Bright Lights Project – Standard & Poor's Rating Services

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Standard & Poor’s is one of three major American rating agencies (Fitch Ratings and Moody’s Investor Services are the others). They’re in the business of assessing risk of various financial instruments and the reliability of the companies and governments that issue or trade them, and their ratings affect both investor interest and the prices paid for said financial paper.

Last week S&P lowered the rating of France and Austria by a notch, just like it did to the US last year. It reduced the ratings of seven other European countries by two ticks.

I can’t believe the world didn’t laugh out loud.

To say that the ratings these agencies produce are vague, biased, and regularly incorrect business would be an understatement. Remember, these are the folks who were as surprised as the rest of us by the mortgage meltdown. They rely on the companies they monitor for their funding, which would be at least a slight hint of conflict of interest in any other industry. The ratings schemes themselves are so complicated and nuanced that they make the government’s Threat Level rankings a paragon of clarity, which allows them to claim retroactively that they noted things, they sort of, kind of.

S&P and their ilk are foxes guarding the hen house, at best, and inmates running the asylum more like it. The only reason anybody gives them any credence is that they assume everybody else does. It’s a giant house of cards. OK, enough of the cliches. You get my point.

The ratings moves last week tell us nothing new or important, but rather reflect the fact that those European countries have been making bad governance decisions for, oh, more than a decade. It’s like S&P announced that the US just landed astronauts on the Moon.

Ratings agencies are an artifact of a distant past when we gave authority to opaque institutions and couldn’t see or track what they did with our trust. Only now we can see…all too clearly. In my inexpert opinion the days of S&P and the others are numbered. Disagree? Who’d yourather trust: A ratings agency in bed with the company it rates via secret processes and incomprehensible code words, or a handful of inspired twentysomethings armed with an Internet connection and the mandate to discover wrongdoing or patterns of concern?

S&P needs to discover new sources of credibility that warrant our trust, and it’s not impossible to do. Here are three thought-starters:

  • Become Truly Neutral — It will never be credible for ratings agencies to rate companies that in any way contribute to them financially, even indirectly. Full stop. Maybe they each contribute funds to create an endowment that is henceforth independent of their slightest influence? I know there are probably a zillion arguments why financial institutions would never do it, but that should be a not-so subtle hint that it’s EXACTLY why they need to do something like it. I’m sure there are other funding models that would get to the same outcome.
  • Simplify The Metrics — I’m sorry, but I can’t fathom the difference between a rating of “AAA” and “AAA-,” and I’d bet good money that nobody else can, either. It’s just that a routine has built up around such nonsense so there’s a dollar figure attached to each incremental change. But that is derivative measure; it doesn’t tell us anything substantive or original about the underlying financial tool. Why not figure out how to risk being somewhat or wholly right or wrong on analyses sometimes instead of being always right and wrong at the same time?
  • Embrace Transparency — Ultimately it’s not the ratings themselves that possess any authority or credibility but the way the agencies get to them. So why not figure out how to involve as many inputs into the methodologies as possible — from the specifically qualified, like expert analyses, to the crowdsourced trolling that the rest of us do online — and then publish it? The proprietary value would be in S&P’s ability to pull it off, not dream up the list.

I am regularly dumbfounded that the financial services industry keeps getting away with propagating nonsense to the world and the world pretty much takes it at face value. The problem is that much of it, and these ratings in particular, possess no real value at all. S&P could change the game if it wanted, but I guess it sees no reason to. Maybe it has assessed its own business using the same brilliant tools is used to discover that those European countries weren’t worth what they claimed.

Stay tuned. I’d expect the ratings agencies to announce shortly that the stock market crashed in 2000.

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