Mysak Plays Devil's Advocate for Rating Agencies

In "Lets All Blame The Rating Companies For Everything" Joe Mysak wonders why every man and his dog has got in for the Moody's and the S&P's. He says investors should accept responsibility for their decisions.

After all, Mysak points out, while we call them "agencies" they are really companies:

"The implication, then, when we hear the term ``rating agency'' is that these are somehow governmental, or quasi- governmental, organizations that must put their seal of approval on the issuers of securities, and on the securities themselves. They are, in some vague and mystical way, ``official,'' sort of like your state's motor vehicles agency.

Of course, nothing is further from the truth. Moody's, Standard & Poor's and Fitch are all private companies that sell their services."

Read more here

Unfortunately Mysak stops short of pointing out to whom. Rating agencies sell their services to investment banks - the guys issuing asset backed securities.

Subprime mortgage backed securities, which were given an investment grade rating by rating agencies, have gone out of favor after an unexpectedly high rate of defaults.

People lost a lot of money because these "private companies" gave subprime MBS the same risk rating as corporate bonds. Clearly something went wrong.

Jesse Eisinger's piece "Overrated", in the September issue Conde Nast's Portfolio, explains this problem in detail. Read it here

Mysak argues that investors put too much trust into rating agencies because the word "agency" inspires misplaced trust.

The problem is, the rating agency business model is inherently flawed.

Eisinger explains that in the past, "Investors bought a subscription to receive the ratings, which they used to make decisions. That changed in the 1970s, when the agencies’ opinions were deemed a 'public good.' The Securities and Exchange Commission codified the agencies’ status as self-regulatory entities."

This forced the rating agencies to change their business model from collecting subscriptions from investors to charging issuers for ratings.

The mismanagement of this conflict of interest is what lands rating agencies splat bang in the middle of the subprime fiasco.

If Mysak is playing devil's advocate, his clients have left more than Angels weeping.