Remember the SEC? That's the Securities and Exchange Commission that was set up after the last great depression in the 1930's to protect American markets from shysters and shenannigans in financial markets. Over time they've gotten quite cozy with those they're supposed to regulate. They completely missed the run up to the S&L crisis in the 70's, and even specific, direct, and repeated warnings to the agency about irregularities at Bernie Madoff's investment company were looked into and dropped. Bernie had the gaul to tell them he was on the short list to be new head of the SEC. I'll bet that got them tip-toeing around! The agency had become useless, decadent, and moribund. They're either too easily intimidated by the boardrooms, cufflinks and tassel loafers worn by those they are supposed to regulate, or they just don't care. Either way, the SEC has become an embarrassment and should be quietly dismantled.
Well, guess what! The SEC is now issuing new regulations affecting, of all industries, the major credit rating agencies-- Standard & Poor's, Moody's, Fitch. Those are the companies that supposedly carefully audit and rate the creditworthiness of companies and publish their findings, either for free, by subscription, or for a fee, for others to use in asessing the risk of doing business with them. The idea is if a company is well run, has stable prospects, and plays by the rules, they'll be rated as such-- getting a "Moody's Triple-A" rating-- and more success will ensue. One way their ratings are used is by other companies assessing the quality of their debt.
Some people noticed, though it never became a public issue of any newsworthiness, that all of the major ratings agencies had applied very high ratings to several large, successful, well-heeled companies back in 2007 and previously. Those companies with gilt-edge, super high ratings from all the agencies, included Lehman Brothers, Bear-Stearns, AIG Insurance, Washington Mutual, and others, which have subsequently failed in a dramatic way. Obviously the credit rating agencies got it wrong with them! But there's another problem, which is that many companies, heeding the ill-got good ratings, lent these companies money by buying their commercial paper, and those companies were, in turn, being rated by the ratings companies.
Now picture a scenario, when the Moody's auditors come to assess your company, and they find you have a significant portion of your assets in the form of commercial notes from Lehman Brothers. They look up their rating (never lower than double-A), and assign your company thereby a double-A rating as well. Now add to that the fact that all of these rating agencies also buy and sell commercial paper for others, whose value hinges on their rating. They're also paid all around-- by the companies they rate, and by the companies who use their ratings. It's in everyone's interest to make sure the rating of the notes being bought and sold stays high! Keeping Bear-Stearns paper at AAA means everyone who holds their debt is also rated highly. Everyone is stuffing piles of money into their own and each others pockets as fast as they can! Triple-A means it's pay day!
Then comes the end of 2007, and all of these artificially high credit ratings came unmasked as it were. Bear Stearns fell. Lehman brothers fell. AIG was bailed out by the taxpayers so they could pay losses that would otherwise be incurred by Goldman-Sachs. Hundreds of billions of dollars in commercial equity value evaporated overnight. Overseas banks and even whole economies teetered. Your 401K and your stock portfolio (or those of your employer) lost tremendous value-- basically the difference between their artificially inflated market value as assigned and propped up by Moody's and S&P, and their actual value.
An interesting note is how little backlash there was for the ratings industry. Ho, hum. They're still rating companies (AIG is back down a bit below AA). Well now the SEC, that loyal and effective federal watchdog has decided something needs to be done to make the ratings more effective and trustworthy. So they've issued some new rules, requiring among other things that the agencies show the history of their ratings. I assume this is so people can compare their ratings over time to what actually transpired. That may be a good idea, but it does seem a bit too little too late. Let's close the SEC which has repeatedly failed to carry out their mandate, and allow the corrupt and incestuous Ratings Companies twist in the wind of the financial tornado to which they contributed. No one should attach any value to the opinion of a company who rated Lehman Brothers AAA the day before they disappeared. They failed it, spectacularly. Let's move on.
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