The danger of relying on ratings agencies

Gregory Warner Dec 8, 2011

Stacey Vanek Smith: When you invest in a fund or bond it has a rating — AAA, B-. Those grades come from ratings agencies like Moody’s or S&P, and those agencies have taken some heat for giving good grades to bad investments. Now federal regulators want to make banks stop relying on those ratings.

Gregory Warner reports.

Gregory Warning: It’s a story we’ve heard before: rating agency gives AAA rating to — fill in the blank with your favorite toxic asset: mortgage-backed security, Greek debt, Enron stock. That high rating means banks are free to invest without providing much of their own cash to back those bets.

Karen Shaw Petrou: Blind reliance on ratings throws money into assets which turn out to be a lot riskier than the rating agencies thought.

Karen Shaw Petrou is a banking analyst at Federal Financial Analytics. Wall street reform requires regulators to use something other than rating agencies. So regulators proposed a range of indicators — more like what individual investors use to guide them.

Ted Truman is a former Fed Reserve chairman, now at the Peterson Institute.

Ted Truman: If you and I were going to buy Greek debt, right, we would not put 100% of our portfolio in that. In the case of a bank, we would want them to ask the same question, but if they take on more risk we would want them to have more capital.

More skin in the game. They can’t throw up their hands and blame the AAAs.

I’m Gregory Warner, for Marketplace.

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