Paul Krugman on the ratings agencies

In my role as Chair of NZCU South, I have recently been a participant in a credit rating process conducted by Standard and Poors on our credit union.  We ended up with a respectable BB rating.

Forced on us by recent government regulation, it was an interesting process.  I will spare you my grief over a small $100m South Island financial cooperative being forced to spend members’ equity on an expensive international credit ratings regime.  What I will say is that I was pleased to see Standard and Poors working to a clear and unambiguous assessment framework as they worked through the process with us.

Sadly, a recent New York Times column by Nobel Prize-winning economist Paul Krugman suggests that this has not always the case with ratings agencies.  Krugman points to the fact that:

…of AAA-rated subprime-mortgage-backed securities issued in 2006, 93 percent — 93 percent! — have now been downgraded to junk status.

His column cites rating agency emails uncovered in the US Senate’s Permanent Subcommittee on Investigations.  These show clear conflicts of interest in ratings agency work.  Wall Street firms would:

…direct their business to whichever agency was most likely to give a favorable verdict, and threaten to pull business from an agency that tried too hard to do its job.

Krugman briefly considers what can be done to avoid the same scenario developing again, though without coming up with a firm recommendation.  Read his column on the New York Times site here.