Why Did We Put Ratings Agencies' Ratings Into The Law?
from the good-questions... dept
Problems and potential conflicts coming from the bond ratings agencies were well-known well before our financial crisis hit, but still many are pointing the blame finger at those ratings agencies. And, it's certainly tempting to do so. Just as with the famed financial analysts during the late 90s tech boom, the credit agencies appear to have rated certain debt offerings very highly, despite recognizing how intrinsically risky the investments were. Given what happened following the dot com bubble collapse, it's quite likely that the bond rating agencies Moody's and S&P will get slapped down for their "mistakes."But that would be a mistake. Both Moody's and S&P were merely expressing an opinion on the credit-worthiness and risk of the various debt offerings. An opinion should never be considered illegal by itself. The problem was that people started relying on these opinions as if they were factual realities. And who's to blame for that?
Well, in part, it's the government -- which wrote the rating agencies' ratings into law, requiring certain regulated institutions to maintain a certain percentage of "highly rated" bonds in order to engage in certain activities. That made it so the real focus was on the opinions of Moody's and the S&P, rather than on what investors believed the actual risk was on those bonds. As the link here notes, why not let the market decide what the actual risk is on these bonds, rather than trusting the (somewhat questionable) opinions of individuals who are biased and conflicted?
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Filed Under: ratings agencies, regulations
Companies: moody's, s&p
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Opinion vs Advice?
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Re: Opinion vs Advice?
Doesn't one's advise always consist of their opinion hopefully based on some facts?
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Re: Re: Opinion vs Advice?
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Re: Re: Opinion vs Advice?
*Before correcting others, make sure you know what you're talking about. It's "construed as advice," not "construed as advise."
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Re: Re: Opinion vs Advice?
A licensed financial adviser provides advice, which if shown to be negligently provided could be cause for legal action.
However if you had a conversation with your mate at the pub, he'd be providing an opinion, which would have no legal basis.
You pay a medical doctor for medical advice, you ask a mate for their medical opinion. You can sue the provider of advice when that advice is offered in a professional capacity, but not of opinion.
Common English usage often blurs the precise meaning of words. Advice and opinion might be used interchangeably while having a general discussion, but they do have subtly different meanings, especially once we start entering the legal realm.
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thin data makes for poor models
On average credit default events are rare and sudden: parties typically become less credit-worthy a little at a time, but the markets find this out all at once: data that is confidential one day is public the next, so markets tend to do a lousy job of estimating creditworthiness.
Credit rating agencies were supposed to mitigate this somewhat by introducing tiers into which commercial paper fell. This did two things, in principle: it separated risky companies from less-risky companies, and it multiplied data: highly-rated companies rarely suddenly defaulted without being downgraded first.
But this doesn't really solve the underlying problem: companies' balance sheets improve or decay a day at a time, but the market (and the credit rating companies) still find out all at once.
So in this vastly simplified analysis you can take your pick: you can either have unreliable credit ratings or you can have unregulated flow of balance sheet information and subsequent insider trading.
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Re: thin data makes for poor models
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Disagree
The government should be held partially responsible, since I think it was a lack of regulation (again the SEC) that allowed the companies to get away with this for so long. But just because there isn't a cop watching, doesn't mean that running that red light is legal - or safe - or you shouldn't get in trouble if you cause an accident by doing it.
There is enough blame to go around and the ratings agencies should get their fair share.
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Fraud?
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the law and the profits
The subprime mortgage problem began with the bad loans and exploded after ratings firms rated the bond packages of these bad loans as AAA. It seems that these ratings firms were giving these ratings either as a favor to the bond sellers or because the firms had been spun off by the bond sellers.
The problem seems to be that the laws were poorly written, such that what the ratings firms did was not completely illegal, and/or the prosecution of the laws is difficult. And expensive.
In general, the financial sector seems to get a free pass when it comes to law enforcement. The perception is that revenue and profits trump the rule of law.
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