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Where Go The Rating Agencies?

What will happen to the rating agencies? Investors are now using other sources to analyze securities.

By Joel Ross | Updated on October 11, 2010

It is very unclear what will be the final role and business strategy of the agencies. They have lost credibility, many of the smartest and most experienced have left or will leave as soon as they find a new job, they will soon be subject to the fear of the tort lawyers coming after them for any reason that can force a payoff to the lawyers, and they have competition. If there were not the requirement to use investment grade ratings from rating agencies imposed on pension funds and certain other investors, it is very likely that the rating agencies would simply go away.

There is now an internal layer of monitors in the agencies checking to make sure the underwriters are doing it by the book and not going out on a limb on anything. This makes working conditions less than wonderful and it results in generally more conservative ratings than might otherwise be the case and might otherwise be warranted. Similar to appraisers who always get it wrong on the upside and then over compensate and get it wrong on the downside when there is a recession, raters are now being conservative. If you know a tort lawyer is sitting there waiting for you to make any judgment that may prove later to be over optimistic, you will err to the conservative side. If you know Barney Frank and his band of clowns on his committee will potentially drag you in front of the cameras for political theater, you will be overly conservative. Being overly negative can be as bad as being overly optimistic if the rating is too restrictive and the cost of capital resulting is higher than it should be.

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