The collapse of Worldcom and Enron revealed the reluctance of the credit rating agencies to make vital decisions to downgrade ratings given to booming assets. The inability of the agencies to inform investors of the risk in backing sub-prime collateral debt obligations was even more noticeable than the failings which led to the technology bubble at the beginning of the century. This negligence has led to many questioning the need for the agencies entirely; surely misleading asset valuation is worse than none at all? At least if investors knew they faced information asymmetries they could act accordingly. Empirically it has been demonstrated that ratings are often reactive to market prices rather than having a more logical effect of dictating them. The false sense of security an overrating can provide, prevents a greater level of market-led investor scrutiny that would otherwise prevail, this would at least be an effective solution in a world of perfectly obtainable information. The oligopoly enjoyed by Standard and Poor’s, Moody’s and Fitches however, have raised these companies’ profits, while lowering the level of service throughout the market. For some reason though, the consumer credit market is not plagued with these same issues; is it uncommon to receive a surprisingly high credit score but not to receive an unfairly low score, why? Not too long ago with no history of late payments on my credit report, I was refused a contract for a phone.. Why does such a disparity between the wild optimism for commercial and financial assessment and inhibitive prudence in the consumer risk assessment world exist?
This can be in part assigned to a form of the notion of regulatory capture. This can be described by the conflicting motives the ratings agencies are subjected to. This is a moral hazard, one particularly apparent in the anti-competitive oligopolistic market within which the ratings agencies operate. In mid 2007 as a direct consequence of the fervent popularity of collateralised debt, the agencies were in the midst of record success. Structured investment products were accredited for nearly half of these firms’ profits at the beginning of the sub-prime crisis. Encouraging vigilance upon their clients was not an option for these firms, this approach did not align with their own incentives; instead they told them what they wanted and expected to hear, what was making them money and what all the other agencies were saying. Furthermore, such is the mentality of the city clique, if one of the agencies was to have unilaterally stopped the madness of overrated debt they would have been disparaged by the rest of the city and operating against their own best interest. Only in an uncompetitive market place would it be in a firm’s best interest to destroy its longer term reputation: as long as all of them were together, bar a rejection of the agencies altogether, there would be no consequences. This kind of ‘race to the bottom,’ a mutually assured destruction of reputation, is one of the key negative effects to identify and combat with both unregulated markets and perhaps more pertinently to our context- badly regulated markets. With all the barriers to entry in this market place, there was no possibility of a start up agency bucking the trend and rejecting the ratings offered. The financial community fell victim to a variety of ‘agency capture,’ one only visible in an uncompetitive market place. Regulators, and ratings agencies too, have alliances to more than their just their own organisation, the factors leading to their decisions, governed by personal allegiances and sometimes future job prospects, never facilitated downgrades of the assets owned by SIVs. Without this same clout over my credit ratings, I am left to wonder where I went wrong and why I am still left with my pay as you go phone… If only Halifax had sold phone loans.