Seems like a conflict of interest to me. In an capitalist economy I think third-party, objective ratings agencies would spring up and outcompete Moody's, Standard & Poors, Fitch, etc. What do you think?
Not only does this appear to be at high risk of conflict of interest but it is a very real means of encouraging fraud and cheating. Because of this and because of somewhat poor correlation between ratings and performance, I tend to ignore all such ratings when making investment decisions,. Even worse as a source of advice are the equity raters and consultants. These either perform as lemmings (following whoever steps out in front) or seem to recommend those companies for which increased equity sales will lead to improvement in their own portfolios.
answered Dec 19 '10 at 10:47
The short answer is: I think this question could be improper in the way that it is phrased.
Long answer: This seems to be something of a moral and a legal question which could be asked more exactly as "should a rating agency be allowed to be paid by the banks being rated by said agency."
To this, I would say "yes". On a free market, there are no regulations that pertain to contributions to rating agencies. Independent rating agencies are free to accept contributions from any institution it wants.
However, the market demands justice in this matter as well. Would consumers trust rating agencies that did not disclose all of their contributions or received contributions that created a conflict of interest? I don't think so. I think consumers would demand objectivity in ratings. Who would expose such scandals, if they ever existed? Journalists and the news media who made it their goal to report such activities, that's who.
I think as a practical matter, and a matter of integrity, rating agencies would want to remain free of financial entanglements with the banks they were rating. There would be no benefit to the agency to accept money from the banks they rate. Rating agencies would be like any other business in a free market. They would have to be long-range and would not want to jeopardize their business by ruining their reputation.
Any rating agency that was found to be giving false or misleading ratings would likely be immediately ostracized in society and would lose all reputable sources of funding (funding not connected to the institutions that the rating agency was supposed to be rating objectively). Even the institutions bribing the rating agency would likely bail on the rating agency, since the rating agency's rating would be worthless to the company after the scandal broke.
answered Dec 23 '10 at 23:12
David Lewis ♦