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Via Nick Baumann, McClatchy's Kevin Hall has written a blockbuster investigation into the rating agency Moody's. After the house market tanked in late 2007, Moody's starting firing analysts and executives in large numbers. Far from punishing those who didn't see the crash coming, however, the firm targeted those who saw the warning signs:
A McClatchy investigation has found that Moody's punished executives who questioned why the company was risking its reputation by putting its profits ahead of providing trustworthy ratings for investment offerings.Instead, Moody's promoted executives who headed its "structured finance" division, which assisted Wall Street in packaging loans into securities for sale to investors. It also stacked its compliance department with the people who awarded the highest ratings to pools of mortgages that soon were downgraded to junk. Such products have another name now: "toxic assets."The amount of detail and number of inside sources for the piece is fairly staggering, so be sure to read the whole thing. That said, the personnel angle can be fairly misleading here. After all, Moody's wasn't purging its Cassandras out of spite. It was doing so because disappointing the customer, by giving poor ratings to debt issuers, is pretty obviously bad business. Why would Moody's issue an honest B2 or B3 (that is, "junk") rating to a bond and risk upsetting the issuers who's paying for the rating, especially when Standard & Poor's or Fitch, its competitors, might offer that issuer a AAA?There is a fairly easy fix to this. As Hall notes, before the 1970s investors, not debt issuers, paid rating agencies. Given as those buying bonds are more interested in an honest assessment of their worth than bond issuers, this should result in less corrupted ratings. As Zach Carter noted in TAP earlier this year, the SEC could implement this change immediately by revoking or threatening to revoke the licenses of all rating agencies not paid by investors. An even simpler reform, proposed by our own Dean Baker, would be to have a neutral entity, for instance the bond-issuer's stock exchange, pick who rates a bond, while maintaining issuer payment. That way, the bond-issuer still has no influence over whether the rating agency is hired in the future, and the incentive for inflated ratings is removed without affecting the existing payment system.Sadly, the Obama administration's financial reform proposals only include modest rating agency reforms which do not change either the payer or the selector. If purges like the one at Moody's are to be prevented in the future, either Congress or the SEC has to get serious about banning bond-issuer selection and/or payment.--Dylan Matthews
