Built-in Upward Bias at Rating Agencies

Moody's, Stupid or Greedy, Flip-Flops on Banks: Mark Gilbert

Someone has gone to the trouble of producing mini-videos mocking the situation and posting them on the Internet. ``I let you out of my sight for 10 seconds and you give out AAA to the Icelanders,'' says a guy in a turban. ``You were just meant to boost fees and get more CDO business.''

There's more than a grain of truth in that little jest about collateralized debt obligations, known as CDOs. On March 13, for example, Moody's shares dropped as much as 6.5 percent on concern the rise in subprime mortgage defaults would crimp the market for new CDOs, hurting fee income for rating companies. Shares of McGraw-Hill Cos., the owner of Standard & Poor's, declined by as much as 2.7 percent.

Pay to Play

The rating companies are scrapping for market share in a business with a built-in bias. Anyone who makes and sells bonds for a living will pay whichever rating company is likely to give their products the highest grade.

So the intellectual honesty of delivering a true assessment of creditworthiness conflicts with the commercial imperative to win business. And whenever one of the rating companies tweaks its methodology, it always seems to result in higher grades, never lower assessments.

Posted on March 18, 2007 and filed under Finance.