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Thursday, September 19, 2013

Rating Agencies

The games played by the ratings agencies are a function of the business model they use (Since Relaxing its Bond Rating Standards, S.&P. Has Seen Its Business Increase. New York Times, Sept. 18 2013: B1, B7).

In their model,  the issuers of the financial instruments chose and pay the rating agencies; thus competition will result in a drive to the bottom, with raters giving high ratings to worse and worse debt issues. The problem is that an investor cannot detect a low quality AAA rating until after the issuer has defaulted.

In my view, there are only two solutions. Either, have the raters paid by the purchasers of the instruments, perhaps through a tiny Tobin-type tax, or nationalize the rating agencies and have a government agency carry out the ratings. I would favor the prior approach as competition would encourage accuracy in the ratings.

Sent to the New York Times