Another credit downturn, another round of finger-pointing. Many of the digits are waving in the direction of the big credit rating agencies. Much, but not all, of the criticism misses the mark, like blaming weather forecasters for a decision to leave your umbrella at home.
The credit meteorologists, principally Standard & Poor’s, Moody’s and Fitch, don’t pretend to be opining on the market value of securities or the ease of trading them—only, in essence, on the likelihood of default. So investors have only themselves or their fund managers to blame for any recent losses on illiquid structured instruments, particularly those linked to US subprime mortgages.
Still, the rating agencies seem to have been a bit slow to see the storm clouds coming, and some rating decisions have seemed bizarre. One thing that particularly grates is that the agencies’ semi-official status is unaccompanied by accountability. If they took part of their fees in a form that depended on ratings turning out right, at least for a time, it might encourage a conservative approach. That must be what officialdom expected when it first started sanctioning ratings. Investors would also see that agencies were taking a bit of risk. To be fair, achieving this would be far from straightforward—taking direct exposure to default-prone triple-C rated debt, for instance, would be a tough sell to the agencies.
Or what if investment banks weren’t allowed to run securities by the agencies until they were issued? This would make bankers structure securities that fall demonstrably within rating agency criteria, rather than dancing along the boundaries as they often do now. Equity researchers connected with an offering aren’t allowed to publish beforehand, but ratings agencies are. If the ratings only came later, this would also make investors to do some work of their own.
Such a change is highly unlikely, too. It would turn the debt markets upside down, since ratings define what securities some investors can buy. But it would be a regulatory response that wouldn’t interfere with rating criteria. And it would force investors to consider the chance of storms as well as sunshine.