One important aspect of the financial crisis was the willingness of the credit rating agencies to rate complex derivative instruments as investment grade, even though they were filled with junk assets. The rating agencies had a motive to do this because they are paid by the companies whose issues they rate. Since they do not want to lose the business of a Citigroup or Goldman Sachs, they have a strong incentive to give overly positive ratings. The NYT notes that Congress seems unlikely to do anything about this basic conflict of interest in its regulatory reform bill. It would have been useful to note that this fundamental conflict could be easily eliminated, if Congress cared about it. It is only necessary to take away the hiring decision from the company whose issuers are being rated. If a third party, such as the stock exchange on which the company is listed, selected the rating agency, then the agency would have no incentive to bend its analysis. Its ability to get future business would not in any way be helped by bending its analysis. It is striking that it appears that Congress never seriously considered this simple measure.
--Dean Baker
