Just like so-called “amateurism” in college athletics, the “unbiased, mere opinions” bestowed by credit rating agencies are largely a façade.
Often what we say is different from what we do. Day-to-day life provides us plenty of examples: “amateurism” in college athletics, the “reality” of reality shows, and Fox News’ “unbiased” political coverage being just a few that come to mind. Yesterday, Second Circuit U.S. Court of Appeals Judge Reena Raggi fell victim to a lesser-known fallacy: the “mere opinions” of the credit rating agencies (CRAs).
In her decision handed down yesterday, Judge Raggi gave rating agencies such as Moody’s and Standard & Poor’s a huge victory. She did so by agreeing with the agencies that they offer “mere opinions” on the solvency of an institution’s debt. Hmmm… So Moody’s is no different than “Consumer Reports" or Zagat’s? Who knew?
Just like so-called “amateurism” in college athletics, the “unbiased, mere opinions” bestowed by CRAs are largely a façade. Debt-issuers pay these agencies to rate their creditworthiness (yes, you read that right—they are paid by the very same people that they supposedly objectively rate); the interest rate on any debt is intimately tied to this rating. In other words, the securities market could not function without these CRAs.
Do you think Fannie Mae would have enthusiastically paid Moody’s to rate its credit if Moody’s raters had thoroughly investigated the bundles of subprime debt amassed by Fannie? Hey Fannie, thanks for the payment, but we’ve determined that without Federal Government takeover you will be unable to repay your loans… Here’s your D rating. What’s more: the ratings agencies are integral to the proper functionality of the market. Without ratings there would be next-to-nothing on which to assume risk or base interest rates.
Although credit rating agencies serve as de facto underwriters for the debt instruments they rate, Judge Raggi relies upon the 2nd Circuit Decision in SEC v. Kern to distinguish their conduct from “those who take ‘steps necessary to the distribution’ of securities”. That "distinction" is a complete fiction. Of course CRAs are necessary to the markets. Indeed, without them there would be no debt market.
Forget the law? How convenient. Chalk up another one (on an ever-growing chalkboard) for big business and the financial industry. Don’t blink, next thing you know “insider trading” may well be regarded as a proper mechanism for distributing risk.
Assisted by David Martin