Saturday, September 24, 2011

Funding of Leading Credit Rating Agencies Must Change

Lloyd B Thomas Jr, a Kansas State professor of economics and the author of The Financial Crisis and Federal Reserve Policy, a book about the financial crisis, says:

Standard and Poor’s, Fitch, and Moody’s—the three leading credit rating agencies—behaved very poorly during the housing and credit bubbles of 2000-2006. Many buyers of mortgage backed bonds can only purchase those rated AAA. The rating agencies routinely stamped mortgage backed bonds and related derivatives AAA without carefully examining the quality of the individual mortgages that backed them.

This failure of the rating process helped feed an enormous expansion in the pipeline of credit to the housing sector, and its inevitable collapse after 2006 is the primary cause of the nation’s economic problems today. Many of these bonds were junk bonds because of the inferior quality of mortgages backing them. He continued:

These credit rating agencies have been funded by the very investment banks that built the toxic mortgage backed bonds and related securities.

It led to corruption of the ratings process as Standard and Poor’s, Moody’s and Fitch engaged in a “race to the bottom”. Such obvious conflicts of interest and poor performance are why the way leading credit rating agencies are funded should be changed:

Standard and Poor’s knew that if it failed to rate a mortgage backed bond AAA, the investment bank would take it’s business to Fitch or Moody’s, which would likely rate the bond AAA to collect its million dollar fee for its rating service from the investment bank. Clearly this obvious conflict of interest needs to be corrected by implementing a new way of funding the rating agencies.

How much evidence of corruption in the higher echelons of the country’s financial sector, and the rich minority that benefit from it, do we need to get enraged?

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