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Rating agencies are just the banker's attempt to solve the inescapable principal-agent problem given conditions of imperfect information (read: incentive to lie, even to yourself) by trying to establish an institutional wall between lenders and risk analysts by outsourcing to a pooled resource. It makes a lot of sense and is an improvement over what existed before
The problem isn't, in and of itself, that the credit rating is outsourced.
The problem is that the credit rating - which, like all risk analysis is inherently (partly) political suddenly gets treated like an objective fact simply by the invocation of an Our Standards Are Poor "AAA" rating.
In that respect, it makes less sense than keeping it in-house: As long as it is done in-house, everybody who has eyes to see with will realise that the risk analysis is at least partly a matter of political fiat. By outsourcing it to a third party, it becomes easier to convince yourself that the resulting rating is an objective fact.
Even if we take as read that performing the political process of risk evaluation in a different organisational entity gives you objectively better data quality (something that is not altogether self-evident), it is perfectly possible that this superior data quality comes at a price of less competent and cautious data processing. And the quality of a decision is limited by the worst of the data and the protocols that deal with the data.
But I may be biased by the fact that I prefer to work with data whose pedigree I know...
- Jake Friends come and go. Enemies accumulate.
Seems simple enough.
(Yeah, that would kill the entire securitisation market dead. That is a feature, not a bug.)
But due diligence is not what rating agencies do.
Well, that's quite clearly true.
Whether they should have been doing it is, hopefully, something that will be decided in the course of a fair an honest criminal trial.
Rating agencies are just supposed to predict the odds of default relative to alternative investments, assuming that what they've been informed about underlying collateral is true,
Then rating agencies are worth fuck all, if you'll excuse my French.
You need to see the underlying data to determine whether it is plausible. If the rating agencies are permitted to take the truth of the underlying data as read, then the investor still has to perform an independent analysis of the data. And once you're looking at the data yourself anyway, you might as well run the full battery of tests.
If you're an institutional investor then you should have that capability, unless the security in question is excessively complicated (in which case you don't want to buy it). If you're not an institutional investor, then you shouldn't be playing in the capital markets with money you can't afford to lose.
Institutional investors, on the other hand, should have the capability of analyzing the data before they buy anything, and most did.
Did have the capability, or did use the capability?
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