Monday, April 26, 2010

Moral hazard for credit raters

Paul Krugman's NYT column today delves into some emails at Goldman Sachs. Not the ones that have been cited in the SEC's charges, these emails come from credit rating agencies, the supposedly neutral arbiters of the safety of various securities issued by investment banks. But how neutral are these agencies, given their need to get a steady stream of business from the investment banks? Many finance experts (not to mention mere labor economists such as myself) have long feared that the credit raters have a-wink-and-a-nod routine going where they promise to give good ratings as long as the ratings business comes their way. Now we have incriminating emails showing this is exactly what is taking place.

So how can we get truly neutral ratings? Some have suggested that a government agency take over the role of Moody's and S&P, and since government agencies did such a good job of warning us about the financial crisis two years ago -- please note sarcasm. Krugman cites a proposal from two NYU finance professors suggesting random allocation of ratings agencies to banks, but why should existing agencies get a permanent lock-in? Maybe the ratings agencies should themselves be rated in terms of how well the securities they rate perform?

1 comment:

  1. Great post Steve. I've long been of the opinion that credit rating agencies pretty much operate like the mob running a protection racket. Firms have to pay them to get ratings because if they don't "bad" things will happen.