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Kai Ryssdal: For decades, ratings agencies like Moody’s and Standard and Poors have rated treasury and municipal bonds. As you might expect, the higher the rating, the more confidence investors tend to have in the quality of the bond.
But in recent years, the agencies have moved into assessing mortgage-backed securities as well. They gave some of those products pretty high ratings, including triple-A, but as the mortgage crisis unfolded, it emerged that many of those products were… well… overrated.
Over the last 24 hours both Moody’s and Fitch have announced they’re looking at overhauling their ratings system to restore confidence in their business. Ashley Milne-Tyte reports.
Ashley Milne-Tyte: The agencies aren’t concerned about their rating systems for regular bonds and loans. They’re focusing on revamping ratings for complex financial instruments like mortgage-backed securities.
Walter O’Haire of consultancy firm Celent says any fix won’t address one of investors’ biggest issues: that the agencies are still paid by the companies whose products they rate:
Walter O’Haire: The perception is if the issuer is paying for the rating, that may bias the rating agency to view the potential risk a little more favorably.
There’s a lot of money involved. CNBC says nearly half of Moody’s revenue in 2006 came from rating these complicated securities.
Bert Ely is a banking consultant. He says it’s not only the agencies’ built-in conflict of interest that presents a problem for investors:
Bert Ely: People place too much reliance on these ratings. Period.
He says at least with regular bonds, investors can do their own research. But securities like collateralized debt obligations are hard enough to pronounce; understanding them is even more challenging, so most people look straight to the ratings. And that’s a mistake:
Ely: One of the things that has come out in recent weeks is the extent to which the rating agencies did not understand the risk, in part because they were not given all of the information they should have had.
That could be partly why Moody’s is considering adding warning labels to its ratings. Celent’s Walter O’Haire says measures like this by the agencies may not be enough to restore investors’ trust:
O’Haire: Yes, they can tighten up their processes themselves and yes, they can apply further diligence in doing what they do, but they’re just part of a larger process.
A process that led to far too many people getting mortgages they couldn’t afford.
In New York, I’m Ashley Milne-Tyte for Marketplace.
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