Here we go again. Apparently, the nation’s largest credit-rating agency, Standard & Poor’s, is back to offering top ratings on bond deals to drum up business — having learned exactly nothing from our recent financial crisis.
The editors at acknowledged that . . .
To be fair, there are built-in conflicts of interest here: Wall Street firms pay big fees to agencies like S&P, creating an incentive for analysts to throw out seals of approval on financial products, just to keep customers happy.
But they didn't acknowledge how those perverse incentives came about. I left the following comments:
The editors don't tell the whole story.
Before the 1970s, bond buyers paid the appraisal fees, based on their own self-interest: They wanted accurate appraisals. Then, about 40 years ago, the government got involved. It created a rating agency oligopoly by licensing S&P, Fitch, and Moody's, then regulating them. One of the regulations imposed a change in the market-based payment model, forcing the agencies to charge sellers, rather than buyers, to pay the fees, setting up the conflict-of-interest the editors talk about.
The licensing requirement also served to protect the rating agencies from competition, along with another regulation; an SEC mandate that requires insurance companies, money funds, banks and other institutions to hold only those debt securities rated by these government-approved agencies.
The implied government "seal-of-approval" implied by licensure compounded the situation by fostering undue market confidence in the competence of the rating agency oligopoly. Consequently, securities buyers the world over got a false sense of security that the ratings were safe and accurate.
Everywhere one looks when investigating the financial crisis, the paw-prints of government interference into the market can be found as the fundamental cause. In the case of the rating agencies, as elsewhere, the government's interference created perverse market incentives that wouldn't exist in a free market. Perverse market incentives reward bad behavior and penalize good behavior. What result does anyone expect? (To be fair, the rating agencies were also mislead, like almost everyone else, by the "housing is safe and will always go up" mentality fostered by government housing policies and the Fed. But that is another issue.)
We need a new government model—non-interference. The government should get out of the rating agency business, and let competition in a free market determine the best business model.
Related Reading:
S&P Fraud Suit: A Case of the Pot Calling the Kettle Black
The Financial Crisis and the Free Market Cure—by John A. Allison
The Housing Boom and Bust—by Thomas Sowell
ARC's Response to the Financial Crisis—Ayn Rand Institute
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