Thursday, March 19, 2009
Ratings Agencies [i.e. skip this post]
Some of you know that the ratings agencies (Moody's, S&P, the other one) pretty much caused this whole financial disaster. A combination of incompetence and conflicts of interest caused them to rate garbage bonds as AAA, without which investors wouldn't have bought them, thus banks wouldn't have created them, thus mortgage brokers couldn't have made insane loans, and thus housing prices would've stayed sane.
So the question is what to do now. Obviously having bond issuers pay for the ratings doesn't work. There are some other proposals being floated around to have a big pool of money from the buy side pay for "independent" ratings. This is an even worse idea, for the same reason that there is no good credit analysis coming out of Cuban financial firms.
So here's my idea:
Keep the status quo, whereby issuers pay the ratings agencies, but add a clause to all the bonds creating a put option requiring the ratings agencies to buy it back from the investor if certain accuracy metrics are not met. The put option could be capped at maybe 5x times fees collected by the ratings agency in the first place, so they would still have some incentive to issue a rating, but this would counter-act the conflict of interest with an even stronger incentive to hire smart people and do a good job.
Some of you know that the ratings agencies (Moody's, S&P, the other one) pretty much caused this whole financial disaster. A combination of incompetence and conflicts of interest caused them to rate garbage bonds as AAA, without which investors wouldn't have bought them, thus banks wouldn't have created them, thus mortgage brokers couldn't have made insane loans, and thus housing prices would've stayed sane.
So the question is what to do now. Obviously having bond issuers pay for the ratings doesn't work. There are some other proposals being floated around to have a big pool of money from the buy side pay for "independent" ratings. This is an even worse idea, for the same reason that there is no good credit analysis coming out of Cuban financial firms.
So here's my idea:
Keep the status quo, whereby issuers pay the ratings agencies, but add a clause to all the bonds creating a put option requiring the ratings agencies to buy it back from the investor if certain accuracy metrics are not met. The put option could be capped at maybe 5x times fees collected by the ratings agency in the first place, so they would still have some incentive to issue a rating, but this would counter-act the conflict of interest with an even stronger incentive to hire smart people and do a good job.
