Quote of the day

Robert Waldmann

Felix Salmon wrote

“S&P and Moody’s are clearly completely incompetent, and no one should base any investment decisions on the random series of letters they apply to bonds.”

second quote (from comments)

“… But without rating agencies…… who other than big investment companies/funds that have their own in-house muscle to do due-diligence can buy these things?”

Posted by MarshalN

My thoughts after the jump.

So what’s the alternative to the random series of letters they apply to bonds? I see two possibilities.

1) a public ratings agency (not a public option mandatory public rating required for all regulatory purposes). Have the SEC rate bonds.

2) Use the prices of CDSs. Now I don’t think regulations can refer to the market prices of CDSs, which shoot up in a panic causing banks to have to liquidate assets justifying the panic. However, if Goldman Sachs were willing to issue CDS on 10% of the securities at a price typical of CDS on AAA corporate bonds, I’d be willing to buy them (Provided Goldman Sachs promised not to buy CDS on 20% etc).

The point is that as noted by MarshalN only a few big firms have the muscle to rate. We have learned it is unwise to trust raters who don’t put their money where their mouths are. Very few big firms have enough money to put where the major mouth investors respect from raters is.

This will not be cheap. If to issue a security that pension funds can buy, you have to find some entity willing to insure 10% of it (with guarantees that they don’t hedge that risk) then it will be very costly to issue a security.

That’s life. In the real world you don’t get something for nothing and rarely get something hugely valuable for almost nothing. For decades we got immensely valuable ratings from Moody’s, S&P and Fitch for almost nothing. Our luck has run out and it’s time to face reality as it almost always is.

Public ratings would be cheaper, but 2008 taught us as much about regulatory capture as they taught us about trusting private firms which don’t put their money where their mouth is. I’d say public ratings would work OK unless and until a Republican is elected President.