Inevitability of the Upward Tilt

This comes from the Dep’t of Unsolved Problems – one of the dumbest f*cking business models in the history of the world and in all the annals of global finance is the user-pays situation we have with the credit ratings agencies. And unlike other perverse compensation arrangements we’ve been regulating out of existence on Wall Street post-crisis, this one has so far survived.

In a nutshell, entities that are issuing bonds or debt instruments are given a rating from the agencies (A, Aa, B minus etc). But the issuers are also the “customers” of these ratings firms – they are the payer of the bill. Picture a scenario where Pfizer and Merck were the FDA’s customers and paid directly for drug approvals. Or a restaurant critic who sends his invoice for coverage to the restauranteur, expecting payment. Or if Wall Street’s big brokerage firms set up and funded their own regulator – oh wait, that’s actually the current reality.

Anyway, you should not be surprised by the following revelation at DealBook:

The Wall Street ratings game is back.

Five years after inflated credit ratings helped touch off the financial crisis, the nation’s largest ratings agency, Standard & Poor’s, is winning business again by offering more favorable ratings.

S.& P. has been giving higher grades than its big rivals to certain mortgage-backed securities just as Wall Street is eagerly trying to revive the market for these investments, according to an analysis conducted for The New York Times by Commercial Mortgage Alert, which collects data on the industry. S.& P.’s chase for business is notable because it is fighting a government lawsuit accusing it of similar action before the financial crisis.

As the company battles those accusations, industry participants say it has once again been moving to capture business by offering Wall Street underwriters higher ratings than other agencies will offer. And it has apparently worked. Banks have shown a new willingness to hire S.& P. to rate their bonds, tripling its market share in the first half of 2013. Its biggest rivals have been much less likely to give higher ratings.

There’s an inevitability to this upward tilt when the three major agencies compete for ratings business from issuers. Someone’s going to start it first, whomever is the hungriest. The rest will be dragged into the game eventually and the whole cesspool begins to swirl again.

How anyone can have so much trouble understanding this built-in conflict is beyond me.

So what’s the right business model for the agencies? What’s the answer? I don’t know – but probably not this.


Banks Find S.&P. More Favorable in Bond Ratings (DealBook)


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