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What’s in a AAA-rating, anyway? Nathaniel Popper writes in Dealbook that Standard & Poor’s, the nation’s largest ratings agency, is winning major business by giving out higher ratings than its rivals on commercial mortgage-backed securities. This is, indeed, the same company currently being sued by the government for defrauding investors by intentionally applying inaccurate ratings to mortgage-backed securities.
The ratings agencies have an incentive to artificially inflate ratings because many investors, like pension funds, foundations, and endowments, can only invest in securities with an investment-grade rating. The banks that issue the securities also hire the ratings agencies, thus top-flight ratings that help the banks easily sell the securities lead to more business for the likes of S&P.
Furthermore, all of the agencies — S&P, Moody’s Investors Service, and Fitch Ratings — compete against each other to rate the same bond issuances. “Imagine the pharmaceutical industry having six FDAs, all competing to approve drugs. Everyone would be dead,” Rob Dobilas, who founded rating agency Realpoint LLC, told Bloomberg back in May.
Matt Levine, however, questions whether S&P adjusting their ratings upwards necessarily means it intended to drum up extra business. Theoretically, S&P was just trying to make its ratings more like the ratings of its peers:
If you’re more lenient than your competition, and adjust to be in-line, everyone’s more or less fine with that, but if you’re stricter than your competition, and adjust to be in-line, everyone’s all “you’re lowering standards to win business because you’re corrupt!,” which is just a category mistake, that’s not a corruption in the ratings agency business, that is the ratings agency business.
S&P sent a letter to the editor of the New York Times, charging that the article misrepresented the difference between S&P’s ratings and those of its competitors, which Quartz received in an email. The agency writes that “based on the dollar value of the transactions cited by The Times, 97% of the CMBS S&P has rated since changing its methodology were rated the same as or lower than other rating agencies”.
On to today’s links: