Oh, what a tangled web we weave. The United States government has sued credit rating agency Standard & Poor’s over the ratings it gave to mortgages just before the financial crisis:
The U.S. government is accusing the debt rating agency Standard & Poor’s of fraud for giving high ratings to risky mortgage bonds that helped bring about the financial crisis.
The government said in a civil complaint filed late Monday that S&P misled investors by stating that its ratings were objective and “uninfluenced by any conflicts of interest.” It said S&P’s desire to make money and gain market share caused S&P to ignore the risks posed by the investments between September 2004 and October 2007.
The charges mark the first enforcement action the government has taken against a major rating agency involving the worst financial crisis since the Great Depression.
According to the government filing in U.S. District Court in Los Angeles, the alleged fraud made it possible to sell the investments to banks. The government charged S&P under a law aimed at making sure banks invest safely.
S&P, a unit of New York-based McGraw-Hill Cos., has denied wrongdoing and said that any lawsuit would be without merit.
It is without merit, but not for the reasons S&P thinks. See, this whole thing is hilarious, because the situation itself was created by the government. That’s right; if it wasn’t for government meddling in the credit rating market, this would never have happened:
The rating agencies were originally research firms. They were paid by those looking to buy bonds or make loans to a company. If a rating company did poorly it lost business. If it did poorly too often it went out of business.
Low and behold the SEC came along in 1975 and ruined a perfectly viable business construct by mandating that debt be rated by a Nationally Recognized Statistical Rating Organization (NRSRO). It originally named seven such rating companies but the number fluctuated between 5 and 7 over the years.
Establishment of the NRSRO did three things (all bad):
1) It made it extremely difficult to become “nationally recognized” as a rating agency when all debt had to be rated by someone who was already nationally recognized.
2) In effect it created a nice monopoly for those in the designated group.
3) It turned upside down the model of who had to pay. Previously debt buyers would go to the ratings companies to know what they were buying. The new model was issuers of debt had to pay to get it rated or they couldn’t sell it. Of course this led to shopping around to see who would give the debt the highest rating.
Government sponsorship of organizations and intervention into free markets always creates these kinds of problems. The cure is not an executive shuffle, third party verification or half-measures and more regulation that mask over the issues by splitting functions within an organization. The SEC created this problem by creating the NRSRO. The problem is easily fixable. It’s time to break up the cartel by eliminating the rules that created it. Moody’s, Fitch, and the S&P should have to sink or swim by the accuracy of their ratings just like everyone else. Ratings would be a lot better if corporations had to live or die by them. Free market competition, not additional regulation is the cure.
Mish Shedlock has it on point. This is not a problem of “market failure” or greedy businessmen. This is entirely a failure of government sticking it’s nose where it didn’t belong, upsetting a perfectly fine market mechanism. This is purely and simply government failure.
And now, 38 years later, instead of cleaning up its own mess, government is suing it’s own patsies. You can’t make this up.