There’s something I’ve been mulling over since the problems with the financial system really began to go into high gear last year. As the result of a process that started almost 80 years ago with the reforms to the banking industry under the Franklin Roosevelt Administration, in the United States a financial institution may only purchase bonds that have been rated as investment grade by one of just three credit rating companies.
Obviously, the credit rating companies have screwed up. They’re not the only ones who’ve screwed up; there’s lots of blame to go around but they are major suspects for Who Shot Cock Robin?
Limiting financial institutions to bonds that have been found worthy by just three rating agencies isn’t the only way to organize that activity and it’s obviously filled with problems. For example, the rating agencies have an inescapable conflict of interest. Whoever pays them, they’ll have a conflict of interest. And right off the top of my head I can think of a half dozen different ways of managing things than we have done historically.
So here are my questions. First, are the credit rating agencies worth what they’re being paid? Frankly, I don’t see it but I’m open to persuasion. The second question is closely related to that but IMO is thornier. The requirement that all bonds whether issued by a company or government or any other entity be rated by the three anointed rating agencies has constituted an enormous subsidy to these companies, possibly running into the trillions of dollars. Are we getting what we’re paying for?
