Can the ratings agencies be saved?
Investors, companies, and regulators all benefit from having a clear and concise way to evaluate credit risk. But the agencies are paid by the issuers—a conflict of interest. Can this be solved?
This conflict has been with us a long time. It became significant when the agencies succumbed to the collective insanity of 2004 to 2006—some bonds were rated ultra-safe that never should have seen the light of day.
This is the same issue that accountants, newspapers, and psychologists have. It’s hard for people to act against their own interests and criticize the people paying them. Because the people paying don’t like to be criticized.
Take auditors. In the light of Enron, we were shocked, shocked that their accountants helped conceal the fraud. But Enron was a plum assignment, yielding millions in consulting contracts. Or newspapers: has a critical story ever been spiked because the subject of the criticism buys a lot of ads? Of course it has.
There has never been “golden age” where independent professionals totally subjugated their personal interests for the greater good. Everyone’s biased. The solution lies not in greater regulation but in more competition. When a competitor stands to benefit if you mess up, you tend to be more careful.
Professional agencies need to take the agency problem seriously. But everyone’s an agent. We all need to understand and recognize this.
Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!
Follow me on Twitter @GlobalMarketUpd