Watching the Watchers

[Joanne98]

The corruption of credit-rating agencies was at the heart of the financial collapse. So far, Congress has not had the nerve to pursue fundamental reform.

James Lardner | April 29, 2010

Credit-rating agencies exist to evaluate the safety of debt securities. Imagine for a moment that they had done their job when financial go-getters began churning out bonds backed by sketchy loans and the dream of endlessly rising home prices. Properly labeled as junk, those bonds would have found few buyers. Denied access to the vast reservoirs of capital held in mutual, money-market, and pension funds, the go-getters would have ended up as minor players. And millions of Americans might still have the jobs, homes, retirement savings, and economic security they lost.

Now imagine what it would take to get the rating agencies to do their job properly. The problem is one of glaring, undisputed, inescapable conflict of interest. Why did the rating agencies gloss over the huge risks of mortgage-backed bonds and collateralized debt obligations? Because that was the way to attract business from the securities issuers who paid them, picked them, and, in many cases, had their help structuring securities to achieve the desired rating.

The first imperative of reform, then, is to align the incentives of these badly corrupted entities with their mission. The most promising proposal, outlined in a policy paper by David Raboy, an economic consultant to the congressional panel overseeing the bailout, envisions an independent clearinghouse to collect fees from securities issuers and assign bond offerings to ratings agencies at random. This would be a game changer: The rating agencies, which have lately become Wall Street players in their own right, would go back to being the cautious, green-eyeshade types they once were -- and the cool observers of the bond market that we need. Their executives and lobbyists would holler in protest; that, too, would be a plus.

http://www.prospect.org/cs/articles?article=watching_the_watchers