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Complicity In Crisis: Can We Trust Ratings Agencies?


Enforcing fiscal discipline is a key function of credit rating agencies. They're supposed to give an objective assessment of risk and a borrower's ability to repay loans. But the current world economic crisis has raised hard questions about the assessments made by the big three ratings firms - S&P, Moody's and Fitch - and charges that they've not only missed the onset of financial crisis, but helped fuel them with faulty judgments. Roben Farzad is senior writer for Bloomberg-Businessweek. He joins us from New York. Thanks so much for being with us.

ROBEN FARZAD: Oh, thank you, Scott.

SIMON: And please remind us what these credit rating agencies do, and why they have such influence.

FARZAD: Long and short of it is they tell you, the investor, the investing community, whether and entity is good or not for its money. That could be a government. That could be a company. But the problem is that the investment management community, the financial services industry, by and large, subcontracts a due-diligence to the big three rating agencies.

SIMON: And how do they miss stuff as big as the collapse of WorldCom or Enron or MF Global just a few weeks ago?

FARZAD: You know, every time, they tell you we rolled up our sleeves and we gave it a good honest try. But they've had critics time and again that have said that's not the case because how many times can you get it wrong? If it wasn't subprime and the great financial crisis of '08, then it was Enron. It was WorldCom. It was the telecom stock bubble. Before that, it was the bankruptcy of Orange County. New York very nearly went bankrupt in the mid '70s.

They got that wrong. And to their credit, they've come back every time when Congress has dragged them forward and said, you know what? This is our constitutional protected editorial opinion. We were not, in fact, making a buy or sell judgment, we were just telling you what we think. So, caveat emptor.

SIMON: Well, and so what should small emptors do? Like small investors?

FARZAD: That's why this is so problematic because small investors, even small mutual fund companies or big mutual fund companies do not have the ability - look at the case of the subprime mortgage crisis - to go in and actually take apart a security that might have tens of thousands of individual mortgages in them, do spot checks and make sure that these people didn't lie on their loans. You largely have to take it all on good faith. Everything, when you step back from this, Washington, every time, swears that it's going to be the last time that we get kind of bamboozled by the ratings agencies.

But the reform is vexingly difficult. You have...

SIMON: Explain that to us because there have been so many proposals, obviously.

FARZAD: There are lots of platitudes thrown at this idea of we need more competition. We need upstarts, the honest hungry smaller qualitative firms that are willing to do this shoe leather research to come out and fight this triopoly of the ratings agencies. The problem with that is that you have governments and financial institutions that are restricted in their charters from only being able to buy investment grade securities. And there's a circularity. Who can rate these investment grade securities? Well, it has to be the big three.

And so there is this idea - people coming to terms with it - that it is increasingly going to be business as usual with the big three ratings agencies. And they live to see another boom and bust.

SIMON: So in the case of a situation like Greece and the Eurozone crisis, the ratings agencies failed to predict the apparent or eminent financial collapse of Greece and yet, Greece will not be able to proclaim that they have made a recovery until they satisfy the financial agencies that they have.

FARZAD: Yes. And this has since moved on from Greece. We're talking about Portugal, Italy, Spain; countries, economies, that in real time are seeing their borrowing costs spike in no small part due to what the ratings agencies say. I mean, these securities get bought and sold on the basis of a stamp that's given to them by the big three ratings agencies. And that's largely been unhindered.

SIMON: Roben Farzad, senior writer for Bloomberg-Businessweek, speaking from New York. Thanks so much.

FARZAD: Thank you, Scott. Transcript provided by NPR, Copyright NPR.