When Katie Benner and I were reporting an article this summer on the role of the big credit rating agencies in the mortgage-finance crisis I had a weird education on how these firms work. To boil it down, companies that want to sell debt in the public credit markets first present their information to ratings agencies, which then issue ratings and research to investors. The agencies — Moody’s (MCO), S&P and Fitch are the biggest — collect fees from the issuers. In other words, the institutions charged with giving advice to investors make their money primarily from companies issuing debt. It’s a classic conflict of interest, a case of the fox guarding the henhouse. Their fee, by the way, is contingent on the sale, meaning that the agencies are motivated, financially at least, to move the goods, not give good advice.
What interested me over the summer was that whenever I pointed out this conflict to anyone in the debt dodge, they told me this was the way it always worked. Case closed.
Things may be changing.
Hank Paulson, the treasury secretary, addressed the issue in a speech Tuesday, saying: “It is clear that we must examine the role of credit rating agencies, including transparency and potential conflicts of interest. We must also assess if regulations and supervisory policies are encouraging an over-reliance on ratings by financial institutions and investors.”
Well, identifying the problem is a start, but Paulson hardly is offering solutions. You’d think debt investors would be willing to pay for impartial advice, right?