05/29/2009 05:12 am ET | Updated May 25, 2011

Credit Rating Agency Scandals Ignored by US

Where's the sheriff for these guys?

Credit rating agencies contributed to the current economic collapse. They were paid fees by banks who sometimes pressured or shopped around for the most favorable risk assessments, an obvious conflict of interest.

Despite the culpability, nothing much has been done about these intermediaries. The credit rating issue has been mostly ignored by the G20, politicians and regulators. Reforms are still being debated even though they should have been implemented long ago.

Business leaders are perplexed about this vacuum of accountability and two were outspoken about this issue at a recent World Economic Forum conference in Rio de Janeiro.

"The problem we had was the rating agencies like Moody's had been paid by the banks to rate these pieces of paper and the banks let it be known they would shop until they got the right rating. The banks fooled themselves," said Jim Goodnight, founder and CEO of SAS, a leading business analytics software provider.

Lord Levene, Chair of insurance giant Lloyds of London asked: "Enron was rated Triple A just weeks before it went bust, so why didn't we learn from that and do something? Their business model was strange: If you have a target rated, who pays for the rating? The target does. That's a conflict of interest and I'm surprised the G20 didn't deal with that."

Perhaps nothing has been done because the same regulators who missed the Enron and tech bubble missed this credit bubble. Perhaps nothing much has been done because of the inordinate political and media clout (and co-ownership) enjoyed by credit rating agencies such as Moody's, Standard & Poor's, and others.

Since the nightmare began in August 2007 with poorly-rated asset-backed paper, Washington has been looking at the inherent conflicts, and other malpractices, among these agencies.

Suggested reforms should have already been put in place and here are some put forward by the Association for Financial Professionals.

-- Credit rating agencies should be stand-alone businesses where their only business would be to produce credible and reliable ratings. They should be financed by a transaction fee, not advice fee.

-- Governments should support competing rating organizations and require two or more opinions on ratings so that there is competition beyond the two main players, Moody's and Standard & Poor's.

The Association has 16,000 members who manage and safeguard the financial assets of more than 5,000 U.S. organizations. Its spokesman, Jim Kaitz testified in Washington this month.
"The current rating agency processes and business model are broken," he said. "The big two rating agencies were a catalyst for the sub-prime debacle and resulting financial meltdown. The time has come for a fundamental overhaul of the system to restore investor confidence and reestablish efficient global capital markets."

The Association told the SEC its members believe that information provided by credit rating agencies has been neither timely nor accurate; that they are serving parties other than investors; and that the SEC should monitor their activities and encourage competition.

Despite evidence and pressure, the SEC said last week that new regulations could take months to put in place even though the agencies issued top ratings for investments - notably sub-prime junk - that have plummeted in value.

What was dropped was a number of modest reforms as well as a major proposal requiring ratings agencies to publish all underlying information they used in making their ratings.

Fixing these intermediaries is essential avoid future crises.

Diane Francis blog