Do the ratings agencies need a downgrade?

Gregory Warner Dec 8, 2011

Steve Chiotakis: A lot of European countries are in trouble economically because of the ratings on their debt. Greek debt that used to be rated AAA is now junk. And banks use those ratings to decide how much risk they want to take. Now federal regulators propose those ratings should lose a lot of their clout.

Marketplace’s Gregory Warner is with us live to talk about it. Hey Gregory.

Gregory Warner: Hey there.

Chiotakis: So talk about this new rule being proposed?

Warner: This takes us back to the years before the financial crisis, when rating agencies gave these AAA ratings to bets we know now were risky — like mortgage backed securities, or Greek debt. And then these ratings meant that banks didn’t have to put up any cash — or hardly any cash — of their own. And then when things went south and they didn’t have money to cover their losses, we had to bail them out.

I called Karen Petrou of Federal Financial Analytics. She says regulators are telling banks they have to use public data, not rater’s opinions.

Karen Shaw Petrou: To cut that cord. To stop unquestioned reliance on the rating agencies. We want the banks to have enough shareholder equity backing their bets so that they’re betting with their money not just ours.

Chiotakis: So Gregory, then after all these financial crises, does this mean we’re “downgrading” the rating agencies?

Warner: The problem has always been we know rating agencies don’t work that well. But what do you replace them with? Who’s going to provide that third party objectivity? So the U.S. solution unveiled yesterday is to introduce these fairly complex algorithms, tables and formulas. Europe’s solution is different, they’ve come up with a government agency to rate bonds.

Chiotakis: All right, Marketplace’s Gregory Warner. Thanks.

Warner: Thanks.

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