating, even if they pay it on time. Such a person is usually financially responsible and more likely to have monetary reserves to ensure repayment. The fact that this person would be turned down for any loan, despite being more able to pay than most should raise many flags.
I think perhaps its time for government to reign in credit agencies and limit their scope. For all the money these agencies charge and cost others, they are more of a weight than a help.
