Tag Archives: Standard Poor

Why did the ratings agencies mess up so badly?

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.”

 

Puerto Rico: What real reform looks like

As the Republican primary drags on, the candidates will face primaries in the U.S. island territories in the coming weeks. In Puerto Rico, 23 delegates are at stake. While Puerto Rico often doesn’t receive much coverage in U.S. news outlets, the case of government reform there provides a valuable case study that American governors seeking to reduce the size of state governments should note. Since taking office in 2009, Governor Luis Fortuño has led the territory in reducing the number of employees by nearly 16 percent.

Source: Bureau of Labor Statistics

While Puerto Rico has been hit hard by the economic recession and struggles with a current unemployment rate of 16 percent, Fortuño has made the difficult decisions necessary to preserve the territory’s ability to borrow money and to resume on-time payments to government suppliers and employees. In this Reason TV video, he explains that he had to borrow to meet payroll his first month in office, but succeeded in bringing its bond rating back from the brink of junk status.

In his work with government streamlining efforts in Puerto Rico, Mercatus’ Maurice McTigue stressed the importance of of shrinking the size of government relative to the economy. Any elected official can attest that the process of achieving these changing growth rates is painful, but Fortuño is in the process of leading just that sort of change:

Source: Government Development Bank of Puerto Rico

The lesson to draw from Puerto Rico is that an important reason to avoid unsustainable levels of government spending is to avoid the pain of cutbacks once a government gets to a point where spending cuts are no longer an option. In March, 2011, Standard & Poor’s raised Puerto Rico’s bond rating for the first time in 28 years, marking an objective change in confidence regarding the island’s economic prospects.