Apropos of thoughts about a potential US ratings downgrade, my colleague Steve Grenville had a nice piece in Monday's AFR looking at the ratings agencies. He lists many of the problems with current arrangements – ratings tend to be a lagging rather than leading indicator, they encourage investor herding, there are significant incentive issues and potential conflicts of interest – but also notes that the search for alternatives has not been particularly fruitful.
Steve reckons that one solution might be to rate the raters – that is, for an independent institution to provide a public assessment of the agencies' own ratings record, and so encourage investors to be more discriminating in following the ratings agencies' decisions.
While that seems like a sensible approach, would it be enough to encourage the agencies to try to distinguish themselves from one another by injecting more diversity into their ratings, or would we still see the same kind of group-think they are currently sometimes accused of?
It may be that the structure of the ratings market – where just three agencies account for more than 90% of all ratings – turns out to be an important constraint here. If so, then another important part of the reform process might be figuring out how to inject more competition into the market for ratings by encouraging new entrants or otherwise breaking down the existing oligopolistic market structure.
Alternatively, it might be that ratings by their nature are doomed to be nothing more than lagging indicators of changing creditworthiness that only amplify market cycles. If so, perhaps the best we can hope for is to downplay their significance by reducing our reliance on them.
Photo by Flickr user Gabriel Madrigal Photography.
