Thursday, April 21, 2011

We need a Public Rating Agency!

So Standard & Poor's has revised the outlook of US debt, which is still triple-A, to negative. The reason according to their report is that: they “believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges.” Basically, the economic rationale is simply that the fiscal consolidation (read contraction) plans are not strong enough. Somebody should explain to them that the US cannot default on debt denominated in dollars. There is always recourse to monetization of debt in your own currency. And yes monetization may have consequences. But, monetization would only lead to inflation if the economy were at full employment. I wish we were there, and excess demand could lead to inflation. But at this point it’s pure delusion.

Note, however, that all the Rating Agencies (S&P's, Moody’s and Fitch) argue, to protect against lawsuits, that their ratings are nothing more than opinions. By the way, the opinions of people that rated subprime CDOs (Collateralized Debt Obligations) as triple-A. These are the opinions of highly unqualified people at best, or worst just completely dishonest. It would be nice if we could just dismiss their ‘opinions’ as the ranting (not ratings) of lunatics and common thieves, but that would be dangerous.

In fact, their views are not just opinions, and their argument is disingenuous at best. The problem is NOT that investors actually pay attention to their ratings, which they do. Worse than that, financial regulations incorporate their ratings and require, for example, that money-market funds have to invest in instruments with high credit ratings. Several laws require pension funds to meet certain credit-rating requirements, and banking regulations determine regulatory capital requirements based on the credit ratings of the securities the bank owns. In other words, the credit agencies have a semi-public status, but they are profit-making businesses, which have a proven record of incompetence (when it comes to risk assessment, not profit-making). This is the strongest case for creating a public rating agency that would be free from the conflicts of interest that the private agencies are so obviously entangled into.


  1. what do you think about the Dodd-frank act on this issue?

  2. I totally and completely agree with you point of view. I wrote a policy proposal on this issue and submitted it to a left-wing think-tank in Brussels. There are naysayers,who worry 1: Who watches the watchmen, and 2: How can we be sure to attract the right type of talent and resources to the Public CRA. While tricky, these two issues can be overcome.


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