When companies or countries issue debt, ratings agencies assign grades based on how creditworthy the issuers are believed to be. Low grades can cost the issuers dearly.
But during the housing crisis, the major ratings firms gave the highest grades to mortgage-based securities that proved worthless. This month, the government sued one of the three dominant agencies, Standard & Poor’s, saying its evaluations of some of those securities were fraudulent.
What should be done to reform the ratings industry?
That is the introduction to the latest New York Times Room for Debate forum. There are contributions from:
Reggie Middleton: “The root cause of the agencies’ problems is the outrageous conflict created by having their primary revenue sources be the entities they rate, or the agents of those entities.”
Lawrence J. White: “The Dodd-Frank Act of 2010 instructed federal regulators to eliminate their mandated reliance on ratings, and some bank regulators have done so. But, maddeningly, for money market funds and broker-dealers, the Securities and Exchange Commission continues to mandate reliance on ratings.”
James H. Gellert: “The poor work of credit rating agencies undoubtedly played a role in the subprime mortgage crisis. But the government’s lawsuit against Standard & Poor’s is freighted with unintended consequences.”
Claire A. Hill: “Ideally, ratings would matter less. Fewer and less precipitous actions would be taken solely because of ratings. A money manager should not be able to justify having purchased a badly performing investment by saying that he relied on the rating agencies.”
And yours truly: “Since the days of Adam Smith, economists have known that a tightly restricted market will often result in higher prices and lower quality. So it was—and continues to be—with the ratings industry.”